How I obtained a negative interest rate mortgage

Why inflation matters

U.S. government bonds in 1990 were paying investors 8% a year. That sounds amazing! Especially for a low risk investment. 🙂 But not everyone was buying them. Why? Because investment returns don’t tell the whole story. The inflation rate that year was 5.4%. That means the real rate of return on those bonds was only 2.6%. Stashing $100 under a mattress would have lost $5.40 in value during 1990. As Ray Dalio says, “cash is trash.”

Obtaining a mortgage from an unconventional lender

Earlier this year I bought a rental property and took on a new mortgage at 2.44% fixed interest rate for 5 years. After asking around different banks I decided to use monoline lender MCAP. They deal with broker channels and often have lower rates than the big banks. 🙂

Since this is an investment property the interest on the mortgage is tax deductible. My marginal tax rate is about 30%. So my effective interest rate after tax adjustment is 1.71%. But this is the nominal rate. To get the full picture we have to subtract the inflation rate. Last year Canada’s official inflation rate was 2.25%. So my real mortgage rate equals the nominal rate (1.71%) minus the inflation rate (2.25%) which comes to -0.54%.

So I’m effectively paying a negative interest rate. I’m earning 54 basis points to borrow money. Woot! 😀 Personal finance author Robert Kiyosaki says smart people use debt to get rich. He’s right. I’m growing my net worth by literally having this mortgage.

The historical average inflation rate in Canada has been about 2% annually. Let’s assume it will continue to average 2% for the foreseeable future.

This is bad for my mortgage lender. The asset they are holding (my mortgage) will slowly lose value over time. Fortunately for them the 2.44% interest rate they charge me is still higher than the expected inflation rate.

What does a negative mortgage rate mean for me?

As a borrower, an inflation adjusted negative interest rate simply means this mortgage is creating wealth for me. 🙂
Here’s how it works:

• Let’s say my initial loan balance is $1,000 to make calculations easy.
• My after tax interest rate is 1.71% as mentioned earlier. So my cost to hold this debt is $17.10 this year.
• Assuming I don’t touch the principal, by the end of this year my loan balance should still be $1,000.
• But it will only be worth $980 because $20 or 2% will be eaten away by inflation.

In conclusion, this year I will pay $17.10. This comes out of my savings or assets. But I will receive $20.00 from inflation – reducing my liabilities. The difference is a net gain of $2.90 to my net worth. 🙂 I’m essentially giving up cash in return for devaluation of debt, and coming out slightly ahead. If I didn’t borrow this $1,000 in the first place I wouldn’t have made the $2.90 gain. Being in debt generates wealth. Being completely debt free doesn’t. This is how borrowers get rich with a negative interest rate.

Of course a mortgage payment contains both principal and interest, where the principal paydown is forced savings for the borrower. A more accurate calculation would also involve discounting each future payment for inflation separately. But to demonstrate my point I simply used a simplified Fisher approximation.

A new reason to borrow money

Some time during the last decade there was a paradigm shift in the way investors use credit. In the past using financial leverage only made sense if the asset you plan to buy has a higher expected rate of return than the cost to borrow money. But today it’s possible to borrow at negative interest rates in real terms. This changes everything. It means the debt itself generates a real return for the borrower – irrespective of how the corresponding asset performs. If the asset provides a positive return as well then that’s just a bonus. 🙂

Who knew that a liability such as a mortgage can actually be a wealth building tool? 🙂 Not only is my new rental property producing monthly income, but I’m also receiving financial value from the loan I took to buy the property. Double win. Welcome to Modern Monetary Theory. We’re living in some strange times.

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Random Useless Fact:

Financial jealousy is when you want someone else’s money. Financial envy is realizing you can’t have the money so you don’t want someone else to have it either.