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New HELOC Rules and How it Affects Smith Manoeuvre Mortgages

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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FrugalTrader About the author: FrugalTrader is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 21 comments… add one }
  • AlexOntario May 21, 2013, 10:31 am

    Hi,

    I recently bought a house and took out the RBC Homeline mortgage product to implement the Smith Manoeuvre.

    I was also interested in the effects of the new HELOC rules that you stated.

    I think you have an incorrect statement in your article. You don’t need 35% equity in your home to start using your HELOC. You need at least 20%+$1 equity but you can borrow up to 65% of your mortgage.

    For instance, you have a 300K house.
    You put 20% as your down-payment (60K). At this moment you can borrow $0. And your mortgage is 240K.

    As soon as you start your payments, let’s say $1,000 out of which $500 is against the principle.
    After your fist payment you can borrow $500 and invest. And so on after each payment (since the limit increases with every payment).

    The new 65% rule states that you can borrow up to 65% of your house, so 300K * 0.65 = 195K.

    So you can keep borrowing until you borrow 195K. After that your equity grows but you cannot borrow it (or as you said you can with an amortized loan).

    Thanks.

  • Erik May 21, 2013, 1:38 pm

    Interesting! Thanks for the update and interpretation.

    AlexOntario, your explanation is also appreciated.

  • FrugalTrader FrugalTrader May 21, 2013, 2:29 pm

    @AlexOntario, thank you for the clarification. I have confirmed with a broker and updated the article accordingly.

  • Sean May 21, 2013, 6:39 pm

    I waited for years to have the equity to do the Smith Manoeuvre. Almost to the day that I was ready to go these new rules came in!

    Its no big deal though. I got one anyway down at Scotia Bank (who told me it was automatically readvanceable & then at signing it WASN’T!, but separate issue…) & it is working out just fine. I made my first SM + Cash Dam last month & will be doing my second one on June 1st!

  • AlexOntario May 21, 2013, 6:40 pm

    To answer your question FT, it didn’t change my view. It just limited the amount I can borrow.
    It’s unfortunate that because of people that don’t know how to control their financial life, the rest of us get to “suffer”.

  • Ed Rempel May 21, 2013, 9:18 pm

    Hey FT & Alex,

    The new rules have not really affected us at all. You can still start the Smith Manoeuvre with 20% down. It works the same as always.

    The issue is not when you start, but when your mortgage is almost paid off.

    You start with 80% mortgage and 0% credit line. The mortgage declines and the credit line rises. The problem happens when the mortgage is down to 15% and the credit line is 65%.

    At that point, the credit line will stop readvancing. However, if you convert part of the credit line portion into a 2nd mortgage portion within your total readvanceable mortgage, then the credit line will continue readvancing.

    For example, you could have the original mortgage down to 15%, a 2nd mortgage portion that is deductible at 50% (converted from the credit line) and the remaining credit line portion at 15%.

    Converting the tax deductible credit line back to a mortgage portion once the mortgage is gone or nearly gone sometimes makes sense anyway. The interest rate is lower on a mortgage and a small increase in the payment will actually pay off everything over time. The downside is that your tax deduction is smaller.

    Ed

  • Tony May 21, 2013, 10:19 pm

    i am happy that it does not change the access starting point as I am soon to implement my sm. the down things do not happen until the last 15% portion, which can hopefully be remedied by some other ways at that time.

  • Canadianmutualfundinvestor May 21, 2013, 11:12 pm

    In bc your local credit union is still able to lend 80% ltv on an equity line.

  • Ed Rempel May 22, 2013, 10:25 pm

    Hi Canadianmutualfundinvestor,

    That’s a long name! Does the credit union have a readvanceable mortgage, or is it just a credit line?

    I support the credit union movement and am the in-house advisor for a small one. The Smith Manoeuvre started with mortgages from a credit union. As far as I know, no credit union offers a readvanceable mortgage today, though.

    It would be nice if a credit union had a readvanceable mortgage with competitive rates.

    Ed

  • Canadianmutualfundinvestor May 23, 2013, 6:39 pm

    Sadly it is not a readvanceable mortgage, nor can we offer that type of product. I’m pretty sure it is more a system limitation rather than not willing to offer…
    The mortgage charge is not for a fixed amount so one could come in with their property assessment (as long as it has gone up in value) and fairly easily apply for an increase. The increase could be in a separate account…We could then decrease the “mortgage LOC amount” based off of the payments that were made and transfer that room to the new investing LOC. It is a bit of a pain, but it can be done. We could also do the same thing with a mortgage. Nothing about this is automatic and could only be done once a year unless a person wants to pay appraisal fees (kinda pointless if done frequently)

    But where there is a will there is a way.

  • Norman May 25, 2013, 1:50 am

    Can this strategy be used to make your mortgage deductible?

    Two friends buy identical houses. They both take out identical mortgages. They then RENT their houses to each other and charge each other the same rent.

    What are the legal implications?

  • Ed Rempel May 25, 2013, 12:45 pm

    Hi Canadianmutualfundinvestor,

    Oh, so you work for a credit union? You’re right – where there’s a will, there’s a way.

    Your method is obviously a pain, but it might work for someone motivated to work with the credit union that is not using nearly all their available credit. Then they could just readvance once every year or 2.

    We have also found the banks will often absorb legal and appraisal fees. So you may find clients not wanting to pay those fees every year or 2.

    Ed

  • Quan Le December 12, 2013, 4:35 pm

    why use the name of Smith Manoeuvre? I would just any name like Rempel Manoeuvre or Smart Mortgage Deduction Strategy etc…It is not like Mr. Smith invented that strategy…it was invented a long time ago by accountants.

  • Ed Rempel December 12, 2013, 11:07 pm

    Quan,

    Based on your comment, I’m not sure you understand the difference between the strategies. You know accountants that used these strategies before Fraser?

    I met Fraser in 2001. At that point, I had been a financial planner for 8 years and an accountant for 20. His Smith Manoeuvre strategy was a new concept for me.

    Accountants had thought of borrowing to invest (The rare accountant that isn’t super-conservative.), but the Smith Manoeuvre added using a readvanceable mortgage (which did not exist at the time), investing bi-weekly with each mortgage payment directly from your credit line, and capitalizing the interest. All 3 were new ideas.

    The Rempel Maximum is the ultimate more aggressive version of the Smith Manoeuvre. There are 7 different Smith Manoeuvre strategies and the Rempel Maximum is the most aggressive. It involves borrowing the maximum amount you can while getting the maximum growth from your investments by not taking any income or capital from them. It is related to the Smith Manoeuvre, but a lot more aggressive and only suitable for a small portion of people that really want to grow wealth.

    Ordinary leverage, the Smith Manoeuvre and the Rempel Maximum are all very different from each other.

    Ed

  • Quan Le January 20, 2014, 12:56 pm

    Ed Rempel:
    Please read decisions ‘Ludco’ and ‘Singleton’ by Supreme Court of Canada. Lawyers and accountants were doing this strategies for wealthy individuals (amongst other – to The Bronfmans Family) for decades! I learned that in my tax classes back in the early 90’s. Whether it was legal or not was another question! It was made legal by the Supreme Court decision rendered in 2001, and accepted by CRA in 2002.

    Another reason why it was not popular before that, which you did mentioned, was that Home Equity Line of credit did not exist until early 2000’s.

    Finally, accountants, like you said, tend to be conservative, and therefore, normally do not offer this kind of debt accumulation strategies to their clients. Nor they have expertise in mortgage products. Granted Mr. Smith did an amazing job popularizing this strategy, hence, I think he does deserve to be named after this strategy. The more people are aware of this strategy, the easier it is for me to explain to my clients. Thank you Mr. Smith.

    On a separate note, I worked as a CPA, CA for 10 years before switching to mortgage brokerage in 2003. I started to offer this strategy immediately to my clients at that time. However, I would not dare to put my name on a strategy that existed, although it was relatively unknown to most, decades before.
    Cheer!

  • Kanu June 10, 2015, 9:39 am

    Hi, first time I came across this blog. I have read about SM before but your blog certainly have more info. I have following question regarding this SM.
    You have suggested that dividend income in an investment account can be claimed against the intrest paid under SM. Please tell me if the capital gain due to sell of some investment can also be claimed against the interest amount or not?

    • FrugalTrader FrugalTrader June 10, 2015, 9:50 am

      Hi Kanu, thanks for stopping by. It’s not that dividends can be “claimed” against the interest paid. The interest needs to be paid with whatever means that you have. It can be paid with your regular salaried income, you can use the HELOC to pay for itself, you could withdraw the dividends from your investment account, and yes, you can withdraw capital gains as well to pay down the loan. For more information, here is a post I put together which will answer most of your questions:

      http://www.milliondollarjourney.com/the-smith-manoeuvre-resource.htm

  • Tom October 4, 2016, 5:10 pm

    Hi, FT.

    I’m confused about the whole “percentage of mortgage” rule.

    My HELOC ‘limit’ states a value of about $200K. My starting mortgage amount is $160K. Which one do I take 65% of (I renewed in 2014 after consolidating other consumer debt into the overall mortgage)? If it is of the $200K, then I have $130K to work with. If it is the overall mortgage amount of $160K, I only have $104K to work with.

    Looking forward to your response.
    Thanks.
    Tom

  • FrugalTrader FrugalTrader October 4, 2016, 8:07 pm

    Hi Tom,

    The maximum amount that you can reborrow from your home is 80% of the appraised value. So say that you have a home value of $100k, then the bank will allow you to borrow up to 80% of the value, or 80%. However, only up to 65% can be in the form of a HELOC.

    I have not attemped to obtain a HELOC since this post. Can anyone confirm the 65% restriction?

    Tom, what is the appraised value of your house (according to the bank)?

    • Tom October 4, 2016, 9:44 pm

      I don’t know where to find this information.

      That said, on my monthly HomeLine statement, it says I have a credit limit of $300K+. Would this mean that I have that whole amount available, or just 65% ($195K) of it?

      Tom

  • FrugalTrader FrugalTrader October 5, 2016, 7:43 am

    I’m not familiar with the HomeLine statements, hopefully someone here can comment, or perhaps you can give RBC a call and report back.

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