Leveraged Investments – Interest Rate Exposure

This is the third post in the “Leveraged Investments” series. Check out the previous post entitled “Leveraged Investments – The Risks”.

My biggest concern with doing leveraged investments since I have a large mortgage is interest rate exposure with respect to cash flow. In my opinion, nobody “needs” to do leveraged investing including myself which is why it is important to understand and minimize the risks. However I find the idea of it rather enjoyable and believe that I can make a profit out of it. Although I’m fully aware that the investment plan may not work out (won’t be the first time) I don’t want it to negatively affect my personal cash flow to the point where I regret doing the plan. This will mean limiting the borrowing to fairly modest amounts (compared to say the Smith Maneuver) which will limit any potential profit but it will also limit my exposure in case things go south.

I outlined in my last post most if not all of the ways that the plan could fail, however my biggest concern is interest rates since if they go up, the cash flow for the plan will go more negative and that’s not a good thing if it’s taking money from other activities that I like to do.

My assumptions for the interest rate calculations are extremely conservative and I wouldn’t think any less of someone who didn’t adhere to the same level of stringency.

My calculations:

In my mind, to calculate your interest rate exposure properly you should include all your debt so I will include my mortgage & investment loan.

Currently I’m paying $1500 / month on my mortgage. This amount is a bit much which is why we are lowering our monthly payment but we can get by ok on this amount if necessary. Regardless of what happens with the leveraged investments or interest rates, I don’t want to have to pay more than $1500 / month to cover my total debt payments

We have recently locked in our mortgage for a five year term which is important in this calculation because it is not the current amount of the mortgage that is at risk if interest rates change, but rather the portion which will still be outstanding at the time that the locked in period ends. In our case I estimate that once the five year period ends, we will owe $110,000 on our mortgage.

I’ve assumed a worst case rate of 15% interest – feel free to pick your own poison. I’ve also assumed my stocks have completely stopped paying dividends. Like I said, my safety test is stringent! I have however assumed that the tax rebate is intact and that my tax bracket is unchanged.

One more thing – I’ve stated that the current monthly maximum loan payment I am willing to handle is $1500. In five years at 2.5% inflation, that amount will be $1700.

Ok, to start off – I will owe $110k on my mortgage in five years and the interest rate is 15%, so the monthly payments will be $1447 – less than the $1700 maximum so there is room to borrow. In this case I’m amortizing over 25 years.

To add the investment interest payment to the calculation I have to account for the tax rebate, so for every dollar of investment interest, I’m only responsible for 56% of that amount. In other words I have to add 56% of the investment loan to the mortgage amount.

After playing with the numbers, if I have a $110k mortgage and a $40k investment loan then the monthly payment will be $1700 ($1500 in 2007 dollars) at 15% interest. So from that, $40k is the maximum amount I can borrow for investments.

Needless to say, this type of calculation has to be kept up to date since any changes in the rate of mortgage payments or any new debts will affect the amount available to invest.

The other limiting factor is the effect on your current cash flow from borrowing. If you were to borrow $100k at 6% and start a plan like this on January 1, your spreadsheet might tell you that your net cost per month is only $79 per month, however you might not get any dividend cheques for a few months and you won’t get the tax rebate for over a year so you need to be able to handle the gross interest payment ($500) for at least a little while. This is why I have only started the plan with $7100 so far and will be taking my time to get up to the $40k limit (if I get there at all).

Anyways, not sure how clear that is but feel free to ask questions or offer comments or criticisms!

The next post in the series is “Exit Strategies”.

8 replies on “Leveraged Investments – Interest Rate Exposure”

Interesting conclusion to a great series. I think you’re quite wise to look at a worst case scenario, figure out what you could carry, then limit your leverage play to that amount. If things go better then expected (which they damn well better since you’re assuming a 15% interest rate!) then life is good!

I did a similar calculation with the mortgage on my investment property. I figured after 5 years, if interest rates shot up what the payments would be on the remaining balance if I “reset” the amortization to 25 years. If you live within your means, its possible to give yourself quite a deal of flexibility to deal with just about any future possibilities.

Thanks Mr C – I actually have a “bonus” post for this series but I’ll wait a bit to post.

I think it’s important to try to measure the risk of borrowing money so you don’t have any unpleasant surprises if things don’t work out.

If you’re struggling to buy your first house/condo then you might not have the option of limiting your borrowing to a ‘safe’ level but for investment loans you always have the option to borrow less (or none).


I like your leverage buying series.

I have not utilized any leverage because my wife is quite risk averse. We spent a long time becoming completely debt free (which has allowed my early retirement) so she sees that as problem.

After a long discussion this past weekend, she seems to be more open to it, but I have to provide a bit of a business case to her. Your spreadsheet will be of great assistance.

Well written blog.


Q: Promise her that if the investment doesn’t work out (to pay the debt incurred) you’ll go back to work. I think that’s one of the best hedges young retirees have, they can always climb back into the trenchs and earn some coin if needed (not fun, but definitely a possibility).

Thanks Q.

I’m not really planning to have any investment loans during retirement partly because I don’t think the tax rebate will be enough with lower income. However in your case if you have enough income it could be worthwhile. As always you just have to manage the risk.

Mr. C. has a valid point too.

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