You don’t have to be an expert to invest, but if you want to invest using leverage, some advanced knowledge is required. This week I sat down with Money Mechanic to discuss how he and his wife invest with leverage to get ahead financially. For the unfamiliar, Money Mechanic is the host of two Canadian personal finance podcasts, FI Garage and Explore FI Canada. He’s a helicopter mechanic by trade but an investor at heart. He loves talking about anything money and is passionate about teaching Canadians how to achieve financial independence. 

 

Welcome to the Maple Money Show, the podcast that helps Canadians improve their personal finances to create lasting financial freedom. This episode of the Maple Money Show is brought to you by Willful. Did you know that 57 percent of Canadian adults don’t have a will? Willful has made it more affordable, convenient and easy for Canadians to create a legal will and power of attorney documents online from the comfort of home. In less than 20 minutes, and for a fraction of the price of visiting a lawyer, you can gain peace of mind knowing you’ve put a plan in place to protect your children, pets and loved ones in the event of an emergency. Get started for free at maplemoney.com/willful and use promo code Maple Money to save 15 percent. Now, let’s chat with Money Mechanic… 

 

Tom: Hi, Money Mechanic. Welcome to the Maple Money Show. 

 

Money Mechanic: Hey, Tom, thanks so much for having me on the show. I’ve been a fan for quite a long time and it’s a real pleasure to be here with you today. 

 

Tom: Well, thanks for being on. I’ve been a fan of you guys, too, at FI Garage. What I wanted to have you on for is just to discuss your use of leverage. It’s something that seems a little a little taboo. People don’t want to dive into leverage all the time. Maybe they’re not seeing both sides of it. Can you just start us off with what leverage is, in your mind? What’s your definition? 

 

Money Mechanic: I think you’re right. It is a bit of a taboo subject. Some people are totally for it and some people are totally against it. I think we even have this discussion within the Canadian personal finance community. We all have different opinions of it. For me specifically, I think of leverage as leverage I’ve built up through equity that I’ve been paying down in my home. I don’t think I would agree with accessing leverage just as an unsecured line of credit. I know some people have done that. I think this is an important topic to talk about right now because we have high levels of leverage in Canada. A lot of times people are really comfortable borrowing to do a renovation for their home, to go on a vacation, or to buy a new car. We’re comfortable with using leverage. We’re comfortable with being in debt. But I don’t think enough people are comfortable using leverage as a form of investment, as a form of getting ahead with their investments. It took me a long time because I grew up very debt-averse. The generation of my parents and grandparents was you don’t have debt. You pay down your mortgage. You pay off all your debts. It took a long time for me to realize there’s opportunity (and people that know how to use leverage wisely) that can really benefit from it. 

 

Tom: Just on last week’s episode, I made the statement that your mortgage really is a type of leverage. We don’t think of it that way, but that leverage is really like a lever. You’re using a little bit, to do more. I agree that it’s more common with the mortgage, maybe a car loan. You can get into which is good or bad debt in that case but it’s all leverage to do something that you say need with less than 100 percent of the money. 

 

Money Mechanic: Well, totally. And we all know what house prices are like in Canada so there’s no way we’re going to save up cash to go buy that. Like you mentioned, you’ve been comfortable with getting into that leverage at the beginning. In my particular situation, we were super excited when we bought our first home. We have this relatively giant mortgage. I know those people that have even bigger ones now, which is amazing to have to service. But our first thought was to “crush” this mortgage. That is really what I see looking outwards from the finance community, the standard way of thinking for Canadians. Crush that mortgage and think about investing later on. I kind of learned this whole journey myself by paying attention to all the experts in Canada. That’s what we did. We started crushing that mortgage. Making extra payments, getting it down to a shorter period of time as we can. And it felt great. That was five years we did that. Then when we refinanced, I realized, ‘Hey, the house has gone up in value. We’ve paid down a bunch of the equity. There’s a bunch of money sitting there now that’s not doing anything for us except making me feel good.” That kind of started the whole leverage discussion for us. It was something my wife and I talked about a lot, because you’ve really got to be on the same page as your partner. For me, that’s my opinion for any kind of financial decisions. Neither of us were comfortable with it at the beginning. But the more we learned about it, the more we realized that we could be putting that money to work and earning us money. At the same time, while there’s a lot of risk there, we felt comfortable because we’re still in full-time employment so that was an acceptable risk for us. That was what started our decision to use it. 

 

Tom: You mentioned your house going up in value. At the end of your term, is that something you had revalued? I’ve never done that personally. Is there a process there to have that value restated so you can borrow more? 

 

Money Mechanic: For sure, yeah. We had a five-year, variable rate mortgage. We paid that off. And because I wanted to have access to some of that equity, we refinanced and went with a different lender so we had to get a new appraisal on the house. That new value was on that appraisal (we had to pay for). We’re using a product where it’s a re-advanceable mortgage. So every time we make a mortgage payment, we get a portion of that principal added to our home equity line of credit in a re-advanceable sense. We won’t go into all the mechanics of how that works, because that’s basically a whole other show but it has provided us the ability to access—They’ve got a number now. You’re only allowed to access 65 percent of your 85 percent of that equity. By getting that redone, reassessed, we had a lump sum amount we were able to access for leverage. And we chose to use it as a lump sum instead of dollar cost averaging or anything like that. 

 

Tom: I’m a big fan of the re-advanceable mortgage. I have the Scotia Step. No matter what you want to do with it, if it’s investing—even if you do want to reno or something, as long as you’re comfortable with your use of it, it’s just a nice to have. I guess you also have to be comfortable with your ability to not rack up the debt because this can be a big number as it increases. 

 

Money Mechanic: I think that’s a trap a lot of people fall into, unfortunately, because they see it basically as access to their own money. They start using their Elock as their own personal bank account for luxuries. I think that’s a slippery slope because all of a sudden you say, “Well, we should get that motor home we always wanted,” and boom, $70,000 is out of your Elock. Sure, you’re just rolling it into your mortgage payments and everything, but that’s a slippery slope. I think specifically, if you’re going to use it for consumer type stuff, that’s your decision. But if you’re going to use it for investing, you really need to keep these things separate because tracking is super important. If you’re going to use leverage for any kind of investing, you’re going to be able to write off the interest against your taxes but you have to have a very accurate accounting and tracking of that. 

 

Tom: You mentioned concerned with risk in using leverage for investing. Is some of that just maybe carried over from some people’s concern about risk and investing? If someone’s not as familiar with investing in stocks or ETFs, there’s this word tossed around that it feels like “gambling.” They’re just putting money in and they could lose it all which is technically true. But realistically, it’s not likely if you’re fully diversified. Is it is it some of that risk? Because people don’t seem to mind having the exact same amount of debt on a house. Even the banks mind less. You have this house that’s a real thing. It’s not just going to get completely wiped out. But with investing, people seem a little more concerned with it. 

 

Money Mechanic: That’s totally fair, Tom. And it is true. I think a lot of that comes from, in general, the lack of understanding of how investing works. I think that’s improving in Canada. People are learning more. There’s a lot more accessibility to it now. I would like to say—and this is just my opinion, of course, I’m definitely not an expert. Leveraging is a bit more of an advanced strategy when you get into investing. I think you need to be really comfortable with what you’re doing. Hopefully, you’ve got your TFSA in some investments. You’ve got your RRSP in some investments. You’re working with a financial advisor or you’re comfortable DIY. You need to have that in place before you start considering using any leverage, because, hopefully, then you understand a little bit better of what the risks are. And to your point, yeah, you’ve leveraged. Now, you risk that money. You can multiply your losses or your gains because you’ve added that leverage. So it’s important to understand the mathematics of it. And like you said, the risk of it. One of the things that I wanted to bring up with you here is, most people think, “I’m going to leverage. I’m going to borrow some of that Elock, that re-advanceable money and I’m going to put it in the stock market,” which is which is volatile and unpredictable. But that’s not always the case. You don’t always have to put it in that particular asset class. That’s where you can get a little more creative. Some might say you’d have more risk, but then some would say that you’d have more collateral or more security in other assets. 

 

Tom: What other assets are you thinking? Are we putting $100,000 into Bitcoin because it’s in the news? 

 

Money Mechanic: Absolutely, Tom. (Laughter). No, I would consider that probably gambling. 

 

Tom: Me too. I still struggle calling it an investment at this point. No to go too far down the Bitcoin path, but I like the term “gambling” in that case because you can make money in a casino but it doesn’t make it investing. It’s not that you can’t make money, it’s just hard to call an investment. 

 

Money Mechanic: Yeah, I agree with that. I would definitely call it 100 percent speculation. It may not be “gambling” because I feel like if you go to the casinos, those slot machines are kind of rigged against you and that’s what makes the gambling. Whereas speculating kind of leaves it totally open. But yeah, I’m on the same page with you. And full disclosure, I have put a small amount of money in there, but it’s like my grandfather used to say, “Never gamble with what you can afford to lose,” or maybe don’t speculate with what you can’t afford to lose. And that’s the amount I’ve put in there. 

 

Tom: What other assets would you consider using leverage for? 

 

Money Mechanic: One of the things we’ve done is private lending. This is a whole other topic we could get into and I don’t want to go too deep into it. People are going to say, “Oh, I’ve heard about goPeer and other platforms where there is peer-to-peer lending. That’s not what I’m talking about. I think that has some pretty high risk. We’ve gone into private lending where we deal with a mortgage broker that has clients that require second mortgages that are backed by their house. For me, I feel comfortable with that because I know there’s an asset that is securing my money, which is their house. I’ve been able to do the due diligence on the prospective customer of why they need the money and what their financials look like. And I’ve been able to look at their house and get an assessment of what value that has. I can look at what the loan to value ratio is. That’s how much equity they have available and how much I’m going to be lending on top of their primary mortgage to help them out for whatever reason they need that money. So it’s a definitely a niche area, but it’s actually more popular all across Canada than you would think. For listeners listening to this, it’s definitely advanced and you definitely need to be comfortable doing your own due diligence and things like that. There’s nobody is going to hold your hand with it. But just to throw out some basic example numbers here, I can borrow for around three percent and then I can lend that money on a house secured investment loan for anywhere from 10 to 15 percent. I’m generating the arbitrage between those two and it’s usually only for a one year term so it’s a short-term lending play. And I’m accepting that risk on both sides. I’m accepting the borrower risk to loan that money and I’m accepting the risk that I’ve leveraged to use that money. It’s not without its risks, but for our particular financial situation, we’ve accepted that to get those outside returns and guaranteed returns for a year because it’s monthly cash flow. 

 

Tom: How does someone go about this? Are people just calling you up and asking to borrow money or are you going through some service? 

 

Money Mechanic: You’ve got to be pretty active, Tom. And anybody who’s interested in this, like I said, I’m not going to throw any names or anything like that around, you need to go and do some research. But there’s a number of mortgage brokers all across Canada where—when you think of a mortgage broker, you probably just think you go there to apply and get a mortgage. But the fact is, they’re dealing with a lot of clients and those clients may be repeat clients for them who (for some unforeseen circumstances or reason) need to add to that mortgage they’ve had, for a period of time. Quite often somebody will say, “You know, I want to sell my house next year but I’m locked into a five-year mortgage. I really want to do some renos so we can get maximum price for the sale of this house. We need to borrow $50,000.” So they’ll go to a private lender and borrow $50,000. They’ll pay it off in that short period of time so they can sell their house. That’s kind of where mortgage lending, second lending, can come in. It’s a place where I’ve felt that my leverage can have maximum impact for me, return. Another thing I really like about it is that it is actually separated from the stock market. It’s an uncorrelated asset in my portfolio. That is important to me because it’s hard to do these days. 

 

Tom: I’ve got to admit, when I’ve heard of private lenders through a broker, I assumed it was some big financial company I’ve never heard of before—not your big banks. I didn’t realize it could also just be (like you) a guy in his garage. 

 

Money Mechanic: Yeah, well, totally. And let’s be honest here. We’re not talking about just lending $1,000. There’s a high barrier to entry. We’re talking $25,000 and above. But if you’ve got a big chunk of home equity that’s not doing any work for you… Let me just give you an example of my own personal situation—what we’ve done, what we’ve created with it. We are now fully paying off our own mortgage with our mortgage. We have zero mortgage payments every month, but we still have a mortgage. The way we worked that is, we’ve used the equity. We’ve put it into a couple deals where the monthly cash flow from those deals is enough to pay the taxes and our current mortgage. This is something really powerful for your listeners. When they get further down the road in the mortgage payoff and they’re willing to take on that little risk, they’ve got stable jobs and steady income—if they’re on the path to financial independence, you can create these strategies where you can be “net zero” on your mortgage cost every month. To me, that’s as big an advantage as having a paid off mortgage. 

 

Tom: I have some questions for you but before I ask them, just so we don’t lose anybody, can you explain what the Smith maneuver is? Then I want to see how this all fits together. 

 

Money Mechanic: The Smith maneuver is a debt conversion strategy. This is more of a long-term strategy where you’re going to gradually convert your taxable mortgage you pay every month into a tax deductible investment loan. If you started with a $300,000 mortgage, you’re gradually going to convert that to $300,00 investment loan that you’re able to tax deduct the interest off. It’s a gradual process over a long period of time. In the previous discussion here I was talking about taking a lump sum of leverage. I think there’s always a lot of confusion about the Smith maneuver being leverage. It is and it isn’t. The reason I say it isn’t, is because you’ve already got that mortgage which is your leverage. You’re never taking anymore. You’re just converting that. What are your thoughts on that? 

 

Tom: Yes, I’m a big fan of the Smith maneuver. I’m not currently doing it. I did it in the past with a move a few years ago. I just left it for now. I do still have that Scotia Step I’m considering getting back into it. And I do agree that on the surface it’s probably more of a tax maneuver because you’re converting something that isn’t tax deductible to a loan that is. But like you said earlier, many people are waiting to invest until their mortgage is paid off. If you’re doing great on your mortgage, maybe you’re left with 10 or 20 years before retirement which isn’t a long time to be investing. It kind of lets you dip your toe into both sides a little bit where you’re getting a little bit investing while you’re paying off your mortgage. And both of those things feel pretty good. 

 

Money Mechanic: Totally. That is the number one benefit for the average Canadian homeowner. By employing the basic Smith maneuver, you’re gradually investing from day one and it doesn’t cost any more money out of your pocket because you’re actually just using the principle you’ve paid down to pay the interest on the investment loan, and you’re building up that investment portfolio over the life of your mortgage. And Tom, as we all know, it’s “time in the market” the matters. That’s what moves out the volatility. That’s where you’re going to see the growth over time. 

 

Tom: It’s another case where you start to pay off your mortgage, because as those dividends add up and are outpacing the interest on the mortgage, it’s the momentum that keeps building. 

 

Money Mechanic: Totally. One thing I find a lot of people kind of get confused on about the Smith maneuver is they think they need to earn income to pay off the interest. But that’s not necessarily true. The interest is self-funded through the withdrawals each month. You don’t need to be invested in dividend stocks. You need to be invested in something that has a reasonable expectation of income so that leaves you open to a lot of choices. 

 

Tom: Thanks for that Segway, because that’s exactly what I want to hop back to, now that we’ve set this up a little bit. When you talk about the private lending, is that part of your Smith maneuver or is it a separate other pocket? I think with my Scotia STEP, you can have more than one loan. I could carve out a $50,000 or $100,000 pocket of equity and then have the re-advanceable part to do a Smith maneuver. Are they separate or is this all part of it? 

 

Money Mechanic: You know, this is where we get into a bit of a gray area. This is also where I get a little frustrated because people will comment on the show and say, “Hey, I’m going to take $50,000 and do a private loan. I’m doing the Smith maneuver.”  And I say, “No, you’re not because you’ve increased your leverage by $50,000.” That’s where the division of the line is for me. The Smith maneuver, in its basic plain-Jane form, is you’re converting your existing mortgage to your investment loan. That takes time to do. It’s on a month-to-month basis. If you add a lump of leverage at the beginning where you say, “Okay, I want to do this private lending so I’m going to take $50,000 out of my Elock…” Boom!  You start that. You’ve leveraged an extra $50,000. You don’t need to do the Smith maneuver as well. You’re not doing the Smith maneuver but there are a bunch of accelerators that can help your Smith maneuver. You could buy $50,000 worth of the EQT or some ETFs that you really like and then start doing the Smith maneuver. That’s called, priming the pump. You started it off but it’s kind of exclusive. In my mind, the best way to think about it is the Smith maneuver is not increasing my leverage. Borrowing to invest is increasing my leverage.  

 

Tom: What’s that look like for you then? Are you doing both or is this all connected to the house equity? 

 

Money Mechanic: It’s all connected to the house equity. And like you said that house equity, that Elock I have can be used for different things. I use it all exclusively for investment. I don’t have any other obligations on there. I don’t have any consumer items. We do a couple things which makes it a little bit more complicated. But that’s why I said this is a bit of more of an advanced strategy. Talk to an accountant or advisor who can help you with it. We do pull out money, periodically, that we’ve been paying down to put into the stock market. That’s a form of the Smith maneuver. As it’s being paid down, we’re pulling some out gradually and dollar-cost averaging it into the market. On the other hand, we have a larger sum available. When I see a deal that’s appropriate for our risk tolerance and for good returns, we’ll say, “Okay, let’s take out $75,000 and put it into this private loan for a one-year term. We’ll collect the monthly payments and when that loan expires and is closed off and that money comes back to us, we’ll be ready for another one.” We’re kind of doing a little bit of both. That’s why it sounds a little complicated. 

 

Tom: I think I get it. It’s all within one Smith maneuver. But you’re not technically taking out new equity as leverage because you’re more or less getting into another loan right after? 

 

Money Mechanic: My leverage increases and decreases. On the other hand, the Smith maneuver (if you want to try and call it that) is where I’m gradually converting what I’m paying down into. For me, I have chosen market stock market investments for that, but I don’t take out $50,000 and put it in the stock market if that’s what you’re trying to get at. I’m looking at lump sums where I leverage. They’re going to be real estate backed deals. 

 

Tom: You doing large amounts because in those cases you have to. It’s not the same as the stock market where you can be putting it in every two weeks or a month. Another type of leverage that seems like it could multiply these gains or losses even more is a margin account. For people that may not be familiar with it, it’s basically that you can borrow right from the broker you’re using—a stock broker. Do you use that as well? What are your thoughts on that? 

 

Money Mechanic: Tom, we might have to do a part two if you really want to get into this.

 

Tom: We can have you back on, but if you want to touch on it for now? 

 

Money Mechanic: Well, that’s a great question because I’m recently in the process of converting. First of all, let me just start with saying that what we’ve been talking about, any kind of additional leverage or the Smith maneuver you need to do in a non-registered or margin account anyway. It needs to be in a taxable account so let’s just throw away TFSAs and RRSPs. That is not part of this discussion. A margin account, that your listeners may or may not be familiar with, is going to be at a brokerage where you may have access to borrowing room against the assets you already have in there. Now, I have that at Questrade for a while, as a DIY investor, and I’m now moving it over to interactive brokers which has an incredible margin rate. It’s super cheap to borrow there. While I won’t be using that margin specifically to withdraw money and invest anywhere else, I will be using it within the stock market because I’m dabbling with options trading, which will require me to use some of that margin room. So, yes, I’m totally comfortable with using it to buy income-producing assets through a brokerage. I don’t know if I answered your question properly, but—

 

Tom: Oh, I think so. I guess my only other question is when you’re doing this, is that also part of your Smith maneuver? The money you’re using from your home to pay off the margin, does it kind of double up like that? 

 

Money Mechanic: No, not really. I don’t think so. And I don’t consider it part of the Smith maneuver because that’s my brokerage account that’s got a lump sum in there. And that brokerage is saying, “Okay, we’ll secure 60 percent of the money you have in there and you can borrow against it,” so it’s kind of totally separate. The Smith Maneuver is focused about debt conversion from your mortgage. Its mortgage conversion. People really need to just kind of separate that and understand there is leverage investing and there’s margin investing and there’s debt conversion with my mortgage. You’ve got to delineate it a little bit. 

 

Tom: If someone’s interested in this idea… Let’s call it a more traditional thing where they’re paying off their mortgage and doing a little bit of investing, probably with their RRSP, TFSA, what’s next for them if they only have a little bit of available equity in their house? I know that would technically be new debt at that point, but it’s there and they want to use it. What’s the next step? 

 

Money Mechanic: The biggest thing at that point is having a discussion (if you have a partner), deciding if it works for you and understanding why you want to do it. Being in this personal finance community and learning more about it, everything is much more psychological than we think. Just because you’ve got access to $100,000 of your home equity doesn’t mean you should use it. You should have a good reason why you’re going to use it. You should kind of have an exit strategy of what you’re going to do with it. You should be very comfortable with where it’s going. If you’re dipping your toes into private lending, maybe it’s not the right thing to start with. You need to be really comfortable with it. But if you’ve got that money sitting there and you’re interested in using it, then definitely, join some communities. If you’re active on some form of social media, reach out to others that have done it. This is an important thing where you need to talk to some other people that have some experience. I was very, very fortunate to have met some good people along the way in my personal finance journey that really helped me learn how to do it because there really isn’t any good books. And even though your blog is great and there’s lots of great finance blogs in Canada, it’s a bit of a fringe subject, any kind of private lending. There’s even other types of real estate deals that are much more cash flow centric where you’re not becoming a landlord. You’ve got the money accessible so you need to do some work to figure out how to put it to work. And you need to find some people that can help you do that. That’s the best way I can answer that. 

 

Tom: No, that’s great. It’s something I think people should look into, especially if they have that room available already. I do like your additional caution there, because just like any investing mistake, it’s going to get multiplied if you decide to use your home equity to jump in with. Maybe some tech company is in the news because they just doubled in value but chances are that’s not a great time to invest in them. You don’t want to be one of those people that would make an investing mistake like that, but then make it even worse by owing money. 

 

Money Mechanic: Totally, Tom. Maybe I should caveat the whole discussion here by saying, it takes a long time for us to pay off our mortgages. But most of us, hopefully, will get to that point where we’re seeing the finish line. To me, that’s where I think this strategy might come into play. You’re a little later in life. You’re at the maximum earning potential. You’ve got secure jobs. Maybe your kids are a bit older. You’ve kind of got their college money. You’ve got everything kind of figured out. Well, instead of crushing the last $100,000 or $150,000 of your mortgage, maybe that’s the time you say, “Hey, you know what, we’ve got $300,000, $400,000 or $500,000 of equity that’s not doing anything for us…”  So many people get to the end of their mortgage, which is fantastic… Yay! They burn it and then they’ve got $6, $7 or $8 million—all this money tied up in their house that does zero work for them. I think as you get further along in your investment goals and all the rest of it, it might be something worth considering. 

 

Tom: With your $6, $7 or $8 million comment, you’re obviously someone that lives in southern B.C.

 

Money Mechanic: True story. Yes. It’s a little expensive down here on the coast. 

 

Tom: Thanks for being on the show. This is a great look into using leverage. And yes, we’ll definitely have you back. We can dive into some of this some more in the future because I can see a few topics we could go deeper on. Can you let people know about your podcast where they can find you online? 

 

Money Mechanic: Absolutely. And Tom, thanks so much for having me on the show. I’d be happy to come back anytime to answer any of your listener questions. They can find the comments or they can find me at a few locations. Your listeners may or may not know that I host two podcasts. One is Explore FI Canada with my great co-host, Krissy. I also host the FI Garage with a couple of buddies where we have beers and talk finance. They’re both Canadian personal finance related—financial independence, specifically. I’m on Facebook. You can find me through those podcasts. You can find me on Twitter as FI Garage Mechanic. And I think I’m on Instagram too. I don’t post a whole lot there, but I’m FI Garage Mechanic there as well. I’d love to hear from people and would be happy to answer any questions, 

 

Tom: Thanks for being on the show. 

 

Money Mechanic: Cheers!

 

Thank you, Money Mechanic, for breaking down the relatively advanced subject of leverage into bite-sized pieces and making it easier to understand. You can find the show notes for this episode at maplemoney.com/168. Thanks, as always, for listening. I really appreciate the community we’re building both on the Facebook group and through the personal messages and reviews I’ve received. I look forward to seeing you back here next week. We’ll have Bob Lai back on the show to share some details on food inflation and how he’s making the most of his grocery dollar. See you next week.