Smith Manoeuvre: make your mortgage tax-deductible
 

I was wondering of anyone does this:
my financial advisor was teaching me this technique and I am planning on putting down 1/10 of my house purchase towards this manoeuvre.

Basically any investment is tax-deductible, so the technique is to take the equity in your house and put it towards an investment (say mutual funds)

for more information:
http://www.smithman.net/

I'd like to get some input before i sign some "forever" deals

Sounds interesting - wouldn't mind getting the book..

Re: Smith Manoeuvre: make your mortgage tax-deductible
 

The strategy comes down to this:

- Interest paid on mortgages in Canada are not tax-deductible.
- Interest paid on loans borrowed to invest are.
- Banks allow you to borrow against the equity in your home, up to 75%.

If you don't already have at least 25% equity in your home, you can't borrow. I don't, so I'm not doing it yet.

I personally don't think mutual funds would be a good investment because they aren't very tax efficient, with the Smith Manoeuvre, you want to maximize your dividends... iShares like XTN, XFR, or XDV. This will help you pay down your mortgage faster.

Your advisor may not like this as much though, because they won't get much commission on ETFs compared to mutuals. I'm pretty biased against financial advisors though.

I was reading about shares that provide dividends and a lot of "experts" out there advise to go that route. but then i read a post on redflagdeals stating that mutual funds that did not provide dividends most always beat out those dividend ones.

also, i don't see really how this is truly a manoeuvre.
Downlow, can't you just borrow money from a bank or switch a portion of your mortgage into a credit line mortgage and just invest it? I mean, it doesn't have to be from your mortgage does it? ANY investment is tax deductible right? So go out and take a 50k loan and get it tax deducted.

or am i totally incorrect?

No, you are correct re the source of the money.

But! if you take out a secured loan with collateral like real estate, you generally get a lower interest rate. That is about the only way you are going to come out ahead with the SmithMan because the spread between interest paid on your loan and money earned on your investments is small.

The people who gain the biggest advantage to this method are ones who already have a large investment portfolio outside of their RRSPs, plus a mortgage.

For someone just starting out, ie having only 25% equity, and 0 investments, it doesn't make as much sense.



The thing about dividends being good for the SmithMan is that they provide very tax-efficient income that can be used to pay down your mortgage or pay the interest on the investment loan. You don't want to have to sell your investments to pay things down, because you will pay capital gains, which is more expensive for all but the highest tax bracket I believe.

PS More discussion at: http://www.canadiancapitalist.com/20...noeuvre-debate

So help me understand in lamers terms....

You are using mortgage to gamble on investments?

Sort of. You are converting your non-tax deductible mortgage into a tax-deductible line of credit.

EDIT:

An example:

- House worth 400k
- You own 200k worth of equity, and owe 200k on the house
- You have 200k in investments, outside of your RRSP.

The goal is to change this to:

- House worth 400k
- You own the house, no mortgage
- You have a line of credit for 200k
- You have 200k in investments, outside of the RRSP

The total amount of money is the same, right?

But the advantage is that the interest paid on the LOC is tax-deductible, whereas the interest on the mortgage is not.

In an ideal situation, after 25 years or so, your house will have appreciated, and your investments will as well.

This technique should be used with caution IMO - if your not comfortable risking your money - this option aint for u. + the person who is doing this shuold have the a bit more than the basics of financial sense....


off topic - wouldnt this kind of question belong in a financial forum - if revscene had one?? .... :D .....

You aren't risking any money, other than what you already have.

I am definitely not recommending that people take out a LOC to make investments, when they don't have the savings elsewhere to back it up.

I have to agree this technique is not for everyone.

You have to be confident enough to earn profits above and beyond the lending rate. Also, you have to consider the fluctuations in interest rates itself. For example, you can lock a mortgage at 1/5/10 yr rates, but you cannot with a LOC.

In the very end, high risk = high return.

Thanks Downlow for all your helpful information.

I am going to go ahead with only a small investment. One with an overall 40 yr return of 8-10% return and annual dividends which I will put towards my house.

Why can't home-owners also have a great investment portfolio too? In the end the "plain Jane" will end up with just a paid-off house but the "smith" manoeuvrer will have that and also a nice investment portfolio.

You can't make money unless you are willing to risk it.

Dividends are a great tax- strategy, but capital gains are tax- deferrable

There are 3 main types of 'income' possible from an investment in Canada:

1) Interest -- taxed at your highest marginal rate.
2) Canadian Dividends -- Taxed at a very low rate, in fact, almost tax-free until your income hits $60,000/year or more.
3) Capital gains -- taxed at one half the highest marginal rate, but deferrable.

After reading this again, the maneouvre seems probable....but i question the reality of it.

Using Downlow's example:

An example:

- House worth 400k
- You own 200k worth of equity, and owe 200k on the house
- You have 200k in investments, outside of your RRSP.

The goal is to change this to:

- House worth 400k
- You own the house, no mortgage
- You have a line of credit for 200k
- You have 200k in investments, outside of the RRSP


1) An average GVRD house is upwards from 650k

2) Chances of your house being 50% paid off before you are 40 years old? (ie young enough to be able to accept financial risk?)

3) Using the LOC to cover the mortgage in the above example would mean that the person must be qualitfied for a 200k LOC minimum.... now how many people you know have 50% equity in their house as well as have 200k LOC?

4) If #3 is attainable, and you have a 200k line of credit, you must be pretty rich. There are a whole bunch of investment options other than the Smith maneouvre to help you make wads of cash.

If I was in that situation, i'd put the 200k into condos or real estate elsewhere. You would end up with 2 real estate properties waiting to appreciate in value.

I'm moving forwards with this Smith manoeuvre and I'm a bit upset with my financial advisor.

He has presented to me where he thinks I should allocate my money. And they're all in his own firm's mutual funds.
Now why would a FA do this? Im sure he will be making much more commission but am i wrong to suspect this or maybe he just truly believes in his company's ability to make me money?

70% will be in a canadian dividend fund
15% in europe
15% in china.

That's exactly why I don't trust them!

It's a dog eat dog world my friend...

is there any way to invest this money without a FA? given that i have very little experience in this field and i don't have much time on my hands.

There is no risk in my example. You start off 200k in debt, you end 200k in debt.

I understand that the numbers I used aren't exactly realistic, but the SM does things incrementally, month by month.

1) Plug in whatever numbers you want...

2) Using a standard amortization schedule of 25 years, 5.7% interest, and no acceleration other than bi-weekly payments rather than monthly, you will have 50% equity at 16.5 years if you put 0% down. This does not vary by price, but it does on interest rate.

But that 50% number was just there to make the math easy. As soon as you get over 25% equity you can start the SM.

Historically, no one bought housing unless they had a 25% down payment. It's only recent history that you could get your primary housing with less than 25% down.

3) I wasn't very clear... the LOC does not cover the mortage. The LOC is against the equity in your house. You can get readvanceable mortgages from most major banks now. As soon as you make a payment that applies to the principal, it is available for borrowing against. Vancity was the first to do this.

4) SM is not an investment option, it is a method to move your bad debt (non-tax deductible) to good debt (tax-deductible). If you want to use the money to invest in real estate, go for it.

Thanks for all the insight DownLow, you have been very helpful.

Well no shit it's in his firm's own mutual funds. FInancial advisors are in general.. twats.

Do a search for the couch potato strategy if you don't want to think

Something else that my accoutant told me, cost involved in doing investments can be written off. In other word, if I use 1/4 of my apartment as my home office, 1/4 of the mortgage can be used as a biz write off. I have to double check with her again..

bump.

Anyone on RS running the Smith Manoeuvre?