Million Dollar Journey

When I started this blog, I wrote about the Smith Manoeuvre in the first month and implemented the controversial strategy in 2008.  For those of you new to the strategy, the Smith Manoeuvre is where you leverage your home equity to invest in the stock  market.  I modified the strategy by first paying down my mortgage with my existing non-registered portfolio, then invested in tax efficient dividend paying stocks while using the home equity line of credit (HELOC) to pay for itself.  In other words, I’m using the HELOC to cover the monthly interest payments without using any of my own cash flow by capitalizing the interest.

Smith Manoeuvre Mortgages

To set up the Smith Manoeuvre, the home owner needs a readvanceable mortgage combined with a significant amount of equity.  A readvanceable mortgage is basically a regular instalment based mortgage combined with a home equity line of credit with a small twist – the HELOC’s credit limit increases as the home owner pays down the mortgage.

Changes to HELOC Rules

Up until recently, home owners could access up to 80% of their home equity in a revolving line of credit/HELOC and pay interest only on the balance.  With the new rules, home owners can only borrow up to 65% loan to value (LTV) in a revolving HELOC.  If an investor has a mortgage free home valued at $100k, the new rules states that he/she can now only borrow up to $65k in the form of a revolving HELOC.

However, the rules also state that you still have access to 80% of your equity, but the remaining 15% must be in the form of an amortized mortgage (instalment mortgage) where the monthly payments are principal + interest.  Many thanks to Canadian Mortgage Trends in helping me clear up the details.

How do the new HELOC rules affect the Smith Manoeuvre?

First, people with existing HELOCs are not affected by the new rules.  However, even with the new rules, home owners still have access to 80% of their equity, but now only 65% can be in the form of a revolving HELOC.  In order for it to be a true Smith Manoeuvre implementation, the homeowner will need at least 35% equity in their home.  As a reader points out in the comments, as soon as a home owner has 20% equity within a readvanceable mortgage, they have access to their revolving HELOC right away for investing purposes, but the credit limit for that account is 65% LTV.

For example, say that a home is worth $500k with $375k left on the readvanceable mortgage balance.  Since there is greater than 20% equity in the home, the home owner has access to $25k in equity which can either be an instalment mortgage, or a revolving line of credit.   If using a revolving line of credit, the account will max out at $325k (65% of home value) using the new rules.

Note that lenders tend to have their own rules (like minimum credit limits etc), so best to consult a broker for the fine details.

Final Thoughts

While the new rules put a small damper on those looking to implement the Smith Manoeuvre, it’s really not all that bad.  The  new rules basically lowers the credit limit for revolving HELOCs from 80% LTV to 65% LTV.  If you manage to max out your HELOC, you can contact your mortgage company to access the remaining 15% of your equity via instalment mortgage.

On another note, I’ve read that some credit unions will still allow up to 80% LTV on revolving HELOCs, so there are other options!

For those of you considering the Smith Manoeuvre, what are your thoughts?  Did the new 65% LTV requirement change your view?

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