A client recently approached us with a question regarding the purchase of a second property. They were wondering whether it would be better to liquidate their investments to raise the needed funds or take out a mortgage. While there are always non-financial factors to consider when contemplating whether to borrow or self-fund (for example, a person's comfort level with debt or concern over losing the income stream from the liquidated investments), the financial repercussions can be modeled to provide a good indication as to which option will leave you better off in the long run.

Laura Johnston, our resident Certified Financial Planner, had an initial conversation with the client where she gathered the details of the purchase. The client, who is in their late 60s, was looking to buy a $600,000.00 property and had sufficient investment assets to cover the cost outright if needed. Alternatively, they could borrow funds at a 2.45% five-year fixed mortgage rate. Using this information, Laura was able to provide two sets of projections for the client: one showing the possible outcome if the client were to liquidate their investments and one showing the result of borrowing the funds. We have included both sets of projections below so you can see how it worked out.

Scenario 1: Borrow the money to purchase a property

In this scenario, the client elects to borrow the majority of the purchase price of the property, taking only a 20% down payment out of their non-registered investment account. As you can see from the table below, this client has a variety of investment vehicles, including RRSPs, TFSAs, non-registered (or not tax sheltered) accounts and corporate holdings. The down payment would come from the non-registered investment account and the mortgage would be amortized over 25 years.

Assumptions

Purchase price: $600,000.00

Down payment: $120,000.00 (Drawn from the client's non-registered investment account)

Borrowed amount: $480,000.00

5-year fixed mortgage rate: 2.45%

Amortization: 25 years

Monthly mortgage payment: $2,138.00

Expected rate of return on investment holdings: 5%

Using these assumptions, we would expect that the client would have a net worth at age 90 of $3,735,765.00.

Scenario 2: Withdraw the money from investments to purchase a property

In this scenario, the client is withdrawing funds from both their personal and corporate non-registered accounts, as well as their TFSA. While this does eliminate the need to borrow, it puts the client's asset base at a lower level for long-term growth. The question becomes, does the benefit of not having to pay interest on the mortgage in scenario two outweigh the growth in the higher investment base from scenario one?

Assumptions:

Purchase price: $600,000.00

Expected rate of return on investment holdings: 5%

Using these assumptions, we would expect that Ms. Smith would have a net worth at age 90 of $3,645,081.00.

Conclusion

Having run both sets of projections, we can see that the client can expect a higher net worth at age 90 if they choose to borrow the funds for their second property as opposed to funding the purchase entirely from investments. Using this information, the client was able to determine whether they were comfortable taking on long-term debt, or if they preferred to stay mortgage free while accepting that it might leave them with a lower net worth down the road.

While this report addressed the client's immediate questions, it also highlighted a few other areas for planning that the client could consider. We will look at those in our next post. In the meantime, if you would like to know more about our financial planning offering, don't hesitate to reach out to any one of us for more details.