Leveraged Investing: Personal Case Study – Credit Cards and Lines of Credit

As you may be aware, I used leverage to invest last year during the crash. Recently with my increase to networth and cashflow, I received several credit limit increases, better interest rates and now find myself largely free of debt besides my new mortgage. Thus, I find myself in a position to do so again (this time the goal will be to improve cashflow). Before continuing further, please note that leveraged investing is an inherently risky strategy, please consult a financial advisor or seek professional guidance before engaging in leveraged investing. I am not a financial advisor and none of the following should be construed as advice.

Here are the tools I have at my disposal:

1. Credit Card – $36000 limit, 0% interest (10 months), 2% balance transfer fee
2. Line of Credit – $45000 limit, 6.34% interest, option for interest only payments

The Credit Card

I will be using the credit card to invest in dividend paying stocks in a taxable account. The balance transfer fee is not tax deductible as it is not interest (you can personally think of it as upfront interest, but for CRA definitions, it does not fall under interest). If there is a fee with a balance transfer, you must include this amount in your calculations as it will be charged to your credit card and you will be responsible for paying this fee to keep your account in good standing (and thus, still eligible for the 0% interest).

First, let’s find out how much I can withdraw from my credit card. We do this calculation to avoid going over the credit limit of the card

Available credit = Credit limit – (Credit limit * balance transfer fee)

$35280 = $36000 – ($36000 * 0.02)

I can safely withdraw $35280 from my credit card.

Here’s how much I will be paying in fees:

Fees Due = Credit withdrawn * balance transfer fee

$705.6 = $35280 * 0.02

I will not be using the withdrawn amount to pay for it’s own balance transfer fee. Instead, the full amount will be transferred to a brokerage account which I am dedicating solely to leveraged investing usage. My thinking behind this is that it will make bookkeeping much simpler as none of my leveraged money is being mixed with personal savings. The balance transfer fee of $705.6 will be paid out of pocket. There is one circumstance I can think of where this could also be tax deductible (inside a corporation), but for the majority of people, it will not be.

Great, so I’m paying $705.6 to access $35280. But how am I going to handle the inevitable interest or repaying the loan once the interest-free period is over?

Firstly, let’s talk amortization. In this scenario, I will eventually be paying off my loan with a timeframe of 5 years. The number looks like this:

$35280 / (5 * 12) = $588

So to repay my loan in 5 years, I will need to pay back $588 a month or $294 biweekly. This payment is additional to the $705.6 for the balance transfer, but will be made starting the following month. But using that math, I’m only paying off $5880 in 10 months. You’d normally be right. I’m actually going to be paying off none of it in 10 months. The 5 year timeframe starts after 10 months. I am doing this to maximize the effective the interest free period. I can assure you, I have no interest in paying high interest credit card debt once the promotion expires either. But how am I going to pay off the debt?

The Line of Credit

“When borrowed money is used to repay existing borrowed money, such as a previous loan on which the interest is tax deductible, the new borrowed money is considered to be used for the same purpose as the previously borrowed money, thereby making it deductible too. Interest that is deductible does not cease to be deductible because the original loan was refinanced” Source: RBC Wealth Management

With $45000 of room at a 6.34% interest rate, the line of credit becomes are very viable route to handling the lump sum debt rather than keeping it on the credit card once the promotion ends. Let’s first find out the amortization and how much interest I will be paying off with a 5 year time frame:

There’s a bit of variation in the monthly payment from our napkin math as we didn’t take into account interest in our payments to reach our amortization timeline.

$6088.07 in interest is still quite a bit. Let’s take a look at this on a yearly basis though to make sure the numbers from this matches up with our napkin math:

Interest Payment = Balance * Interest Rate

$2236.75 = $35280 * 6.34%

The numbers are roughly inline. Our napkin math doesn’t adjust based on changing monthly balances.

However, the interest is tax deductible. How much is tax deductible depends on your marginal tax rate. Let’s assume the average pre-tax income of $52000. This puts us in the marginal tax bracket of 29.65%. Let’s find out how much we can deduct from taxes.

Cost of Borrowing Rate = Interest Rate – (Interest Rate * Marginal Tax Rate)

4.46% = 6.34% – (6.34% * 29.65%)

This provides us with a new rate to figure out how much interest we’d be effectively paying:

$1573.49 = $35280 * 4.46%

Did I just save $663.26 in the first year? Yes. Yes I did.

Our cost of borrowing is now only 4.46% which is much more manageable and not too high a hurdle with current market prices on Canadian dividend paying stocks. For example, BNS offers a 4.54% yield, TRP still offers 4.85%, and ENB offer yields of 6.77%, while BCE offers a still attractive 5.08% (these are at the time of writing).