Garth Turner Column

 

July 16, 2001

 

You bet there is. It's debt you never want to repay because it's of such benefit keeping it in place. This is the case with a home equity loan, described in last week's column. To recap, a HELOC (home equity line of credit, as you will hear many financial advisors call it) is a loan taken against the wealth you have accumulated within your residential real estate.

 

ear after year you have faithfully made all those mortgage payments, and with each one a little more equity has been shoved to your side of the balance sheet. For many folks, they reach their forties or fifties and suddenly have the bulk of their net worth tied up in a single asset - their homes. To me, this is a dangerous, unstable and dumb situation to maintain.

 

And while there are legions of media wimps who disagree with me and who cling to the notion that a physical asset like a home is a safe place to keep your wealth, I remain steadfast in the opposite belief. Real estate values have generally held over the last five years in most markets, because of a relatively strong economy, and over the next five years this will likely remain the case. But contained in the very reason housing will retain its value in the short term are the seeds of its eventual decline, and that is the aging of the population.

 

Canada has the biggest crop of Baby Boomers in the world - a legion of nine million people just entering their peak income years, who have been raised their entire lives as real estate Believers. They watched their parents grow wealth primarily through the appreciation of residential real estate values, as did I.

 

So today, enough of these generally-affluent Boomer children are moving up into trophy homes to influence the entire market. It's the B-generation's last hurrah, after moving real estate values sharply higher in the 1980s, when they were forming families.

 

Ten years from now the average Boomer will be sixty years old and downsizing. Those big houses, especially in the suburbs, could be falling in value as demand disappears. More in favour will be smaller bungalows, townhomes and condos in near-city locations, recreational property and adult communities on golf courses.

 

The second reason I want you to sell that big house is inflation. It's dead, gone and buried. The core inflation rate in Canada is well within the 1% to 3% range set by the Bank of Canada, even despite frequent surges in the cost of energy. As technology races along, fueling productivity and dropping costs, inflation will be the last thing on economists' minds. Instead, they will be struggling with the notion of dealing with deflation, when prices (and wages) are falling, rather than rising. Check out recent trends in the prices of cars, computers and every other electronic device. The thousands I paid for a laser printer for my computer in 1999 today have turned into mere hundreds. The printer is a doorstop. It deflated to nothing. I thought of that the other day as I walked down Bay Street and saw some video monitors and an electronic typewriter sitting on the curb amid garbage bags.

 

For my parents, inflation was good. My father's salary (and the pension based upon it) went up every year. The value of their home rose relentlessly, as did their net worth. It was a great outcome in retirement - indexed pension and cash from the sale of a house that tripled in price every half-decade. But those days are vanishing quickly, and as demand for large homes dies up, there will be no environment of generally rising prices to sustain the value of the asset.

 

So, think hard about whether you want to keep your equity in your home, or get it out now, while real estate is still a viable commodity. Think hard about the long-term wisdom of a home equity loan, which I consider to be good debt.

 

If you borrow to invest in growth assets, like stocks or mutual funds, the interest is tax-deductible. You get a significant tax break at the same time your equity is put into things that will mushroom in value over the coming years. So, how do you cope with the cash flow demands of having a home equity loan in place? After all, you need to make interest-only monthly payments.

 

Systematic withdrawal plan

 

The answer is a SWP (pronounced swip), or systematic withdrawal plan. With the help of a financial advisor, do the following: Arrange a home equity loan in the form of a line of credit, with interest-only monthly payments (you should avoid taking this money in the form of a mortgage, with blended payments of both interest and principal). Your payments are now entirely deductible from taxable income, so long as you put the money in the right place.

 

So, use the funds to buy units in equity mutual funds. (Some people feel more comfortable with segregated funds, since they want a guarantee there will never be a loss - however higher fees will impair fund performance.)

 

Have your advisor set up a SWP, which means enough money can be taken from the fund on a systematic, monthly basis to cover off the interest-only payment on the home equity loan. Now the mutual fund is actually making the loan payments, rather than you. But every year when you fill out your tax return, the interest is deductible in your hands!

 

Held long enough (a minimum of five years), the mutual fund should give you substantial capital growth, despite the fact you have removed money through the SWP to cover all financing charges. It's a win-win situation: the HELOC is good debt and the SWP is a great way to finance it.

 

But, what if you borrow against your home, and buy mutual funds that decline in value?

 

This is a question the media wimps often toss out, but without much validity. Unless history is absolutely no guide, mutual funds based on the performance of companies which are part of the economy increase in value over the long haul. Of course, there are years when markets decline, but they are far outnumbered by years of gains.

 

So you may well buy assets with a HELOC than temporarily fall in value. But because your loan is secured by the value of your home, and not the value of the funds you buy, there will never be a margin call to make up the shortfall (as is the case with borrowing money to buy stocks from a broker). Meanwhile, of course, you continue to write the interest on the loan off your taxable income, for a net benefit.

 

Finally, you will never take a loss on funds that have gone down in value unless you take the wrong advice, and sell. The proper strategy is to wait out any market correction and ignore the wimps who confuse short-term events with long-term trends. They know not what they do.

 

Watch Garth Turner's Investment Television, Sundays at 1 pm on Global. www.garth.ca.

 

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