What are the pros and cons when borrowing money to invest?

Q: My wife Karen and I are 45 years old and each of us earns $100,000 annually. We have one child, a son, who is 14 years old. We also have $200,000 each in registered retirement savings plans (RRSPs), but no employer pensions nor other savings except for $25,000 in a chequing account for emergencies. We are considering borrowing money to invest. What are the pros and cons of doing this? We have no consumer debt, but still have a $150,000 mortgage at 2.5 per cent on our principal residence, which is worth about $1 million. — Miguel

FP Answers: Borrowing to invest is a financial strategy that presents opportunities, but also pitfalls. It would be prudent to review your overall financial planning before choosing to implement a leveraged investment strategy since it can add a significant amount of risk to a financial plan and is not appropriate for all investors.

The main reason why borrowing to invest in real estate is so much more common is that the underwriting process involved in buying a home is much different. There are credit checks, income confirmations and a home appraisal before any dollars are borrowed for a purchase.

Borrowing to purchase other investments, most typically a portfolio of stocks, mutual funds or exchange-traded funds (ETFs), is different. A home’s value is unlikely to significantly drop, although it can go down, but there are no restrictions on an investor putting their money into risky investments. Real estate is also less liquid. A stock or other publicly traded investment can be sold with a screen tap on a smartphone.

Given your income and age, Miguel, I’m guessing you have RRSP room. You should probably max out your RRSPs before building a non-registered account. You both likely have $88,000 of TFSA room if you have never contributed, and that should be used before building a non-registered portfolio.

Let me outline the most common way a leveraged investing strategy would be set up. First, a source of funding is determined. In your case, since you own your home, it is most common to set up a secured home equity line of credit (HELOC), which could then be used to advance the funds to purchase the investments. Investors will use their home as security because it usually allows them to obtain better interest rates.

The prime rate is often seen as a benchmark for borrowing rates across the retail banking sector and this has been in the range of five per cent to six per cent over the past six months, and could rise further. Given that rates are this high, the breakeven point on the expected investment return would have to exceed that amount to make the strategy reasonable. It’s no use borrowing to invest if you pay more in interest than what you could expect to earn on the investments.

If you do want to proceed with borrowing to invest, you need a high risk tolerance, low investment fees and a long time horizon to make it worth considering. At age 45, I suppose you have some runway to consider this. Just be careful and be mindful of some of the other considerations raised.