Smith Manoeuvre: Advantages and Disadvantages

On Tuesday we introduced you to the Smith Manoeuvre and how it works as a wealth building, bad debt reducing process.  Essentially, the Smith Manoeuvre allows you to borrow against the equity of your personal residence, then invest the borrowed money into income producing units, and then use the tax refund to accelerate your mortgage principal paydown.

As with every good thing, there are advantages and disadvantages of using the Smith Manoeuvre.

The Disadvantages:

• As this is leveraged investing, you must be good with risk and comfortable with leveraging and investing as a whole.
• As a second back up, in case property values depreciate and you need to move, it is advisable that you have a plan ‘B’. As long as you have followed the Smith Manoeuvre steps properly, your portfolio net worth value should cover your loan.
• As long as you keep the tax-deductible loan, your mortgage will never be paid off. However, this will also allow you to keep on deducting the interest of your loan against your taxable income for as long as your keep the cash flowing investments.

The Advantages:

• By the power of compounding, you are able to build an investment portfolio while paying off your mortgage, not being restricted to paying off your mortgage first.
• The investment loan that you have acquired is completely tax deductible.
• You have the power to pay down your non-deductible mortgage MUCH faster.

If you continue to utilize the Smith Manoeuvre throughout the entirety of your mortgage, by the time you have paid off your mortgage, you should have an investment loan and an even larger portfolio. You will have turned your mortgage into an investment loan that is tax deductible!

If you would like to learn more about the Smith Manoeuvre, please read our previous post here.

Disclaimer: This blog should be used for informational purposes only and should not replace the advice of a licensed financial professional.

What is the Smith Manoeuvre?

The Smith Manoeuvre, created by Mr. Fraser Smith, is a Canadian wealth strategy that allows you to structure your personal residential mortgage so that your payments are tax deductible. A Canadian tax rule outlines that if you borrow money to put in an investment that provides you income, the annual interest paid on the investment loan is deductible from your income, creating a tax deduction.

The Smith Manoeuvre in Specific Steps

1. Sell any investment you may have in a non-registered ie. non-RRSP account to put towards your existing mortgage or use as a down payment for a new home.
2. The type of mortgage that you need to obtain is a “readvanceable mortgage”. This type of mortgage will give you a secured line of balance limit that increases as you pay down your mortgage loan. Before you are able to get a secured line of credit, you must have 20% of your home paid off. Although most banks do offer readvanceable mortgages, be sure to check with your bank before signing up.
3. Use the money that you have on your secured line of credit to invest in income producing products, such as positive cash-flowing real estate, any cash flow opportunity that pays you monthly or quarterly, such as a Real Estate Income Trust (REIT), and any other non-RRSP accounts; this is important, as only non-RRSP accounts give you the opportunity to write off interest earned.
4. When you file your taxes, be sure to deduct the total interest you paid on your line of credit throughout the past year. Dependent upon which tax bracket you fall into, you could get up to 40% of the interest you paid back.
5. When you receive your tax return, use that and any investment income you have earned, to pay down your mortgage principal amount. You can now use your increased credit limit on your line of credit to invest more.
6. Repeat these steps continuously to pay off your mortgage quickly, while building your assets.

Essentially, the Smith Manoeuvre allows you to borrow against the equity of your personal residence, then invest the borrowed money into income producing units, and then use the tax refund to put towards accelerated principal reduction of your mortgage. If you continue to utilize the Smith Manoeuvre throughout the entirety of your mortgage, by the time you have paid off your mortgage, you should have an investment loan and an even larger portfolio. You will have turned your mortgage into an investment loan that is tax deductible!

Check back on Friday to learn about the advantages and disadvantages of implementing the Smith Manoeuvre. We welcome your comments, especially from any of you that are successfully using this process!

Disclaimer: This blog should be used for informational purposes only and should not replace the advice of a licensed financial professional.