What you need to know about the Smith Manoeuvre
For the majority of Canadians, a mortgage is the only way they can become homeowners. As time goes by, you will have to pay a lot of money in interest.
Yet unlike the United States, this interest is not tax-deductible. For Canadians, the only way to make your mortgage tax deductible is to employ the Smith Maneuver.
What Is The Smith Maneuver?
The Smith Manoeuvre is a technique used to convert the interest you pay on your mortgage into a tax-deductible investment loan interest. This concept was born of a financial strategist named Fraser Smith in his book, The Smith Maneuver.
To execute this strategy, you need to have a Home Equity Line of Credit (HELOC) alongside a mortgage. You cannot implement the Smith Maneuver if you only have a HELOC without a mortgage.
The good news is that the Smith Manoeuvre is not a complex procedure. However, you need first to examine specific factors like your financial control, your perspective on investment and risk-taking, and the economy’s present state.
How The Smith Maneuver Works
In the United States, there is a provision for homeowners to deduct their mortgage interest when they file their taxes. However, this option is not available to homeowners in Canada. Interest paid on mortgage loans for your home is not tax-deductible.
Canadians can use the Smith Maneuver as the appropriate legal tax strategy to make productive tax-deductible dividends on a residential mortgage. With the Smith Maneuver, homeowners can;
- Make their mortgage interest tax-deductible
- Obtain better yearly tax refunds
- Lessen the number of years on their mortgage
- Grow their net worth
As an economic preparation strategy, the Smith Maneuver involves converting the interest a homeowner pays on their mortgage into tax-deductible investment loan interest.
In Canada, you can borrow money to provide capital for an investment that generates wealth. The interest on the borrowed money may become tax-deductible.
You can borrow against the home equity, make investments that bring returns, then use the tax refund to pay down your mortgage. If you can successfully get returns on investments each time you do this, you will pay off your mortgage after some time.
You can also invest in Guaranteed Investment Certificates (GICs), money market mutual funds, exchange-traded funds (ETFs), stocks, bonds, or even realty.
According to the Canada Revenue Agency (CRA), interest on money borrowed for investments is tax-deductible. But this is if you can use it to earn investment income, such as interest and dividends.
Nevertheless, if the only returns your investment can bring in are capital gains, you will not be allowed to put in an application for the interest you paid.
To ideally put the Smith Maneuver into effect, you must have a re-advanceable mortgage. A re-advanceable mortgage is a type of mortgage with a Home Equity Line of Credit (HELOC) combined with it.
It is impossible to appropriately execute the Smith Maneuver without a re-advanceable mortgage because you need your home equity for this strategy.
Getting a re-advanceable type of mortgage increases your Home Equity Line of Credit each time you pay down on your mortgage. It is on this ground that you will be able to influence tax-deductibility using the Smith Maneuver.
Simply put, what you need to do to perform the Smith Maneuver is to:
- Get a re-advanceable type of mortgage; one that merges a mortgage with a Home Equity Line Of Credit (HELOC)
- Re-borrow the capital sum you pay off with each mortgage payment in the HELOC
- Use the borrowed money to make investments that bring returns in investment income and not capital gain. Your returns also have to be higher than the interest rate on your Line of Credit.
- Subtract the Line of Credit dividend from your taxes and use your repayment to make a mortgage disbursement.
- Implement this strategy continuously until you clear your mortgage.
Is The Smith Maneuver Right For Me?
Note that even though properly implementing the Smith Manoeuvre promises to make your Canadian mortgage tax-deductible, it also includes a leveraged investment strategy.
What is a leveraged investment strategy?
A leveraged investment strategy refers to the concept of borrowing money to increase the potential return of an investment.
One thing to pay attention to when using the Smith Maneuver is that you will still pay interest on your investment loan if the markets go down.
Borrowing money to invest can be a high-risk move in the short term. If you need the money from your investment quickly, then the leverage will work against you.
Understanding how investing markets and equity markets work should give you confidence in a profitable, long-term investment. Exercising financial discipline coupled with your view on risk-taking will help you stay calm over time while you keep making your mortgage payments.
If you are not entirely sure of this strategy and how it affects you, seek a financial expert’s advice for different options.
Pros and Cons of The Smith Maneuver
Like every other financial strategy, the Smith Maneuver has some advantages but also some downsides. Some benefits of the Smith Maneuver are:
- It helps you establish an extensive investment index while you are still in the process of paying off your mortgage.
- It helps you reduce your mortgage stress. You can quickly pay down your traditional mortgage.
- It can be a means of increasing your net worth if your investments perform well.
- Unlike a conventional mortgage, the Smith Maneuver does not pay down your debt over time. Your net debt remains the same since you are re-borrowing the principal mortgage.
- There are bitter consequences if the value of your property falls significantly. This setback would put you in a situation where the loan amount is higher than your property’s actual market value.
- If your investments don’t produce good returns, then the interest rate paid on the Line of Credit will be higher than the profit made from investments. This drawback will be bad for your investment portfolio.
When it comes to the Smith Maneuver, you have to understand how comfortable you are taking risks.
Suppose you have low-risk tolerance or still have a thing or two to learn about investments and risk-taking. In that case, the most brilliant option will be to visit a financial planner to help you make a decision.