Using A Margin Loan To Help Finance A Down Payment

Are you looking to buy a house and currently have a large investment portfolio? Do you want to finance the house down payment without liquidating your investment portfolio or are looking to take on more loan risk than the bank is willing to provide? Maybe taking out an alternative loan alongside your mortgage is for you. You can even deduct the interest on the loan if you do your accounting correctly effectively reducing the loan interest by your marginal tax rate. 

Words of Caution

I’m not a certified accountant or tax expert and haven’t run this strategy by one yet so before applying it make sure you check in with a professional first (I certainly will).

Deducting Loan Interest

Loan interest in Canada is tax deductible if the loan is used to purchase an income producing asset. Income producing assets are things like investing in personal businesses, buying dividend producing stocks and bonds, investment properties, etc. 

Buying a house to live in is unfortunately not an income producing asset (though any proportion of the home used for income producing purposes like a rental suite can be deducted from the loan accordingly). However, by reframing the accounting situation a bit differently, you can instead think of the situation as funding a margin account using a portion of the cash you have available in your savings and purchasing stocks on margin to bring your portfolio exposure up to where it would be had you transferred the additional funds from your savings account. You can then show the CRA your statements showing the stock purchased on margin as proof of using it for income producing purposes. The remaining cash in your savings account is now available to be used for a down payment.

The premise is demonstrated in the example below:

  1. You have a TFSA with 100k invested in stocks.
  2. You sell the 100k shares in your TFSA (tax free) and withdraw the balance to your savings account
  3. You calculate that you are comfortable withdrawing 33% of your portfolio as a margin loan (putting you at 1.5x leverage in the margin account)
  4. Rather than transferring the full 100k to the margin account to buy 100k of stock and then withdrawing 33k as a margin loan, you transfer 100k less the amount you eventually plan to withdraw as a margin loan (in this case 100k - 33k = 67k)
  5. In your margin account with 67k cash, you purchase 100k of stocks (33k on margin ). the statement of this purchase can be used to demonstrate the loan being used for income producing purposes.
  6. You now have a margin account with 67k cash and a 100k stock position (33k loaned on margin), and a savings account with 33k in it that can now be used for a down payment.

A similar strategy can be applied using any type of loan or line of credit.

Types of Loans

There are various options available to you to increase your down payment using a loan or line of credit

Unsecured Line of Credit

While convenient, unfortunately unsecured lines of credit command relatively high interest rates ranging from prime +2% to prime +5% for typical lines of credit (potentially lower for professional lines of credit, but those are only extended to highly paid individuals like doctors). It may also be more difficult to justify deducting the interest on a line of credit if you can’t easily show that the loan was used for income producing purposes.

Margin Loan

The better option appears to be to use a margin loan. In essence, a margin loan is a loan that uses an investment portfolio as collateral. Interest rates tend to be lower than alternative loan products (Interactive Brokers currently offers prime - 1%), as the presence of the portfolio provides the lender with the ability to margin call if the balance in the account falls too low for the given investment products. After a margin call, some brokers will provide the portfolio owner with the opportunity to add additional cash to the account to avoid shares being sold. Other times, brokers command the ability to immediately sell shares as required to cover any shortfall in the account. Interactive Broker follows the latter approach, with the trade-off for that risk being the lower interest rates than other brokers who allow more flexibility.

Typically margin accounts and margin loans are used to achieve leveraged investing positions, but they can also be treated similarly to any other loan with the benefit of lower interest rates.

Problems may arise if you already own the stocks you want to use as collateral in a margin account since you won’t be able to show stock purchases following the withdrawal on margin which would make it difficult to prove to the CRA that the money was used for income producing purposes. You may be able to sell and re-purchase the shares in the margin account (or sell and open a new margin account to purchase the shares) but this could trigger a capital gain and a large tax bill which could easily outweigh any benefits of the strategy.

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