The Smith Manoeuvre
Ever heard of the Smith Manoeuvre? For those who don't know what it is, it's a Canadian wealth strategy to structure your mortgage so that it's tax deductible. There's a tax rule in Canada where if you borrow money to invest in an income producing investment (like a dividend paying stock or investment property), you can deduct the annual interest paid on the investment loan from your income tax.
So, who came up with this idea and how does this apply to making a mortgage tax deductible? Mr. Fraser Smith has written a book on the topic which explains how to do this properly. To summarize the Smith Manoeuvre in a nutshell, you borrow against the equity in your home, invest it in income producing entities, and use the tax return to further pay down the mortgage. Repeat until your mortgage is completely paid off leaving you with a large portfolio and an investment loan. Voila! Your mortgage is now an investment loan which is tax deductible and hopefully, your portfolio is larger than your loan.
Here is a slightly modified version of the Smith Manoeuvre :
1. Obtain a re-advanceable mortgage. This is a mortgage that has 2 entities, the Home Equity Line of Credit (HELOC) and the regular mortgage. There is nothing unique about this setup EXCEPT that as you pay down the mortgage, the credit limit on the HELOC increases. This is a key feature that is needed when implementing the Smith Manoeuvre . Note that you usually require at least 20% equity/down payment before you can obtain a re-advanceable mortgage. There are several financial institutions that offer this type of mortgage and I would be happy to assist you in obtaining one or simply providing advice on which lender might be best for you.
2. Use the HELOC portion of your mortgage to invest in income producing entities like dividend paying stocks or rental property. With every mortgage payment you make, your HELOC limit will increase. So with every regular mortgage payment, you will invest the new money in your HELOC. Note that you SHOULD NOT use the HELOC money to invest in your RRSP as you will lose the tax deduction on the invested money. If you don't already have an investment account, contact an investment specialist.
3. When tax season hits, deduct the annual amount of interest that you paid on your HELOC against your income. So, if you paid $6,000 in interest payments for the year and you have marginal tax rate of 40%, you will get back approximately $2,400 of it.
4. Apply the tax return and investment income (dividends etc) against your non-deductible mortgage and invest the new money that's now available in your HELOC.
5. Repeat steps 2-4 until your non-deductible mortgage is paid off.
As you can see, this process will pay down your regular mortgage in a hurry.
- You get to build a large investment portfolio without waiting to pay off your mortgage first (the power of compounding).
- You get to pay down your non-deductible mortgage quickly.
- Your new investment loan is tax deductible.
- You need to be comfortable with LEVERAGE and investing in general.
- You need a plan ‘B' in the event that you need to move and home value has gone down. If you invested properly, your portfolio should at LEAST cover your loan.
- Your mortgage is NEVER paid off because you keep the tax-deductible loan (this can be a good thing).
The Smith Manoeuvre is a simple concept, but fairly technical to set up. It is easy to do, but also easy to mess up. I would recommend that you work with a mortgage broker and a financial planner to make sure you get it right!
Jerry Sims is a mortgage broker with Ambro & Associates Mortgage Consultants Ltd. with over 20 years of lending, banking and financial planning experience. A highly satisfied and loyal client base can attest to Jerry's knowledgeable, creative and caring service that rises above and beyond expectations. Jerry has worked at several financial institutions in the capacity of loans officer, branch manager and credit manager.
Please feel free to ask John for an endorsement if you would like to know more about my services.
This entry was posted on Thursday 16th of October, 2008 at 1:43 pm | Posted in Mortgage Tips