How to Be Like The Bank – Borrow at a Low Rate Invest / Lend at a Higher Rate

The usual advice is for individuals to avoid borrowing to invest. If you save to invest then a stock market loss may hurt but it is almost always something you can overcome.

Losing borrowed money however could be financially devastating. You could be forced to sell investments at the bottom in order to make loan payments.

But for some people right now may be a time to make an exception to this rule.

Borrowing rates on secured lines of credit and mortgages are at HISTORIC lows. They have NEVER been lower.

There are lots of investment ideas where you could EXPECT to earn far more than bank interest in the next five years. But the actual return earned in many cases would be uncertain and could turn out to be negative.

But you can also find reasonably certain investments that will earn about 2% higher than your borrowing costs.

Now 2% is not a lot to earn on YOUR money. But if you borrow at 3.89% you may be able to earn a 2.0% spread or more on the BANK's money. In effect, you become like a bank borrowing at a low rate and investing /lending at a higher rate.

You can borrow at a given rate and then turn around and buy something like Bank preferred stock that is actually earning you more than loan interest. It's bizarre and it won't last. Now is the time when you could take advantage of this unusual opportunity.

Some people may be mortgage free and may be in the position where they could take out, say a $300,000 mortgage and earn a spread of say $6000 per year or $500 per month. That might work out to say $400 after taxes. That is not a huge amount of money, but if you can make $400 per month using the bank's money that is worth considering for some people. However, you may not be able to make the spread in cash. The mortgage will require principal payments as well and so you may not realize the profit in cash until you ultimately sell the investment(s) and pay off the mortgage in say five years.

Here are some investment ideas to apply this too. (None are risk-free)

Canadian Western Preferred Shares (CWB.PR.A) are yielding 7.2% and are eligible for the dividend tax credit. Pre-tax spread on money borrowed at 3.9% is 3.3% or $3300 per year per $100,000 borrowed.

On a more risky note, Boston Pizza Income Royalties Trust is yielding 16.0%. This is fully taxable like interest. This yield may drop to closer to 12% (or lower) when the Trust becomes taxable in 2011. Also the distribution could be cut if the restaurant sales slow with the recession. But due to the fact that this Royalty is based on sales and not profits it should be relatively stable. One salivates at the thought of the apparent 12% spread or $12,000 per $100,000 borrowed! But be aware of the risks here.

There may be 5-year investment-grade corporate bonds available that pay in excess of 6%. TD Waterhouse has only a small selection including Wells Fargo yielding 5.34% and maturing June 30, 2015. and Bell Canada yielding 5.29% and maturing June 15, 2014.

I suspect there are some higher-yielding but still investment grade bonds available but you would have to check with the bond desk at your broker. Even discount brokers can offer these.

Obviously on a $300,000 mortgage one could spread the investment across three to six different bonds or shares to limit (though not eliminate) the risks.

Shawn Allen, CFA, CMA, MBA, P.Eng.
President, InvestorsFriend Inc., April 25, 2009