The Smith Manoeuvre – A Wealth Strategy (Part 2)

Hey QCash!

That is a very interesting point of view!

I would need a spreadsheet to calculate the difference between using the SM or just paying down the mortgage. Actually, I believe that http://www.smithman.net has some scenarios that does the calculations for us.

From my point of view though, why not pay down the mortgage faster using the Smith Manoeuvre and use the portfolio to invest in dividends which give you more cashflow? Using the tax refund at the end of the year towards the mortgage should help speed the process. The SM does not cost you any cashflow as you can “capitalize” the interest meaning you can use the loan for pay for the loan interest payments.

FrugalTrader

BTW

I have added your blog to my daily read, so I wish you all the best.

You asked earlier what other saving strategies I used, well, we are definitely in agreement with the used car approach (although deep down I still want one of those pontiac solstices :-)

My wife is a fan of garage saling and it is her summer hobby. Every Saturday morning she gets up at some ridiculous hour to go scavenge through other people’s junk. But she has managed to get tonnes and tonnes of kids stuff dirt cheap (books, toys, big plastic things that clutter up our back deck) but at a hugely reduced cost.

I also set up an ING account with a direct deposit on the same day as my paycheque to save towards a rainy day.

I use Microsoft Money to track investments and cash flow and spending. I am entirely too obsessive about it, but it keeps me happy knowing how much of our monthly grocery budget we have spent so far each month.

Q

Hi, Frugal,

Great summary of the SM. We are the main Smith Manoeuvre advisors in the Toronto area and have implemented it for more than 100 families, including many variations and enhancement strategies.

You summary is quite good. A couple of tips:
1. You can do it with as little as 10% down, as there are a couple of sources for 90% readvanceable mortgages.
2. No institution will capitalize the interest, but you can do it yourself with one simple transaction a month. This way, the SM uses none of your cash flow. The reason for this is that any of your cashflow used for debt should pay non-deductible debt.
3. After the mortgage is gone, the most effective strategy is to keep the investment credit line for ever. Once you are retired, there you will be very thankful for both this tax deduction and for having a large non-RRSP portfolio. For our retired clients with large RRSP’s and a large non-RRSP portfolio, tax planning is full of options. This is in contrast to those with only RRSP’s and pensions, who have no cash available they can take without paying full tax.
4. You’re right that the only real risk is the investments. Your dividend stock idea is sound, as long as you diversify enough. We tend to use tax-efficient mutual funds with what we call “all-star fund managers” (the Wayne Gretzky’s of the the investment world). We get good diverification, a long track record, stats to measure risk, and many have been 100% tax-efficient.

Good luck and I hope you find this helpful.

Ed

FT

A couple of comments about the SM. I did a little (very little) reading about it and it seems to me that while the idea is sound, I am concerned that it still involves leveraging your personal residence to make investments.

Taking what you posted in your Net worth post, wouldn’t it make more sense to flip your 38K in non-registered portfolio into the SM and then just keep paying down the non-interest bearing debt?

Also, you have a rental property. How much is that leveraged for currently? (if you don’t mind me asking). If you have room on the property, you probably can use that extra equity to leverage some investments, if you feel comfortable doing it.

Also, I remain skeptical of “capitalizing” the interest. You pay 500 in interest, you get a deduction of 500, but at 46% tax bracket you see a net cash flow of -270 (500 interest out – 230 tax reduction in). Plus the 500 is now adding extra interest costs.

I think you have to look at as “I have a mortgage of 75% of my house value and the payment will be X for the next 25 years” part of that X will be deductible, part will not.

I am probably more conservative in that I don’t believe in leveraging my principle residence to invest.

Just some added extra thoughts. Not to disuade you from investing using the SM, but just make sure you plan it out and look at the real cost/benefits.

Q

This is an interesting blog. I use leveraging to make my mortgage interest deductible. Obviously, I think it is a good strategy, but I am already into the fray for a few years now, and the project is providing handsome rewards given the large returns in the equity markets the past few years, and incredibly low interest rates. It makes it look like a no brainer, but it was far from a no brainer when I dove in. You can’t predict what the markets are going to do (otherwise, you would be on a beach in Bermuda talking about your first 100 million rather than blogging about when your first 1 million will be). If it was a sure thing that the markets were going to go up, everyone would be levaraging. But as one poster indicated above, levaraging is risky business that cuts both ways. Optimists see handsome returns and large retirement portfolios. Pessimists see losses and cash calls. If you undertook this maneuver with a lump sum investment from a HELOC in January 1973, you would be wishing you never heard of the Smith Maneuver.

” I will have to take the time to review the risks carefully before I dive in.”

I think these words are very appropriate in this dicussion. The risk is a bear market at the beginning of your journey that could take two decades to recover from, all the while you are paying interest on a loan with only a fraction of the funds to show for what you borrowed. That’s a tough pill to swallow, and therefore, this strategy is really not for the faint of heart, and is far from a sure thing.

NF

If I were to start today, I would have the same portfolio I have now which is diversified globally and in market cap. When I started, I crossed my fingers, and hoped that if the US or Canada (or both!) tanked, EAFE and fixed income positions would limit the losses. Diversification is your only protection, but nothing is guaranteed since the only thing certain about the stock market is its unpredictability.

NF

I am a do-it-yourself investor using a discount brokerage. While I have dabbled in individual stocks in the past, I generally did not guess very well, and gave up that exciting game for a boring portfolio of diversified low cost ETF’s.

Very nice job on the article. You state (and I’ve seen it stated in other sites) that the strategy should be to pay off the non-deductable mortgage with cash or other non-RSP investments first and then re-borrow to fund the SM.

What if the non-deductable mortgage is less interest than the credit line minus the tax deduction? Eg. non-deductable mortgage at 4%, Line of Credit at 6% and 30% tax bracket = 4.2%. In this case, does it still make sense to sell a non-RSP investment to pay off the non-deductable mortgage and then reborrow to pay re-buy the non-rsp investment?

Hi, FT, Q & Neil,

I’ve just been reading all the comments. FT, yes, I think you have the capitalizing right. You pay the interest from your chequing and then take the money out of the credit line to reimburse yourself for paying the interest. And yes, there are of course CMHC fees involved if you go to 90%.

The tax rule is that, if the interest is tax deductible, then the interest on the interest is also tax deductible, which is why capitalizing is useful. Why use your cash to pay tax-deductible interest when you also have non-deductible interest to pay (such as your mortgage).

You all mentioned reviewing the risks carefully before diving in. The strategy and tax rules are simple and work. The only real risk is with the investments. If you invest effectively, can tolerate the risk and will stay invested for the long term, then the SM is very profitable.

Neil, you have exaggerated the risks of the stock market, like most people do. The figures often shown about the markets being down for 20 years always exclude dividends. The longest period the markets have been down since the 1930’s has been 6 years, when you take the total return. This was from 1973 and from 2000, which were the 2 largest bear markets in the last 60 years.

FT, your dividend strategy is sound, but dividend stocks have had a perfect storm lately. Long term, you should only expect 8-10% from dividend stocks, since they are very mature companies.

We tend to use equity mutual funds managed by managers with long term records of beating the indexes at low risks than the markets. There are managers with 15-30 year records of beating the markets by wide margins with returns of 15-19%after all fees) and lower standard deviations.

The advantages of mutual funds are that many come in tax-efficient corporate structures, so that they have never paid a distribution. With dividend stocks or fixed income investments, you lose much of the gain to annual tax on the investments. The risk is measureable when there is a long term track record and mutual funds offer all kinds of risk stats (such as standard deviation, alpha, beta, etc., and correlation between investments). The risk stats vary in different markets, but if you look at them in the worst times (such as 2000-2), you can be relatively confident that that is about as bad as it will ever get.

The main risk that you do-it-yourselfers face is trying to time markets or trade. Several studies show that the average investor only makes 1/3 of the investments they own, because they tend to always buy high (something currently “doing well”) and sell low (something currently “not doing well”). It is always tempting to sell when your dividend stock or ETF struggles and to buy something that has just had a few good years.

This is actually your main risk, since studies consistently show that the average investor loses most of their return by trading, because trading consistently means selling low and buying high. Your best strategy is to research your investments well and then hold them forever, especially if they go through a few bad years. Only own investments that you would be comfortable owning all the way through bear markets.

Hope you find this helpful.

Ed

Ed,

Where do you buy these mutual funds with 15%-19% return after fees? I’ve been looking for them. I searched through MorningStar.ca, the best funds with over ten years track record are mostly Canadian dividend funds managed by the banks. They only made between 13% to 14% for the last ten years.

FT,

Your article is marvelous.

There is only one thing I can add. Going through all the comment, I realize that a lot of people have the perception that the Smith Manoeuvre is pretty risky. It is not. It is much less risky than the original purchase of the primary residence.

Let’s thing about it. For the original home purchase, if you had put a 30% down, you had 3.3 times leverage on that investment. If you had put only 10% down, that was a 10 times leverage. And, the worse part, the whole quarter million to half million investment was made in a single shot, at one particular market price.

On the other hand, when you employ the Smith Manoeuvre, you are only taking out the portion of your home equity which you already paid off. Technically, you are not leveraging at all. On top of that, you can take out a fixed dollar amount every month from your HELOC to invest on your favourite stock or mutual fund. You get the advantage of dollar cost averaging. That is, it really doesn’t matter whether the market goes up or down in the short or medium term. If the price goes down, you accumulate more shares, if the price goes up, you accumulate less shares.

As long as your stock or mutual fund grows faster than your interest cost in the long run, you are ahead on the investment. You don’t even have to play the risky game of market timing like the purchase of your residential investment.

Let’s look at some hard number. Between 1978 and 2005, the average price of Vancouver’s detached house rose from 77,778 to 658,910, the volatility was 21.72%, annualized price increase was 8.24%. In that same period, the TSX Composite Total Return Index rose from 1,436 to 26,619, the volatility was 16.31%, average yearly gain was 12.58%, annualized gain was 11.42%. In that 27 years, the average detached house price in Vancouver rose 3.18% less than the TSX Composite Total Return Index per year, but the volatility (aka risk) was 5.41% higher.

So, if you were in Vancouver, the SM approach for investing is less risky than the detached house investment.

Let’s look at the investment return. In that 27 years, your average HELOC interest rate would be 10.84%. If you were in the 30% tax bracket, that would reduce your effective interest cost to 7.4%. Your investment funded by the home equity would have made a 4.02% annual return. That only beat inflation by a little, but that is extra return in addition to the price gain of your primary residence. And you did not invest any extra money out of your pocket. Thanks to Fraser Smith.

Best wishes on your million dollar journey.

EZ

I’m planning to implement the Smith Manoeuvre on a 65% mortgage totalling $215,000 (huge down payment) new condo unit here in Toronto.

Can anyone recommend a financial consultant who can take me through this? I don’t really feel like calling up the 60 or so qualified individuals listed at http://www.smithman.net :/

Hey Fred,

Thanks for your explanation. What is your investment strategy?

FT

Hey Splash,

Thanks for your comments.

There are some arguments that the risks involved outweigh the benefits. My counter argument is if you’re planning on living in the home for the long term, and investing for the long term (investing in strong dividend paying co’s), why would a down market in real estate or stock market bother you? Just keep collecting those increasing dividends (which are resilient to market down turns), and the market will turn around eventually.

FT

Tetris,

If you need help setting up the SM, we are the main SM advisors in the GTA with over 150 families doing the SM monthly. We are only looking for serious clients, though, so we will want you to attend one of our unique seminars before we would meet. It is not a waste of time, since we address the main issues (mainly emotional & investment). 2/3 of our seminar is not in the SM book.

If you are a do-it-yourselfer, we can still help you get the right mortgage. We know the pros and cons of every SM mortgage and have contacts with the banks (some of the big 5) with the best SM mortgages.

Click on my name if you want any more info.

Ed

Shaun:

Valid points, but you neglect to point out the effects of taxation @ RETIREMENT. With an RRSP, your portfolio is taxable as INCOME upon withdrawal. Your SM account though will face the preferential tax treatments of capital gains and dividends (my article on investment taxes).

You also give the RRSP an annual return of 15% and the SM an annual return of 10%. Is this realistic? If you earned $150 in capital gains in a taxable account, only $75 is taxable, which would probably leave you with around $120 after taxes. So 12% would be a fair annual return for the SM assuming 15% for RRSP.

On top of that, I believe that an efficient way to invest the SM money is through the purchase of dividend paying co’s (Canadian preferably). Buy strong dividend paying companies, never sell, collect increasing dividends/year. In certain tax brackets and provinces, you can pay as little as 0% on dividend income (article to follow). Does your analysis change then? So with this scenario, you get TAX FREE SM growth, a tax deduction / year, AND reduced taxation at retirement. I will bet that this scenario will beat the RRSP every time(providing that you invest in the same vehicles in the RRSP).

I’m not saying that the RRSP is a bad way to go. I think it would be prudent to build BOTH your RRSP and SM. Both have their advantages.

ED:

Thanks for your insights. However, I’m not sure that I agree with your statement that you’re “leveraging real estate”. I would agree with that statement IF you used the HELOC money to buy rental property, not stocks.

FT

Shaun,

Another great comment, thanks for sharing.

Say that your numbers are correct.  Perhaps the SM is NOT a method to REPLACE your RRSP, but to supplement it. Why not invest in both your RRSP AND the Smith Manoeuvre? Not just one or the other? You have a maximum contribution limit / year on your RRSP, and if you capitalize the interest on the SM (see article), you’ll never have to pay for it out of pocket.  So it will be kinda like what i’m doing now, maxing out my RRSP, and putting any excess into my non-reg account.  Except with the SM, instead of putting the money into my non-reg account, i’d pay down the non-ded mortgage and re-borrow to invest from the HELOC.

A more fair comparison would be SM vs traditional non-reg portfolio/paying down mortgage.

Another point about dividend paying stocks, as long as the dividends keep increasing, the stock price will follow. I doubt that we’ll see growth over the next 5 years as we did see during the last 5 years but they are stable and give you a guaranteed return (providing that you don’t sell on a down turn). If you buy the strong dividend paying stock on a DIP, you will get strong returns.
FT

FrugalTrader,

BTW – didn’t me to ignore your other points: I would love to see someone run some scenarios and numbers to see how this compares!

But for me, I know now, that I won’t be using the SM. I am currently 40 years old, married with two kids. We have a house valued at $700,000 and a mortgage of $150,000. From here, I am going to borrow against my HLOC to top up my RRSP deduction limit, and make my maximum RRSP contribution annually, while I pay off my house. Very conservatively at retirement in 20 years, I will have in excess of $2,000,000 in my RSP, and a paid up house worth about $1,200,000 million (assuming 3% annual growth in it’s current value). I think that will keep us happy until death. :-)

I really have no significant experience in dividend paying stocks, but if you have a system that works, just use those numbers in your calculations. The major issue for me has been finding enough growth in the Canadian markets. My portfolio is usually 80% us, 20% cdn; therefore, with my approach, I see no disadvantage to continue investing in my sheltered RSP. I will say the major disadvantage to investing in the US markets within my RSP, is by law, the account can’t hold US cash, so I am always getting dinged on the conversion. There also has been reduced earnings due to the currency fluctuations in the past few years.

Shaun: Congrats on building up your nest egg! Regardless of if you use the SM or not, you will come out just fine in the end. With regards to your USD conversion problem. Apparently, TD bank will allow you to sell your US stock and transfer the money to a USD money market fund, thus avoiding FX fees. I believe it’s called wash trading. Here is the link on Canadian Capitalist for more info.

Chris: Thanks for posting the spreadsheet.

Ed,

Thanks for the insight on how to pick the high return mutual fund. It is a very smart idea to choose the jockey rather than the horse.

Yes, the Vancouver real estate market was pretty volatile in the last three decades. The figures I used was the detached home, the figures for attached home and condos was less volatile. And, with less appreciation of value, it was about 5.8% per year over the last two decade.

EZ

Ezboy: Yes, although the SM offers a tax refund, it is NOT a replacement for the RRSP. If you work out the numbers, the RRSP will out perform the SM in the long run.

CK:

1. You are right with the mechanics of capitalizing the interest. Simply withdraw the interest payment required for your heloc FROM your heloc, and redeposit.

2. You can utilize the SM with your new mortgage, IF you have substantial equity in your home (>>25%). The only disadvantage now is that you wont’ be able to get an increasing credit limit on your heloc as you pay it down. If you want to do the SM at this stage, pay down your mortgage as much as you can, or as much as your terms will let you, and obtain a new HELOC. You “could” pay down your mortgage every year, and re-apply to get your HELOC limit increased, but I believe that this will require a new application every time. Another alternative is to take the penalty and move to another mortgage, which is undesirable. If your mortgage is already with RBC, perhaps they’ll switch you to the homeline mortgage for no penalty?

3. Can you clarify this question? Did you mean that if you’re income increased, who should claim the tax deduction?

4. IF you like mutual funds, go to http://www.morningstar.ca, they have a great rating system and screener available.

Hope this helps, FT

Thanks for the answers. It is a little unfortunate (for us) that we have decided to give SM the green light the night we signed our mortgage (i.e., last night), thus limiting our options on HELOC. Our mortgage is with TD, and I don’t think they have a mortgage product similar to ManulifeOne or RBC’s Homeline.

As it currently stands, we are only borrowing about 65% for the mortgage, leaving us with roughly 10% available credit if we apply for HELOC now. I’m not sure if TD’s HELOC automatically adjusts the available credit every month. If they don’t, how often do we draw money out from the HELOC depends on the hassle required to ask credit increase.

Since it’s RRSP season, we’ll probably wait a month or two before jumping into the market. On the bright side, if we zealously pay off our mortgage for the next quarter, including the capital originally set aside for investment and tax refund (but excluding the RRSP amount), we probably have another 10-15% credit available. It may be better to get our HELOC then.

I was more concerned about reduction of household income than a huge raise. This reduces the amount available for mortgage payment, slowing the process of mortgage-to-HELOC conversion.

On an unrelated note, the math we did to arrive at the decision to go ahead with SM is different from what I’ve read so far.

CK

CK,

TD Bank has a readvanceable mortgage that works better for the SM than Manulife or Royal. They just call it a HELOC, from which you can lock in a portion. They don’t have a variable rate on the mortgage within the HELOC (which saves you the most money), but they might well backdate your request to change to a HELOC. Manulife and Royal are actually more awkward for the SM than some of the other banks.

If they won’t backdate a change, I believe TD will convert your mortgage to a HELOC without charging a penalty. Let me know if you have trouble with this, because I have a good contact at TD (the one mentioned in the SM book).

If nothing else, I’ve done the calculation many times and I think you will find the SM benefit over 5 years will be significantly more than your penalty.

By the way, did you take a 5-year fixed? I saw a study going back to 1950 that shows that 5 1-year mortgages or variable mortgages would have saved you money 100% of the time over 5-year fixed?

Ed

EZ,

I have a better suggestion for you. RRSP and SM are not either/or. If you decide on RRSP, add it to your mortgage – don’t use the HELOC. Even if your mortgage is not due, several banks allow multiple fixed mortgages within the same readvanceable. The mortgage will be a lower rate than the HELOC, and this will allow you to also do the SM.

As for your calculation comparing the SM & RRSP, I think you will find the best choice is based on optomizing your tax brackets each year. The SM doesn’t use any of your cash flow, so there is no reason not to do both. In all likelihood, you will both fully convert your mortgage and max your RRSP during your work life. Just figure out how much of each will maximize your tax refunds over your work life based on your tax brackets.

The actual difference may vary depending on your circumstances and assumptions. RRSP gives you a bigger refund sooner, but is only a tax deferral. The SM can give you refunds possibly all your life, depending on how tax-efficient your investments are.

If you want to have a clear benefit, combining the SM with additional leverage can make it clearly better than RRSP’s. For example, the “Rempel Maximum”, where you calculate the maximum additional leverage on which you can make the payments completely from your readvancing mortgage payments. With an enhancement like this, the SM will clearly be better than RRSP’s. However, you can still do both, since the SM requires none of your cash flow.

FT,

Since when have you been concerned about the risks of the SM? I thought you were very confident in your dividend strategy. The risks of the SM are really only in the investments. And the break even point is quite low.

Based on studies by Talbot Stevens, the breakeven point for leverage in general is 2/3 of the loan interest rate over 5 years, or 1/2 the interest rate over 15 years. So, if your HELOC is at prime, you only need to make 4% over 5 years or 3% over 15 years to break even. This is because of the different tax treatments and because the investment growth is compound growth while the loan interest is simple interest.

While I prefer a different investment strategy than you, your dividend strategy should also work just fine.

I was just surprised to see you comment on the risks of the SM, FT.

Ed

Ed

Ed,

Are you sure you have your information correct? The subaccount’s limit does not have to be “increased”. Provided the combined value of your M1 main account and subaccount do not exceed 75% of the appraised value of your house, there is no need to call.

My transfers are done monthly and automatically between my M1 account and my investment account (i.e. at the beginning of each month $1500 is removed from my M1 account and invested in 15 stocks with my Shareowners account – I then increase my Investment Line of Credit by $1500 by using it to credit my main M1 account). There is no phone call, one of the transactions is done automatically, and the other is done manually online, taking all of 30 seconds. Again, I’m not sure why you’d call this “awkward” and I don’t really get what you mean about about a subaccount “limit”.

With respect to mortgage rates, you are correct – M1 tends not to be as competitive. However, I can live with that given that everything that I deposit into that account is automatically applied to the mortgage, rather than me having to manually make the “extra” payments at a traditional bank myself, and being limited in my pre-payment options (which was the case with my old RBC mortgage). Given that our expenses vary on a monthly basis (CPP limits reached, insurance due, etc), it was a pain in the rear to have to do this manually every month and ONLY on the payment date. That’s my definition of awkward.

Anyway, I think you may want to revisit the Manulife One product – based on the inaccuracies of your previous post I get the impression that you may not completely understand it.

Chris

Ed,

Thanks for the suggestion on the Rempel’s maximum. I just finished the spreadsheet and confirmed that the Rempel’s maximum make a big difference on the investment return. It beats all other strategies I came across.:)

The only setback I found so far is that I may have to sell a tiny portion (about 0.2% of a $200K portfolio for 17 months) of the investment in some odd years to cover for cash defficiency. Also, there are years which I might have a bigger credit line loan than my investment portfolio’s market value.

Nevertheless, the strategy yields almost twice the return of the other strategies in a 25 year investment span. I apply the Rempel’s Maximum to a Vancouver detached house purchased at the average price in 1981, and invest the loan money on a TSX Composite index fund. After 25 years, in 2006, the Rempel’s Maximum strategy produces an annual yield of 2.81% after tax and inflation while my next best strategy yields only 1.74%. The conventional mortgage yields only 1.34%.

WORD OF CAUTION: If you are an investor who is considering the Rempel’s Maximum, make sure you fully understand the math behind it. In some odd years or poor implementation, it may not look pretty on paper.

Ed,

Thanks for the tip. We have already set up another meeting with TD on Saturday, and I’ll ask the FSR if we can switch to the HELOC without penalty.

With just the HELOC, I wonder though, for taxation purposes, how do you differentiate the tax-deductible debt from the non-tax-deductible part?

FT,

I have to clarify that we are comfortable with investment in general. Due to the small capital we (individually) had in the past, we have only held a small number of stocks at any time. We are just not familiar with mutual funds.

CK

FT & EZ,

The Rempel Maximum is an enhancement to the SM that is the maximum possible benefit of the SM, without using any of your cash flow. The benefit is usually triple the Plane Jane SM (but depends on the situation). It is for people that believe in leverage and are comfortable with their investments, even when they get to be large amounts.

It involves the maximum leverage that can be financed from the SM. For example, if you are paying down $500/month principal on your mortgage, instead of investing the $500, you multiple by 12 and divide it by the loan interest rate (say 6%) to get the maximum loan you can finance from the $500/month (in this case $100,000).

In short, instead of investing $500/month, you would borrow $100,000, but the payments are all made from within the SM, by readvancing the principal portion of the mortgage payment. So, you have a $100,000 investment on which you never have to make any payments from your cash flow.

The $100,000 will grow much faster than the $500/month would grow. And while the $500/month will increase as you pay increasing amounts down on your mortgage, you can use this to increase the loan every year or 2, still without ever using any of your cash to make any payments.

The investment loan could be from using your secured credit line within your readvanceable mortgage (if you have enough equity), or it could be a separate investment loan (or some combination of the 2).

EZ, I don’t know how you did your calculations, since you mentioned requiring the use of a bit of cash flow in some years. Also, my simulations get rates of return about 5% (about 4.5% after tax if you assume total liquidation after 25 years, which we wouldn’t actually do), which is slightly higher than the Plane Jane Smith Manoeuvre, but on a much higher dollar amount. These rates of return are quite good, considering that they are on a large loan, that they are after all loan interest payments, & that none of this is from your cash flow.

The projected benefit of this is surpisingly high. For the SM, it is typically about double the starting mortgage over 25 years. The projected benefit of the Rempel Maximum is typically about triple that number, or about 6 times the starting mortgage.

Ed

Ed,
I understand the Rempel Maximum now, it is mainly for people who have close to 25% equity in their home and are looking to invest the maximum amount right away instead of waiting until they pay off the mortgage. How would the rempel max work if someone already had a LOT of equity in their home? Or someone who has their mortgage paid off? Also, is it difficult to get ANOTHER LOC in ADDITION to your HELOC?

FT

Hi, Chris,

Manulife One obviously works well in your case. I’ve just found there are better choices out there for the average person. Where I have used it is for the odd cient with no mortgage. Let me give you an example.

Let’s take a client with no mortgage and money in savings that wants to do leverage. If the credit limit is $300,000, we can invest the full $300,000. But since he has $20,000 in savings, the Manulife One balance is $280,000, but the subaccount is $300,000. The advantage here is that his chequing account is getting about 4% daily interest.

Now the home rises in value. Every 2-3 years, we like to get the house reappraised to increase the value. If the limit is now $350,000, we can either invest the extra $50,000, or we can keep it to use to capitalize the interest on the leverage account. Now if I want to increase the subaccount from $300,000 to $320,000 to capitalize $20,000 of interst, it requires a phone call to Manulife and they actually need to collapse the subaccount and create a new one with the higher balance. We would like to capitalize this interest monthly, but it is too difficult. We just do this once each year.

Does that clarify the situation, Chris? Yes, this is an unusual situation and I’ve done hardly any of them.

So, you say Manulife reappraised your home and increased the total limit without charging you legal fees? I’m impressed. I was not able to get them to absorb the fees, even for my own Manulife One mortgage. What’s your secret, Chris?

So, I just get a 2nd HELOC put on after the Manulife One. Some banks will do that for free, if you use it.

Yes, we are talking about the same Manulife One. I understand why you like it. I realize the subaccount tracks your tax-deductible interest, but that is only as long as you make sure that you match transfers from the subaccount to automatic investment purchases. We tend to work with some bank HELOCs, where the investment purchase is directly from the credit line.

You are doing it yourself, Chris, so you can make sure it works. I am working with clients and have to hope they follow my instructions and make sure they transfer the $100 every month, for example, from the subaccount to the main account, when the investment purchase of $100 is made from the main account.

I’m not suggesting you change it, Chris, since you seem to know what you are doing. I just find I can get mortgages with more competitive mortgage rates and less risk that the client will screw up the tracking or their tax deductions.

Ed

Ed,

Thanks for clarifying – it all makes sense to me now. With respect to “my secret”, if I remember correctly, provided the re-appraised value results in an increased valuation greater than a certain threshold (I think $20K is the magic number), then M1 bears all of the costs. In my case we went from $425K to $580K (thanks to the crazy real estate market out here), so they didn’t charge me anything. I imagine in most situations, an increase of $20K every couple of years is not realistic.

Again, thanks for taking the time to clarify the points I wasn’t understanding.

Regards,

CF

If the above understanding is correct, the essence of SM is that you invest with a loan secured by your home property. The only benefit of SM is that it allowes you to invest without putting extra cash.

So you must be very careful to ensure that you can earn enough money to cover the interest paid. X must > Y.

FrugalTrader,

Thanks for the reply! Actually your answer is another way of what I said.

Say your annual income is A, tax rate is 40%, your HELOC investment profit is X, interest is Y. Your overall income is A+X, then you deduct Y. The tax you pay is: (A+X-Y)*40% = A*40%+(X-Y)*40%. If you don’t do SM, your tax is: A*40%. The difference is (X-Y)*40% (the 50% tax exempt rule for capital gain may be applied). If X>Y, you win and pay more tax (no impact to your income A).

If X less than Y, you lose and pay less tax, but that’s definitely not what you want from SM.

So SM is still a way to invest with loan. There is no tax benefit of doing that. The tax rule makers are not stupid. I never doubt that.

Of course, SM still has the advantage of NO CASH OUT OF POCKET.

John: “So you must be very careful to ensure that you can earn enough money to cover the interest paid. X must > Y.”

John, you are correct that one must try his/her best to make ensure that the rate of return on the investment (X) is greater that the cost of fund (Y). However, even if the return on investment is slightly lower than the interest cost, it will still be financially beneficial.

Let me explain it with an example. Let’s say you are in the 40% marginal tax bracket. Your investment interest cost is $1000 for the year. On your investment, you earn $800 as capital gain. Since capital gain is only 50% taxable, so only $400 is taxable. Therefore, for tax purpose, you pay $400 x 40% = $160 for the capital gain, and the after tax gain will be $800 – $160 = $640 .

On the interest cost part, the entire $1000 is tax dedeuctable, so it reduces your income by $1000. This translates to $1000 x 40% = $400 tax saving. When you add together the after tax gain of $640 and $400, you get a total of $1040. This is $40 more than your interest cost.

So, despite your investment earn $200 less than the interest cost, you still make a small after tax profit of $40.

EZ

Does anyone know or deal with CIBC and employ the SM along with a HELOC? I’m considering M1, but struggling with the .9% difference in rates.Seems silly to me to give up a better rate for the convenience of one blanket account

Hi ED & EZ:

Thanks for the comments! But I still have some questions.

“Capital gains are only 50% taxed, while the interest is fully deductible (as EZ mentioned).” But deduct from where? By my understanding, if you have loss or expense from investment, you can only deduct it from investment gain, either backward or forward, but not from any other income sources. For example, if I loss in stock, I can only claim the loss first and deduct it from future gain in stock. I can’t deduct it from my permanent job income.

So is the rule different in SM? Did anybody confirm it with an experienced accountant or CRA agent?

Thanks,
John

John:
If you have an investment loan, according to CRA, you may deduct the interest against your income IF you have an expectation of income from your investments. According to the finance department(2003), they require an expectation of “profit”. So, according to Tim Cestnick (a tax pro), CRA will not enforce the finance departments decision to only allow tax deductions IF the investments are profitable.

In Quebec however, you can only deduct the investment loan interest against your investment income.

Hi, John & FT,

You guys are confusing capital losses with interest costs. A capital loss can only be netted against capital gains. You cannot claim a capital loss against other income on your return.

However, interest from the SM is claimed as a “carrying charge”, or investment expense, which can be claimed against other income (except in Quebec).

Your formula may be approximately right for year 1, John, if you sell the investment every year on December 31. However, if you keep it and it is tax-efficient, the tax on the gain can be deferred almost indefinitely. Also, your formula understates the gain, since the investment profit compounds on itself, this profit will be higher every year, and far higher after 20 years of compounding.

Ed

Hi, John,

All of those fees would be considered “carrying charges”, except for the trading commission. That is part of the capital gain calculation (adds to the cost of reduces the proceeds of sale).

The breakeven on leverage, in general, based on studies by Talbot Stevens, is 2/3 or the interest rate after 5 years, or 1/2 the interest rate after 15 years. For example, if you borrow at 6%, your investments will need to make only 3%/year over 15 years for you to break even after tax (surprising, but true).

The specific investments need to be chosen very wisely. They should be less risk than your RRSPs or other non-leverage investments, but tax-efficient. We prefer not to publish our favourites, but we focus on finding the world’s best fund managers available to us (we call them “All-Star fund managers”).

The 2 big risks in the SM are choosing bad investments and being a bad investor. The 2nd one may sound funny, but most investors consistently buy high (something “doing well”) and sell low (when it is “not doing well”). Many studies have shown investor behaviour consistently wipes out most of investment gains.

To avoid these to risks, it is best to hire professional fund managers (use top mutual funds) & work with a trusted advisor. If you own mutual funds, you are already paying for comprehensive financial advice in your MER, so why not get the professional advice you are paying for?

Ed

Maura: “… I do have one question on EZboy’s post (#67). It looks like your calculation shows an 80% ROR. Am I reading it wrong?”

The calculation did not make an explicit assumption on investment return. The $1,000 is the total interest cost for the year, not the investment loan amount. Let’s say you can borrow money from the HELOC at 6%, $1,000 interest cost would mean an investment loan of $1,000 / 6% = $16,666. For the $16,666 to yield a $800 capital gain, that is about 4.8% ROR. Therefore, you can still make a few bucks even if the investment return is somewhat lower than the interest cost.

On top of that, since a person normally won’t realize the capital gain every year, the capital gain tax is deffered. On the other hand, the interest cost is carrying charges, so it can be claimed as tax deduction every year. If you hold the investment for a long time and take inflation into account, the tax defferal will make a big difference.

EZ

Warren,

As long as you can keep a paper trail of your transactions, you will be alright according to CRA.

FT

FrugalTrader:
Thanks for this discussion about the SM. I read it and used it when making my decision about starting the SM. Mind you, I also read Fraser’s book 3x and have the SM Calculator software too. My RBC Dominion Securities advisor is online with me doing this. We see no more risk in this than having an RRSP exposed to the stock market via mutual funds. I have 19 years until retirement, plenty of time to help eliminate the odd correction. My mortgage will not last 12 years. In the end, the SM is going to be one of three income streams for us into retirement. Pension from work & RRSP being the others. I don’t count on seeing a dime from CPP.

Why not just switch your mortgage to a HELOC and start paying interest only right away? Why bother going through all that extra time of making principal and interest payments on the mortgage. From my understanding of the SM, you are paying down your mortgage until it is fully a HELOC. Makes more sense to me to just get a HELOC to begin with and save that extra money that was going towards the mortgage.

FrugalTrader:
I understand that the interest paid on the principal residence is not tax-deductible. That is why you use your net worth to take out an investment loan. Granted, you will pay slightly higher interest, generally about 6.75% on an investment loan these days, but you will still get a nice tax write off. Also, for people who already have more than 25% equity in their homes, they can use a portion of the HELOC to pay to cover their existing mortgage, and use the rest as an investment portion.
Example: Home value $400K
Balance remaining on mortgage: $200K
This example shows 50% equity. On this home, you could take a HELOC of $300K (75%) Pay off the $200K mortgage, and put good chunk into investments as well. Keeping in mind that real estate values pretty much always rise, the home value will increase over time. Although your principal on the HELOC is not getting paid down, the amount of equity in the home is rising and would allow you to take out more later on.

To add to my comment above, another advantage to doing a full HELOC is that if you do have more than 25% equity, you can use this to consolidate other higher interest debts. In the above example, you have $100K leftover after paying off the mortgage. Let’s say you have $20K of credit card debt…take that from the $100K, and use the rest as investments. $80K from the HELOC would cost $400/month which at 40% tax would be $4800 (annual interest) x40% = $1920 tax refund. Use that to start paying down the principal on the HELOC, and after 20 years (assuming you don’t borrow any more to invest later) You’ve paid down $38400 of your principal.
Another way you could do this would be a source deduction through CRA. $1920/12 = $160/month. A source deduction for those who don’t know, is where instead of giving you the tax deduction when you file your income taxes, they give you the tax deduction monthly. $400/month off of your cheque each month would get you a return of $160/month, so technically you’d only be paying out $240/month. This is an advantage for people worried about cashflow.

JCK: That is incorrect, a HELOC is compounded monthly, where a Canadian mortgage is compounded semi annually. If you work it out, with both rates being the same, the HELOC will come out more expensive.

Gentlemen, JCK and Frugal,

Inndeed, the mortgage compounding and the M1 are so different, that this difference alone, combined with the tax refunds provided by the SM, is enough to make the strategy work.
The monthly payments on the M1 compared to a mortgage of the same amount will be less, even if the interest rate is a full percent higher on the loan.
JCK, you would do better, if you have read the Book. There is no reason to doubt the efficacy of the SM in light of the many successful and profitable applications.
In fact, I am willing to risk the prediction that in about 5-6 years the frequency of SM will equal, if not surpass, the frequency of traditional mortgages.
Not only is it servicable in the conversion of mortgages, but as I find, it is great to start with it at the time of purchasing the home.
Especially so, since about two weeks ago, when the rules of CMHC requirements were changed to the advantage of home buyers; the advanceable portion now is 80% before insurance is required.
I found this out a week ago, when I menaged to help the buying of a house by one of my clients with the SM, up front, with 20% down payment.

Chris,

My claim was not as bold asit seems at the face of it.

The M1 was started in Australia 12 years ago, from nothing. They never advertized it and yet today 54% of all houses are purchased with M1 there. But they don’t have the SM, since that is predicated on the Canadian tax system. I really don’t know if they are in the position to do anyting like it. But we are! The M1 type product combined with the SM are more potent than the M1 alone. Therefore my estimate is not overly bold. It has a very promising future.

When I used M1 and told other people about it, I’d say roughly 10% “got it”, but they in no way, shape or form ever considered it for themselves. As I did more research (after the fact – and thanks to this place and Red Flag Deals) I realized that the weakness of the product is going to hinder its growth. Not only are they asking people to forget about the traditional mortgage (and the mortgage their parents had, and their parents had, etc), but you are asking them to pay a higher interest rate for the privilege of a new way of thinking.

With respect to the SM, you are under the assumption that more than 50% of mortgage holders are (a) comfortable with carrying their debt position longer than they originally anticipated, and (b) comfortable with investing in products that they anticipate will return a higher interest rate than their HELOC (minus the tax deduction). That simply won’t happen.

It would be great if your prediction proved to be accurate, but I think you are dreaming.

Dude, you can save the calculations and you don’t have to lecture me on the benefits of the SM. I use it. But because I am comfortable with leveraged investing doesn’t mean MOST people are. MOST people want to eliminate their debt. Until most people change their thinking about wanting to eliminate their debt, most people won’t use SM.

If you want to know how Canadians feel about mortgage debt, I suggest you read this: http://www.rbc.com/newsroom/20070502ownership.html.

I also don’t need to be lectured on the benefits of M1. I used it. If you like I can email you my M1 interest payments versus my BMO interest payments and you can explain to me how I was actually paying less interest with M1 @ 6% versus BMO @ 5.15% when in fact I was paying more. My BMO mortgage is open so I can put any additional funds I have on it just like I did with M1, and as such I will pay off my mortgage debt faster than I would have with M1. The only difference is it is a manual transaction versus an automatic one, and sorry, the convenience of it happening automatically ain’t worth an extra $2K+ per year in interest.

If you want to quote Ed Rempel, you should know his feelings of M1 versus other competing products and he’ll tell you that M1 isn’t worth it. I know this because it was his advice that I followed when I made the switch.

Sandor: Manulife introduced the M1 to Canada in 1999. They currently claim some 30,000 customers. It would seem that they have a long way to go to capture 50% of the Canadian mortgage market. I also note that in the UK, the premium for ‘one’ accounts is not as great as here in Canada. I do not know if the same holds for Australia. As such, if I wish to amortize my mortgage, M1 is more expensive than a traditional mortgage.

JCK: It would appear that your strategy is dependent on a continuing rise in the real estate market. While some parts of the country have seen tremendous growth, other parts have been flat, or declined. Many purchasers, and most lending institutions wish to reduce the exposure, and look to a reduction of the outstanding principal on a loan. If you are offering an interest only proposal to your clients, both you & they must be very comfortable with the liklihood of continued rising RE prices in their market.

Uh, who pays the banks posted rates?

JCK:

I am not sure I follow your HELOC strategy. Can you provide more concrete example?

From my understanding of your comment, let’s say you have a $300k HELOC with a monthly interest-only payment of $800 vs. a monthly interest+principal payment of $1000 for a mortgage, SM or not. What do you do with the extra $200 you claimed you “saved”?

Assuming you invest the $200 in the same manner as you would with SM, what are the differences between SM strategy and HELOC strategy at the end of SM (i.e. when the full mortgage is converted to be tax-deductible)?

CW

Although I think leverage can be a useful tool in moderate quantities, I’m not a fan of the SM for the reason that it keeps your debt at a level which may mean too much risk for most investors.
JCK – you seem to take the SM a step further and borrow even more than the original mortgage amount which I can’t imagine is appropriate for the vast majority of people.

JCK,

Interesting leverage strategy. The 2 issues I see with it are:

- the non-deductible mortgage does not get paid down, since you are paying interest only.
- the interest rate is higher on a HELOC than on a mortgage.

The SM has some significant advantages. The mortgage is fully converted to tax deductible over time. With your example of a $300,000 mortgage paying $1,700/month, you would be paying down $525/month of principal. This entire amount can be invested each month, not just the $200.

You could also use this $525/month to finance a leverage loan of up to $105,000, instead of investing it monthly, with a variation called the Rempel Maximum.

The SM is a little tricky to implement, but well worth the effort.

Ed

Hi JCK,

The $525 is the amount of principal being paid down on the mortgage each month in your example. With the SM, $525 of the mortgage is converted to tax-deductible every month. And you can either invest $525/month without using your cash flow or you can use $525/month to make the payments on a leverage loan up to $105,000. So, you could invest up to $105,000 without using any of your cash flow.

With the SM, the non-deductible mortgage is already being paid down, but you could ALSO pay it off faster by selling some investments to pay down the mortgage, and then reinvest.

The strategy of selling the investments to pay down the mortgage and then borrowing to rebuy them (thereby paying down the non-deductible mortgage) is usually not worth doing even though it makes future interest tax deductible, because of the capital gains tax you would have to pay up front when you sell the investments.

Actually, a HELOC is interest compounded monthly while a mortgage calculates interest with a formula based on semi-annual compounding. Even if the HELOC was not at a higher rate than the mortgage, the same payment will pay down a mortgage more quickly than a HELOC of equal size.

Ed

Hi JCK

I have mortgage amortization software. If you have a 300,000 mortgage and are paying $1,700/month with a rate about 5%, then the principal portion of the first mortgage payment is about $525. It then increases with every payment.

Interest on a HELOC is calculated and charged monthly. It is simple interest within the month, but it is charged and needs to be paid or compounded every month.

The formula on mortgages are based on semi-annual compounding. While banks show it on each payment, the interest calculation is based on assuming that 100% of all payments are applied directly to the principal for 6 months, and then the interest is charged. So, the interest is charged only once every 6 months – instead of every month as with a HELOC.

Ask any banker. Interest on a mortgage is less than on a HELOC of the same size and interest rate.

Plus, of course, the mortgage is always available at rates well below prime, while HELOC’s are almost always at prime.

Have a look at the SM, JCK. It works more effectively than the HELOC strategy in every aspect.

Ed

I wish to address Sandors comments in post 66:

> 1) The numbers would prove to the contrary. Whether you have an RRSP or not, the large non-registered investment can only benefit you.
Really? Can you show me how?

If you read the post, you will see I compared equal investments in SM vs. RRSP (from post 30), assumed the BEST possible tax treatment for SM (deferred capital gains until withdrawal), and showed that the individual with the RRSP would be able to live on a 66k after tax retirement income for 21 years, vs. the SM at 9 years.

> 2) They don’t take a piece of your pie at all. They create the pie for you in the first place and as long as you make a lot of money by “doing the right thing,” without any sacrifice, why should you begrudge if the advisor is paid for his work and skills?
My point was, they stand in conflict when the advice they provide makes them money, when alternatives make them none. If you are going to choose to go with an advisor, I think it is important to consider this.

> 3) You would be better off by paying off your house and amass a non-registered portfolio, because:
> a) that is always at the ready in case you need cash for unexpected expenses and
And what if your investments didn’t pan out? Will you have the cash? Also, you can always pull cash out your RRSP if you needed to, but you will taxed of course (which can be thought of as a claw back of the tax deduction you were given at the time of the deposit – which you have used interest free to build your portfolio).

> b) in your retirement the taxes will be less, since you already paid the income tax when you earned the income, unlike in the case of he RRSP.
Read post 32 – I demonstrate that although your taxation is higher with the RRSP, your investments have grown to such a point that they last a whole lot longer into retirement. The focus on taxes is irrelevant, the goal is a long and wealthy retirement. If I pay twice the taxes every year, but have an income of 66k for 21 years, but the SM person pays half the taxes but can only have an income of 66k for 9 years, who did better?

> By the way, the capital gains tax can also be avoided with a bit of planning.
Really? No context, no reference, no numbers to establish your claim?

According to this article (http://www.assumption.ca/English/press/details.cfm?id=106) Canadians have only used 7% of the total room available in their RRSPs, leaving a total of $285 BILLION dollars in unused contributions. So, the question that needs to be asked, and seems no one is talking about, is which strategy is better for retirement:
1) Using your home equity for the SM
2) Using your home equity for your RRSP

The summary is that using your home equity to maximize your RRSP is waaaaaay better for your RETIREMENT then the SM. You will pay more taxes at retirement, but you won’t care … you will have a larger income stream for longer. Details? See post 30 & 33.

>>By the way, the capital gains tax can also be avoided with a bit of planning.
>Really? No context, no reference, no numbers to establish your claim?

Maybe the plan is to live in British Columbia where Capital Gains remain untaxed until they contribute nearly $80,000 annually to income?

DAvid

David – regarding BC capital gains.

There is always the federal portion!

Check out this calculator: http://www.walterharder.ca/MarginalTaxRateCalculator.html

Looks like Nunavut has the lowest provincial captial gains taxes.

this is for the sm non skeptics. i have just started a sm. i also have a rental property. would you think it wise to sell the rental and can i flip my profit onto my principal mortgage to increase my investment heloc. would i have to pay capital gains then. that would make “remple max” sense wouldn’t it??
thanks

sounds very interesting. a couble of questions. do any type of investment vehicles qualify. I see some guaranteed return products paying as much a 8.75%. Also my house is worth approx. 350k with 230k left on the mortgage. How much of an HELOC can I get without CMHC getting paid. Finally as long as you hold your tax decuctable loan and make interest payments will you also be generating tax deductable interest to claim against your income. Thanks

A few follow up questions. could u show how u came up with 291k, thought it was supposed to be 75 or 80% of your assessed value. Also if 61k is the correct amount (and i’m definitely not saying it isn’t), is taking the 61K and investing it essentially the SM or is it more along the lines of the RM.

Mortgage is 230k with mortgage payment of 1280 and a blended rate of roughly 4.6% fixed. If possible could u give numerical examples. Thanks

This is all very preliminary and i very much intend to read the book. One more thing for now, my principle payment is $340 so doing the math it works out to 340 X 12 / .046 = 88 700 approx. for the RM. So with the SM you start out with 50K + 340 a month in good debt. With the RM you start out with 88 700 with no monthly increase b/c the 340 is going to the investment loan. How do you secure the $38 700 over and above the 50k. Finally with your dividend investment method will you be withdrawing them as you earn them to pay down your bad debt along with the yearly tax break received from the loan. It’s a mouthful, sorry and thanks. I’ll try and get Ed’s input as well thanks again.

Quick question.
I did get a HELOC and got myself a rental property. However, since i’m planning to keep this property for a while, would it be better idea to change HELOC to variable mortgage instead? this way, the interest rate is lower. from 6 to 5.1 %
if anyone can give me advice on this, email me or leave a feedback here~

I agree with David. Unless you are using the equity in your HELOC to invest in other assets, it’s cheaper to get a variable rate mortgage.

My heloc is totally readvancable because it’s just like credit card. whatever I pay off, I have access to use it again. It’s not mortgage at all. it’s more like line of credit. I can pay whatever amount and whenever I want. I’m paying my rent income into my HELOC. but, I want to change this flexiable HELOC into 5 year variable mortgage instead because it’s cheaper rate. 5.1% instead of 6 % heloc that i have. I’m not going to have flexibility like HELOC but I can enjoy lower rate. There’s good and bad side to this i guess. I wonder how other people plan out. Should I have the flexibility with high interest or no flexibility but lower interest rate. Thanks

It’s probably cheaper if you have the lower interest rate.

Mike

Connan,

I’m with FT & FP. Get a readvanceable mortgage. You should be able to get it at 5.1% or close to it. This will save you money on the interest.

The readvanceable mortgage is linked to a credit line, so you can borrow the amounts back for the Smith Manoeouvre.

With your rental property, your interest is tax deductible against rent income, but you are also creating equity that can be used for investments with the SM. We have one client with a home, 5 rental properties and a cottage. They are doing 7 Smith Manoeuvres. Talk about building wealth!

Trevor is talking about the Cash Dam, which is a strategy that can use your rental property expenses to make your home mortgage tax deductible against the rent. It is a nice additional strategy that you can do in addition to the SM, but it gets a bit technical. The Cash Dam is purely a tax strategy – it is not an investment strategy. Therefore, the benefits are much less than the SM, which is both a tax and investment strategy.

Ed

“Nor would you be able to deduct the mortgage interest from your taxes”.
Is this mean that I can’t get tax deducted from variable mortage for my rental? and yet HELOC I can? can someone clearify this?
Thanks

Aren’t morgage payments always consist of interest part and principal re-payment part? If so – the principal repayment part should not be tax deductable and reduces the amount of loan with every payment. This defies the purpose of the SM in a way and makes the tax deduction calculation more complex.

Please comment.

Felix

Felix,

You are exactly correct – which is why the SM is usually done with a credit line linked to a mortgage – so we can pay interest only.

FT uses income producing investments with the SM, but this is not the traditional SM. The SM is best done with 100% tax efficient investments managed by “all-star fund managers”.

If you can get growth higher than indexes with risk lower than indexes and ZERO income or tax from your investments, then you can get the “Magic of Compounding” that produces the HUGE long term benefits from the SM.

ED

Hello Gentlemen!

I found an interesting article from Garth Turner by happenstance and thought it to be so relevant and so well argued, that I cannot resist posting it here in full.
About Turner I just want to mention that he is a former federal government minister and a bona fide financial guru.
This is the article:

“CAN THERE BE SUCH A THING AS GOOD DEBT?
Garth Turner column
July 16, 2001
You bet there is. It’s debt you never want to repay because it’s of such benefit keeping it in place. This is the case with a home equity loan, described in last week’s column. To recap, a HELOC (home equity line of credit, as you will hear many financial advisors call it) is a loan taken against the wealth you have accumulated within your residential real estate.

Year after year you have faithfully made all those mortgage payments, and with each one a little more equity has been shoved to your side of the balance sheet. For many folks, they reach their forties or fifties and suddenly have the bulk of their net worth tied up in a single asset – their homes. To me, this is a dangerous, unstable and dumb situation to maintain.

And while there are legions of media wimps who disagree with me and who cling to the notion that a physical asset like a home is a safe place to keep your wealth, I remain steadfast in the opposite belief. Real estate values have generally held over the last five years in most markets, because of a relatively strong economy, and over the next five years this will likely remain the case. But contained in the very reason housing will retain its value in the short term are the seeds of its eventual decline, and that is the aging of the population.

Canada has the biggest crop of Baby Boomers in the world – a legion of nine million people just entering their peak income years, who have been raised their entire lives as real estate Believers. They watched their parents grow wealth primarily through the appreciation of residential real estate values, as did I.

So today, enough of these generally-affluent Boomer children are moving up into trophy homes to influence the entire market. It’s the B-generation’s last hurrah, after moving real estate values sharply higher in the 1980s, when they were forming families.

Ten years from now the average Boomer will be sixty years old and downsizing. Those big houses, especially in the suburbs, could be falling in value as demand disappears. More in favour will be smaller bungalows, townhomes and condos in near-city locations, recreational property and adult communities on golf courses.

The second reason I want you to sell that big house is inflation. It’s dead, gone and buried. The core inflation rate in Canada is well within the 1% to 3% range set by the Bank of Canada, even despite frequent surges in the cost of energy. As technology races along, fueling productivity and dropping costs, inflation will be the last thing on economists’ minds. Instead, they will be struggling with the notion of dealing with deflation, when prices (and wages) are falling, rather than rising. Check out recent trends in the prices of cars, computers and every other electronic device. The thousands I paid for a laser printer for my computer in 1999 today have turned into mere hundreds. The printer is a doorstop. It deflated to nothing. I thought of that the other day as I walked down Bay Street and saw some video monitors and an electronic typewriter sitting on the curb amid garbage bags.

For my parents, inflation was good. My father’s salary (and the pension based upon it) went up every year. The value of their home rose relentlessly, as did their net worth. It was a great outcome in retirement – indexed pension and cash from the sale of a house that tripled in price every half-decade. But those days are vanishing quickly, and as demand for large homes dies up, there will be no environment of generally rising prices to sustain the value of the asset.

So, think hard about whether you want to keep your equity in your home, or get it out now, while real estate is still a viable commodity. Think hard about the long-term wisdom of a home equity loan, which I consider to be good debt.

If you borrow to invest in growth assets, like stocks or mutual funds, the interest is tax-deductible. You get a significant tax break at the same time your equity is put into things that will mushroom in value over the coming years. So, how do you cope with the cash flow demands of having a home equity loan in place? After all, you need to make interest-only monthly payments.

Systematic withdrawal plan

The answer is a SWP (pronounced swip), or systematic withdrawal plan. With the help of a financial advisor, do the following: Arrange a home equity loan in the form of a line of credit, with interest-only monthly payments (you should avoid taking this money in the form of a mortgage, with blended payments of both interest and principal). Your payments are now entirely deductible from taxable income, so long as you put the money in the right place.

So, use the funds to buy units in equity mutual funds. (Some people feel more comfortable with segregated funds, since they want a guarantee there will never be a loss – however higher fees will impair fund performance.)

Have your advisor set up a SWP, which means enough money can be taken from the fund on a systematic, monthly basis to cover off the interest-only payment on the home equity loan. Now the mutual fund is actually making the loan payments, rather than you. But every year when you fill out your tax return, the interest is deductible in your hands!

Held long enough (a minimum of five years), the mutual fund should give you substantial capital growth, despite the fact you have removed money through the SWP to cover all financing charges. It’s a win-win situation: the HELOC is good debt and the SWP is a great way to finance it.

But, what if you borrow against your home, and buy mutual funds that decline in value?

This is a question the media wimps often toss out, but without much validity. Unless history is absolutely no guide, mutual funds based on the performance of companies which are part of the economy increase in value over the long haul. Of course, there are years when markets decline, but they are far outnumbered by years of gains.

So you may well buy assets with a HELOC than temporarily fall in value. But because your loan is secured by the value of your home, and not the value of the funds you buy, there will never be a margin call to make up the shortfall (as is the case with borrowing money to buy stocks from a broker). Meanwhile, of course, you continue to write the interest on the loan off your taxable income, for a net benefit.

Finally, you will never take a loss on funds that have gone down in value unless you take the wrong advice, and sell. The proper strategy is to wait out any market correction and ignore the wimps who confuse short-term events with long-term trends. They know not what they do.”

So there.

Sandor

Thanks Ed for your response.
>

Is the interest on the linked credit line different from the one on the mortgage? (I couldn’t find an answer on this on the respective bank’s websites and this point is missing in your explanation of the SM.)

Someone help me with my situation once and for all. My mortgage on my prime estate is 100 percent paid and no mortgage is left. Now, I used the line of home equity from it and bought a rental property. Now i want to convert that HELOC (based on my prime estate) into fresh new mortgage based on my second property. Only reason i’m doing this is because of 1st Lower interest. 2nd I’m in the longer term investment. My question is, going from HELOC to Mortgage like this is good idea? also, my second property mortgage, would that be tax deductible or not?

Thank guys!

Ed,

Thanks for your response.
Once the mortgage is fully converted to the SM investment loan, is there a way to reduce the interest to below prime? All the HELOCs seems to be prime only.

Thanks
Felix

Felix,

You’re right – HELOC’s are almost all at prime. We’ve had the odd one with a very strong client or a very large mortgage that managed to negotiate a better rate.

Otherwise, the only way is to turn it back into a mortgage, in which case you can get variable below prime. This almost always means, though, that you have to pay principal plus interest.

I don’t recommend this, though, since it means you are paying at least as much and it is now not fully deductible. This means you are paying your tax-deductible loan down, so your tax refunds will decline.

Be happy with prime, keep collecting your refunds and focus on the investments, Felix.

Ed

Thanks for the response Ed, no I’m a financial advisor just an engineer with some finance background trying to understand smith and his manoeuvres.

Ok so after 25 years your mortgage is paid off, and you have a HELOC of $400,000 (max. out) with the lending rate at 7%, you would have to pay $28,000 in interest on the loan and I understand that depending on the tax bracket you are in at that point in life you could receive $11,200 to $14,000 in tax refunds, but where does the $28,000 come from in the first place to pay the interest on the loan? Do you have to get a reassess to borrow on the house again to get a loan to pay it or do you need to withdraw $28,000 (really $35,000) from your investments to pay it off?

Hi Ed and Hi Manoeuvring!

Not withstanding the slight difference between our “technical” approach Ed, you forgot to mention that the house would be paid off possibly in six to ten years, depending on the personal circumstances. There is also the version of replacing the mortgage with the LOC at the outset and invest the principal portion of the mortgage payments.
This method would lower the monthly payments and increase the efficacy of the strategy. Although the risk of interest rate fluctuations would increase.

Hi there, This idea is great, however i do have a few questions:
1. TD Canada Trust has a HELOC whereby you have a max credit limit say 80% LTV and can decide how much is fixed (”mortgage”) and how much is variable (”Line of Credit”). every payment you make to the fixed side becomes available to you on the revolving side. so….
200000.00 limit

revolving
0.00 owing
0.00 available

fixed
200000.00

after say 1 year it would look like this if nothing new were to be borrowed (8000 total payments to principal)

200000.00 limit

revolving
0.00 owing
8000.00 available

fixed
192000.00 owing

i hope that makes sense.

my issue/question is as i borrow the $$ from the revolving side to invest in non reg income producing investments, how do i pay the interest on the revolving side plus the fixed “mortgage” payment too. should i leave a buffer say 1000 on the revolving side to transfer every time i make a fixed payment to my chq acct then transfer it back as a revolving payment and the difference invest?

2. let’s assume after 10 years the fixed amount is paid down fully and the revolving side is fully borrowed and invested. (with tdct you can fix the amount again). if i fixed the borrowed 200000 again for 5 yrs this would mean that the revolving would be back to 0.00 to start and i can make payments to the fixed and borrow back the revolving to invest. because the interest was already used as a tax write off can it be used twice because more investments are being purchased?

3. how long can you use the interest from borrowed sources as a tax write off? what if the securities are sold after some time… because the borrowed money was used to purchase them could it still be written off?

4. what do you do with the dividends etc from the investments once the ‘mortgage’ is paid off and all your debt is ‘good debt’? is it used to make the interest payments?

Thanks,
Marc

Marc,

Actually, with respect to the first question, you withdraw the entire principal paydown and then pay the interest costs of the growing HELOC portion. The remainder then goes to investing. Depending on the interest rate spread and how much your principal payments are, you generally see less and less money being invested each period. However, when you factor in the tax refunds, the amount to invest generally goes up each year.

i still dont understand how this ‘capitalizing the interest’ works….could you work off this example with me:
i have a heloc for 200k

160k of which is fixed (like a mortgage) 25 yr amortization 5yr term 5.14% payments are 943.37 (p+i) a month

40k of which is revolving credit on the HELOC which is not being used for anything.

do i keep making the p+i payments to the fixed and invest the 40k revolving?

if the 40k is fully invested the interest per month is 208.00. if i make that payment from my own pocket every month i would still have 40k still outstanding and nothing to borrow to invest. does this mean i have to wait for a tax refund before i can invest more?

I realize that every payment i make to the fixed is made up of some princ (265.00) and some interest (678.00). which means after this payment to the fixed i have the ability to borrow 265 from the revolving. if this is the case i would invest the 265 and now owe 40265 on the revolving and have to make interest payments of 209.00 (increase of 1.00) for the next month. where is this extra money coming from to make these interest payments?

maybe you guys could help me understand this concept with this specific example… I would greatly appreciate it!

Thanks,
Marc

Thank you Sandor,
I do believe my HELOC is readvancable since every princ payment to the fixed becomes available on the revolving. all this is under 1 account number and the product is a heloc…. see TD Canada Trust Home Equity LOC features:
>

Fixed portion:
“if you would like to protect yourself from interest rate increases and establish regular fixed payments to help you plan your budget, you can choose to convert all or any portion of your Home Equity Line of Credit balance to the Fixed Rate Advantage Option and lock in a competitive fixed mortgage interest rate at any time.”

could you confirm with me that this is in fact a readvancable heloc as the advisor at the branch doesn’t seem to understand the terminology.

2) How do i look you up… do you mean email you….. would you provide me some sort of example say for 1 month, kind of like the ideal way to do this?

Thanks,
Marc

Hi,

A quick question regarding the mechanics of SM… Let’s say I have fully paid down the mortgage after doing SM for a few years and now the only debt remains is an interest-only, tax-deductible line of credit (LOC).

My intention is to be debt-free*. For the bank I use, and I believe for other banks too, the interest rate of a fixed-term loan (mortgage) is cheaper than that of the LOC. So, is it possible to convert the LOC back to a mortgage to take advantage of the lower rate and still retain the tax-deductibility status?

*The reason I want to pay down the debt is because I am of the type who doesn’t like debt. I fully understand that the reward is probably bigger if I’d live with some debt until the end of things.

Thanks,

i see,
1)so what happens when your mtg is paid off and you have a fully maxed loc do you allocate your ‘mortgage’ payment to the loc or to your investments

2)do you ever begin to receive dividends as cash or should you keep them reinvested like a DRIP. if that’s the case, once the mtg is paid off do you use your dividends to pay the interest?

What is the proper way to capitalize and document interest?

1. Borrow from the investment line of credit and deposit into your bank account an amount equal to your interest payment.

2. Pay your investment line of credit from your bank account an amount equal to your interest payment.

Does the order in which you do this matter? Does this need to be done each month or can you catch it up every 6 months or once a year? Does this need to be documented in some way or is just doing transfers on the computer sufficient?

Thanks for your comments

Has any one looked at taking existing RRSP investments and purchasing a labour sponsored fund? Use the tax credit to do Smith. Set it up so you do $5,000 a year for 8 years and then keep rolling them over until the mortgage is converted. It takes no new money. Ok, in Ontario we are going to lose some of the tax credit and LSF don’t have a good track record. Depending on your income plan in retirement this may be the best use of your RRSPs?

Hi, ok great postings! I have learnt alot. But similar to Man from Atlantis, I am foggy about the capitalization of interest.

I understand the movement of the funds back and forth between the heloc and say, a regular checking account. But my questions are:

1. When you capitalize the interest, does that change your adjusted cost base of the investment you are purchasing.?

For example,, I buy XYZ corp for 5000. In five years, i have capitalized 1000 interest. Total amount on heloc is now 6000. The stock price remains flat at 5000. So am i now triggering a capital loss of 1000?

As an addendum to the example above…I sell the stock for 5000, with 6000 in heloc. Use the proceeds of the fund to pay the heloc and 1000 remains owing. Does that 1000 remain interest tax deductible?

2. I gather the best funds, if you want to use the cash dam, is one with distributions that have absolutely no return of capital… But often times a fund with give you monthly distributions and you dont know that part of that is a roc until their statement at the end of the year. So can you redeposit that roc component into the fund at the time to maintain full interest tax deductibility?

thanks sandor , a couple more questions though:

1. “you can write it off as interest owing on money borrowed for investment”. Can you elaborate on what this means? How do you write this off, other than on the interest accured due to the 1000 while you still own the stock. Also, for a segregated fund, I know the chances that the fund will be up, but lets say it isn’t, then the capitalization of interest arm of the SM may actually leave you in the hole?? I thought you could add the 1000 to the carrying cost of the stock/fund, such that when you sell it, the acb would be reduced?

2. I don’t understand how paying down the proceed and borrowing it back to invest make the interest tax deductible. Other than having a cash flow potentially neutral, why not just have the fund do a DRIP? What is the increased tax write off opportunity? the amount owing on the debt remains the same ( with the exception that you would have to service the loan), and the amount in the investment remains the same. What I was hoping to do was to use the proceeds to pay off my mortgage faster then use the proceeds in the readvancible loc to repurchase a portion of the investment. But without knowing which percent of the distributin is roc, then it is difficult to keep the loan interest deductible.

Am I missing something here?? I remain confused.

calberst,

1. Once the investments are sold, you cannot deduct any interest costs related to the sold investments. Nor can you write off investment losses, except from investment gains. If you sell the investments, there will be no future gains against which you could write off the 1000 loss.

2. The cash flow is intended to remain neutral, i.e. the same. Your interest is to have as much of the invested capital borrowed as possible, because then your tax refunds are maximized. If you direct the distributions into the mortgage, instead into the LOC first and from there to the investments second, then you are actually using your own money to invest and therefore do not qualify for tax write-off.
Besides, if you do as I suggest, it won’t matter either how much of the distribution is ROC, or gain, because you will use it (your own money) first to pay down debt, then borrow the whole thing back. Now it is all borrowed, then invested, therefore, the interest is all tax-deductible.

Generally speaking, my preference is to replace the entire mortgage with a LOC. This immediately eliminates the monthly principal payments. The first consequence of this is that the monthly interest payments are usually less than mortgage payments were before, so, you can save and invest more. Records are easier kept and the house is also paid off faster.

I am also against the capitalizing of the interest, because it increases the debt. If however, all you owe is a line of credit, then you don’t have to capitalize, because you only have one payment to make: the LOC interest. And if you could handle the mortgage payments, surely you will manage the interest payments as well.

If you don’t want to be confused anymore, then make a chart of which moneys are, and which aren’t eligible for the tax write-off.
Then try to shepherd as much of the ineligible money into the group of eligible ones.

cal,

As you can see, our postings are getting longer and longer. A certain proof that the confusion is growing.

Do write to me in private (falconaire@sympatico.ca)and I shall do an example for you.

See you

Sandor

Even if that were so, it is too costly, considering all the losses.
The same effect can be accomplished with more profitable means.
Example: take your 5000, pay it down on your mortgage and borrow it back for investing.
This will give you the same tax advantage without the abysmal performance.

All of this information sharing is just amazing, I’ve been doing a lot of reading over the past few months about managing my money (a lot of focus on the SM & ML1)

Until recently I’ve done what I thought was best by investing my time in my career, but it’s clear to me now that this is just a narrow vision that won’t get me as far as I’d like… and am now a bit behind in the game…

Was hoping to get some feedback from all the experts on this BLOG (be nice, I clearly don’t have the same level of knowledge, experience or insight as most)

1) Congratulations guys, I was certain ML1 was the greatest product going, but I can see from all your posts that by being more active in the whole process it’s not all it’s cracked up to be… 14$/month or 168$/year which means you’d need to put in 2688$ at the beginning of the year to cover this cost at the ML1 rate of 6.25% & if you took that money to put towards a regular mortgage that doesn’t have fees at a lower rate you’re looking at almost a difference of 3000$. It would also seam as though you could keep the same ease as ML1 by having an open mortgage which then looks ridiculous to pay a higher rate also…

2) My scenario:

My Base salary: xxK but with OT I never make less than xxK
Wife Base salary: xxK with OT maybe xxK

I have 20K in RRSPs
Wife has no RRSPs

I have more than 41K in unused RRSP room
Wife unused RRSP is aprox 2K

My plan is to use my group plan RRSP to contribute 2K every 2 weeks to a spousal RRSP before TAX because we plan to buy our 1st home in July & I’d like to get her to the 20K limit for the HBP (will borrow to top off her RRSP because I know there is a 3 month holding requirement) We’d love to buy a nice big house, but we’re both 30 and can sacrifice for a while (no kids) so I was thinking of buying a place for 150K to 200K in which we would not have to pay the CMHC.

At 1st my goal was to pay off the mortgage ASAP (maybe 3.5 years) but now I’m torn… because I’m so behind on my RRSPs I was thinking of keeping that up since with each passing year I fall further & further behind and as you all know that’s a lot of wasted growth…

Of course all this was to be played out while performing the SM, but after paying off the mortgage the plan was to maybe invest in a revenue property (hoping to buy something in the 750K range) in some of the previous posts I read you could use your HELOC towards this as well. But something just doesn’t sound great about this, at a point in which the mortgage would be paid you’d be looking at half being paid out of pocket & the other half with the HELOC, this doesn’t sound good, if we wanted to then sell it, we’d only see half the money? Any advice?

Also (feel bad for asking because I see it has been asked & answered several times before, but I just don’t get it) about HELOC payments, I get that ideally you should pay the interest out of pocket which is fine for a while when the payments a relatively small (under 1K) or as long as you still have a mortgage (so you pay towards the capital, your HELOC goes up & you can use this money to pay the interest & put the rest into investments) (and I know FrugalTrader seams to love his Dividend stocks, but dividend is paid quarterly, it also doesn’t sound like a good idea to only get these & I can only speculate if it will cover the costs especially when taxed at the end of the year) but what about after your mortgage is paid off & I imagine payments of the interest can get quite high (thousands), do you have to sell some of your investments every month to make the payments? Or should you just keep buying bigger & more expensive homes to keep your HELOC growing? I’m good with risk & get in the long run markets constantly grow, but it is a lot like sitting on a big bubble…

As a final question (please don’t make me cry) In post 75 Ed mentions a quickie about “except in Quebec” (where I’m from) is the beauty of the SM of being tax deductible against my income not gonna work for me?

Hi Sandor,

Thanks for the reply, but perhaps I wasn’t clear but lets say at a certain point I have 100K invested from my HELOC at which point I would be paying about 500$ interest on that month, but as I pay more of the capital off of my home I would invest more money from the LOC so obviously the amount of interest I will be paying will go up regardless of the interest rates. If I paid off and invested another 20K I will be paying interest on 120K. So as time goes by the interest of the HELOC may get to be quite high. If it gets to an amount of 500K I have invested from the HELOC the monthly interest may be above 2500$/month & if at that point I no longer have a mortgage the money has to come from somewhere… So my guess is that you would have to sell off some of your investments each month to cover the amount you have to pay in interest. Is this correct?

Thanks

Cisco Kid,
As you pay off your mortgage, the amount of interest you are paying on the mortgage also decreases. The premise behind the Smith Manoeuvre is that your total debt servicing costs remain the same. Read Smith’s book to understand this better. At the end of the day, you have a deductible investment loan, on which you have the same payments as you did the day you purchased your home.

Cannon-Fodder created some spreadsheets that show the how the investment side of things works, and that the amount you have invested quicky climbs once your mortgage is paid off, and you contribute more to the investment side of things. Your SM mortgage carries the full original term (i.e. 25 years), though much of that is as an investment loan, not a mortgage.

DAvid

Ashamansony, you can check your marginal rate here:
http://taxtips.ca/marginaltaxrates.htm

You can do the SM at any tax bracket, however, the benefits are obviously highest for those with higher marginal rates. You can check out the SM spreadsheet that we have here to see your potential returns.

Thanks David. I had exactly the same thing to say.
With the possible addition that replacing the mortgage with a line of credit would liberate additional funds for investing, since the principal portion of the mortgage payments could go into the investments as well.

Cindy, there is a small discussion about the cad tire mortgage here.

To summarize, the mortgage doesn’t allow sub accounts which means you can’t keep track of your tax deductible investments. In other words, until they offer multiple sub accounts, this product will not work with the SM.

Hi Cisco!

I am sorry but the argument doesn’t work with me.
Far be it from me to try luring you to Ontario, from that refined and amusing Quebec, but as far as the financial part is concerned, your explanation won’t do well for you.

Never mind how much your tax bracket would be reduced, because it won’t be really substantial. However, the tax refund you would receive here would be an additional sum of money, every year, that you could use to boost the investments. This would come to you every year. Nor would it depend on whether you loose or gain in the investments.
The scenario you describe promises only conditional tax write-offs and only in the uncertain future.
I venture to say that the certain tax refunds would be a greater advantage.

If you want any concrete idea about the effects of the strategy, ask the advisor to create a spread sheet and a comparison chart of what you have now and what you would have in case you embarked on the SM.

Cisco Kid said: “I suppose another thing I need to consider in my calculations is how often you re-balance your portfolio and how much you cash out while doing so (any comments?) I know for the “couch potato” portfolio they suggest to redistribute your funds once a year”

If you reduce the automation of your purchases of shares, you can often re-balance simply by adjusting which shares you buy. IF there is a large discrepancy you may wish to sell some of the high valued shares to purchase some of the lower; if its just a small difference, just adjust your purchases in the last few months of the year.

DAvid

Hey Dropby, no, it is not necessary to stay in the house for a long time with the SM. The new readvancable mortgage will simply pay for the old one, effectively replacing it. You just have to make sure that the numbers work out.

David,

Try this calc:
http://www.milliondollarjourney.com/smith-manoeuvre-potential-returns-spreadsheet.htm

David, lets do some straight up calculations for you. To clarify, since your mortgage is a HELOC now, there is the option of interest only payments. Say on $200k, the heloc interest is 6%, that would be $12k / year interest. If you are in the 40% tax bracket, you would get a tax refund of approximately $12k x 6% = $4800/year (maybe a bit less if you drop a bracket).

Does this clarify things?

Again, i’m not an accountant, so you should run the numbers by a professional.

sorry, the posting went twice

David, if you read the book, Fraser Smith recommends that the HELOC never be paid off to collect the tax deductions for life. Personally, I would start paying off the HELOC as I approach retirement.

Str, i’ll be posting about this exact situation tomorrow. If you can’t wait that long, do a search for “rempel’s maximum” on this blog and you’ll see a formula you can use. It’s basically takes your annual principle payment divided by your heloc interest rate. So if you pay $5k in mortgage principle every year, and the interest rate is 5.25%, then the max you can borrow is $95k. The formula basically calculates the maximum loan that your principle payments can service.

There probably isn’t a much better time than now to use the Smith Manoeuvre with the prime at 5.25% and an average dividend of ~4.4% if you have a portfolio which takes an equal position in each of the follow 7 financial stocks: TD, RY, BNS, BMO, CM, SLF, IGM

what do y’all think?

Lucius,

Not sure if I agree with your return formula. I think one only has to achieve an after-tax return greater than tax-credited HELOC interest rate to make this worthwhile. Using your number, the required after-tax return is (1-0.4)*6% = 3.6%. So, pretax return required would be about 5-6% depending on the type of investments. Also note that interest on the HELOC is constant (for constant interest rate) while investment return is compounded, which means it becomes easier to beat the interest cost over time.

Dom, consider the entire calculation:

earnings on investment: 100k*9.3%
interest on HELOC: 100k*6%
———–
earnings before tax: 100k*3.3%
tax: 100k*3.3%*0.4
net after tax: 100k*3.3%*0.6

interest on mortgage: 200k*r
net interest: 200k*r-100k*3.3%*0.6=
200k*(r-1/2*3.3%*0.6)=
200k*(r-0.99%)
Conclusion: to reduce rate on (outstanding) mortgage by 1% you need to earn 3.3% above HELOC rate. This is with assumption of 1:2 equity to debt. So this strategy doesn’t seem to work when equity/debt is low. If equity part is larger than debt it gets better. For example for 3:1 with above rates it requires 0.5% above HELOC to reduce mortgate rate by 1%. Still 6.5% is not what you get easily (with no risk). It seems that strategy makes more sense when larger part of the mortagte is paid off althoug even then it is not without risk.

Lucius,

Your calculations make no sense. This is not an SM by any means.
What you are doing here is just comparing two things as two pieces of meat.
The SM is a dynamic process. As time goes on, the tax refunds and the mortgage savings are continually added to the investments, therefore, the investments are gradually, but surely outgrow the original principal debt. All this happens regardless of the returns on the investments.
The returns only play a role in the duration of the process. Higher returns, of course, will help to pay off the mortgage sooner. But just putting borrowed money into some funds does not a Smith Manoeuvre make. It takes a bit more and that little more is what you left out of your calculations.
As it happens, I just sent out the tax write off figures to my clients this week. This is part of the process too. Some of them are ready to claim six to eight thousand refunds and this amount, thanks to the SM, is growing year after year.
None of that is accounted for in your calculation.

Hi Lucius,

CRA has consistently had no issue with deducting interest when you borrow to invest in mutual funds or stocks – even if they never pay a dividend. Your link says that you cannot deduct interest if “the only earnings your investment CAN produce are capital gains”. Mutual funds and stocks CAN all produce dividends – whether they actually do or not.

In short, the fact that the investment COULD produce dividends and that there is an expectatioan of profit is all you need. This means you cannot invest in raw land or gold bullion bars, etc. that cannot possibly produce dividends or interest.

Virtually every company and every business owner have borrowed money to invest in the company, and most companies don’t pay dividends (especially private companies). There is no problem with businesses or funds investing in businesses.

Ed

Hi Acorn,

In general, it is best to look at the SM as a lifetime investment. Hitting a life milestone, such as having your mortgage paid off or retiring does not necessarily mean you need to make any changes in your investment strategy. Usually, your time horizon is still 20-30 years or more (lifetime), so “long term” investing still applies.

Once your non-deductible mortgage is entirely paid off, it is usually best to pay the interest on the tax deductible credit line from your cash flow until you actually retire. This payment will generally be lower than your mortgage payment, since it is interest only, and it is fully tax deductible.

One of the biggest mistakes many people make after paying off their mortgage is to get used to spending all of the amount of their mortgage payments for a few years. Then when they retire, they have to cut their lifestyle way back after they retire.

Depending on your situation, there are a variety of options and opportunities once your mortgage is paid off, but it is usually best to pay the credit line interest from your cash flow until you retire.

Ed

Ed is the advocate of capitalizing, I am against it.
It will make your debt grow unnecessarily, and eventually even outgrow your limit.
There is a method, using a sub-account, from which the interest is paid into the main account and the sub-account is paid back from cash flow. This is also considered as capitalizing, but in fact, it only adds an other thin layer of tax-deductible interest payment to the strategy. This I don’t mind doing.
The only problem with it is that the record keeping is even more complicated.

Sandor

Thanks, Ed.

This is the part I wasn’t understanding before:

“The amount that is invested regularly is the principal paid down from your regular mortgage payment less the amount needed to cover the tax deductible credit line interest.”

The explanations I’ve read before all state (or imply) that the amount invested regularly is equal to the principal paid down by the regular mortgage payment (without any mention of covering the credit line interest).

Again, thanks for the clarification.

Yes, you can claim the interest on the 10,000, as long as it is invested. In fact, you can cash out your gains if you wish, but the interest on the original amount is tax-deductible.

Hi Ed,
Can to tell me how to file the interest exp on line 221?
i have dividen mutual fund from RB which i get dividen every quarter.
how do i file interest exp for loan that i borrow to buy the fund?

thanks,
ben

Thanks for summarizing the mountains of info out there!

The question I have is: Is the interest paid on the HELOC still tax deductible if the interest is paid from the HELOC itself (”capitalizing the interest”)? To me, there seems to be no transaction, simply ‘A’ paying ‘A’, instead of using money earned and already taxed (i.e. from your job) to pay loan interest. Any clarification on this or is it just that simple?

Thanks.

I’m surprised by the answers to Khan’s question. It seems to me that you guys are saying that as long as the money stays in the investment account (even though it is not invested – the shares have been sold), the interest on the HELOC is still deductible. Is this correct?

I thought the money had to remain invested. Or is it just the original loan amount that must stay invested (any profits can be sold and held as cash)? What are the rules here?!!!

Thank you.

All seems pretty straight forward. What I don’t understand is the interest capitalization part. Lets take a hypothetical example of $1000 loan at 10%/period. At the end of each period you’ll have $100 of interest accruing. If you withdraw from the HELOC the extra $100 to pay the interest, you have now increased the LOC balance to 1100 and the following period, your interest will be 110. In this sense, the interest capitalization is working towards your disadvantage.

In addition, some short term cashflow problems may arise in cases when your portfolio falls.

Just wondering, do majority of you use ETFs or index funds to avoid high MERs on mutual funds? I know ETFs can only be purchased in bulk, say $1000. What other alternatives do you have for dividend growth that’s fairly diversified and low MER? Examples would be appreciated.

Regards,

PK

PS. Interest and carrying charges fall under Schedule 4 of your T1. Schedule 3 will have all of your taxable property income/capital gains. You should be receiving a T3 or T5 from your investment advisor, depending whether you have interest income or not.
You can deduct interest expense against all of your other income, not just investment income.
In terms of taxation matters, the dividend gross up and credit for eligible/non eligible companies is there just to avoid double taxation where income is taxed at the corporate level and then on your personal income. Gross up of 1.25 and 1.45 is just there for integration.
After legislation changes for trusts, there isn’t really much advantages in investing there.
In a nutshell, capital gains are taxed at the lowest amount (only half is taxable), then you have dividend income and lastly interest income.

Take care

Capital assets, meaning items that are depreciable (i.e can claim CCA on it).
Sorry for multiple msgs.

PK Said: “What I don’t understand is the interest capitalization part. Lets take a hypothetical example of $1000 loan at 10%/period. At the end of each period you’ll have $100 of interest accruing. If you withdraw from the HELOC the extra $100 to pay the interest, you have now increased the LOC balance to 1100 and the following period, your interest will be 110. In this sense, the interest capitalization is working towards your disadvantage.”

The Smith Manoeuver is about converting a non-deductible loan to a deductible loan. According to Smith, if you have a $200,000 loan at 6% with each payment, a portion of the principal is paid down. If the principal was reduced by $400 this month, you would purchase $398 of investments and put $2 towards capitalizing the interest. The next month your principal might be reduced by $404, now you set aside $2 + $2.02 for interest capitalization and invest $399.98, and so on.

According to Smith, it’s really simple.

I’m not so sure……

DAvid

PK asks: “I haven’t looked into the readvancable mortgage spreadsheet, but I’m wondering if any of these actually take into account these admin costs of revaluing the equity, transferring funds for investment purposes etc…”

No, none of the calculators include those admin costs, as they could range from effectively 0% to about 5% of your investment. Since this is So variable, it would be up to the investor to choose their investment vehicle, and adjust their return based on acquisition cost.

“I assume SM isn’t perfect for everybody.”

Nope! Canadian Capitalist has a lot of information on the other side of the Smith Manoeuvre. Have a look there for his comments.

Smith indicates it has value for most taxpayers, but especially for those who could not build an investment portfolio without the benefit of his Manoeuvre. Read a copy of the book — it is an eyeopener.

DAvid

Some people think of their homes as investments – other people look at them as security, a necessary requirement for living, an improvement in the quality of life.

If we were to take the approach of evaluating them only on the basis as a long-term, buy-and-hold investment, then consider this:

Assuming a $300,000 variable rate mortgage that averages 5.5% over 25 years in a 2.5% inflationary environment, the inflation-factored cost for the mortgage would be $412k in today’s dollars.

Assuming a $300,000 variable rate prime loan (used to invest in securities which pass CRA’s scrutiny for deductability) that averages 6.25% over 25 years in a 2.5% inflationary environment, the inflation-factored cost for someone in a 28% marginal tax bracket over that time would be $412k in today’s dollars. (It’s about $370k for those in the 40% tax bracket. It assumes you pay only the interest except for the last payment at which point you discharge the original principal.)

Would it be reasonable to expect that the after tax performance of a well-balanced, long-term diversified portfolio would be superior to the rise in the value of the home?

If so, then perhaps it is better to downplay the idea of a home as an investment – for those that have the luxury of being able to afford a home and save for retirement.

When I was single I was firm in the opinion that purchasing a house would not have been financially prudent. I also did not find any need to own a home – I looked at it very practically.

Now that my wife and I own a home we very much enjoy and feel fortunate to live in, I can say it still crosses my mind that perhaps if we bought a little less house and invested the difference in mortgage payments, we’d be better off.

But, getting back to the costs of borrowing example, I am using that to help support the idea of tapping into the home equity we have built up to invest. I think the idea is sound: over a minimum of a 15 year horizon, I should be able to purchase a portfolio of Canadian stocks in the dividend achievers’ list and generate an after tax performance well in excess of the cost of the tax deductible loan.

If I can achieve a 7.5% annualized return, the value of a $300k portfolio over 15 years using borrowed money at 6.25% and a 43.41% MTR should be more than double vs. taking the same amount of after tax income and dollar average my way in.

Dom,

It is obvious my example was poorly written. I completely understand and accept that we have to live somewhere and thus there is a tangible benefit to a home. My point that I did not adequately make was that there are people out there who look to fund their retirement through their home equity. And some of those people (unfortunately I know too many) buy more expensive/bigger/fancier homes than they need because they anticipate the big windfall down the road when they sell. In fact, I know one single mother who sold her house less than 2 years after purchasing because its value rose so dramatically. Then she ended up buying a bigger, fancier house in the same area – which of course also had risen dramatically. Does that make sense?

A better example would have been to compare a $400k mortgage vs. a $300k mortgage and a $100k investment LOC. I think, on average, a person would be better off in the latter scenario down the road.

There are also other costs to having a bigger, expensive home that don’t always offset the joy of that home. More $ spent on furniture (to fill the space or to replace older furniture that doesn’t fit the elegance of the home), drapes, landscaping, property taxes, insurance, utilities and the dreaded 4-5% when you go to sell that goes into the pockets of lawyers, real estate agents, etc.

It was thinking like this that led me to rent vs. buy when I was single and resist moving from our townhome to a detached when we were so close to being mortgage free. I love our new home (we all do) but it has come at quite a price.

Cannon_fodder,

I see your point now. Yes, I agree with you that people shouldn’t buy more house for their own living than they should. If they have extra money sitting around they should get a second place and rent it out instead. By living in a large house, one essentially forgo some rental income (which is a large portion of the total RE investment return) on his capital when it could have been deployed for an income producing apartment.

Remember that when you designate the house you’re selling as principal residence, take away one year from it as the formula adds an extra year. That way you’ll be able to claim an extra year on your other house.

Also I’m hoping that you didn’t claim CCA on your home, if you rented it out, as you’ll get taxed on recapture and a capital gain on the sale and you won’t be able to claim it as principal residence.

Cheers!

Wow … what a great resource! Its nice to find a bunch of Canuck financial geeks in similar situations to myself. This blog has exactly the type of information that I have been missing from the traditional financial institutons etc. most have never heard of the SM and none could explain it or help me implement it.

I happened upon the Smith Manoeuvre book while on vacation last summer and read it front to back in one stting. (my wife chastised me for not being able to relax while on vacation but this was exciting info and the best use of my vacation in my mind).

I also purchased the calculator off the web site and ran my senerios.

My situation is slightly more complicated than many as I own a Ltd. company ~ $750,000 in sales/yr and growing the corp owns a building worth ~350K owes 92K

plus the usual RRSP (~85K) etc. I also am a 50% shareholder in a $400K/yr Ltd company and have a non active sole prop business

I have implementing the SM in a way that I haven’t seen discussed here yet.
I have invested ~$77,000 from our HELOC into the business this interest is used as a personal tax deduction.

Our home Mortg is about $89K and value is ~ $350

I want to pay off the mortgage ( currently in a 3yr open var term) off in full without triggering tax implications

I often have $90K in cash available in the business that I could take out as a shareholder loan pay off the mortgage and then put back in the business off the HELOC within 15 days or so.

Would this be considered tax avoidance? If so …. what are some other strategies that I may be able to put together to get rid of the mort so I can use all heloc room as a a tax deduction.

I have also considered running some of my corp expenses through the sole prop and paying the bills out personally and getting rebursed (draw) This is discussed in the SM book as well.

We also have ~$60K of other pers (bad debt) at ~8% int rates

Everyone I talk to re: this are uncertain of the SM and the consequences of my plan.

OK … that makes sense

While I love the name …. The Flintstone Flip does not sound like my best strategy.

I could very easily run all inventory purchases (materials expense)through the sole prop company and implement the cash flow dam. I currently spend ~$250K+ /yr on materials.

The cash flow dam is a bit of a mind twist for me though

Here is how I see it flowing

1. sole prop biz buys inventory on paper $50K
2. sole prop sells exact inventory to corp 1 $50K
3. Inventory is deivered to corp $50K
4. I pay sole prop bill from supplier from my heloc 50K
5. corp pays sole prop bus for inventory 50K
6. sole prop bus pays me a draw of $50k (this draw pays back inv purch of $50K and actual income to report is 0)
7. I put $50K on my mortgage or pay off other pers debt
8. repeat untill all pers debt / mort is paid off and all credit use is now tax deductible as long as it is used for earniing income.

I also sell inventory at a 10-20% markup to a non related corp and the other corp I own 50 % in (I am not on books yet though)

Are their negative tax issues? Would this be seen as illegal in CRA’s opinion ?

I have tried to discuss this with my accountant , a CRA auditor and bankers and everyone just looks puzzled with no input…..

Thx

Selling to a related party, you might have some transfer pricing issues. You should probably talk to an accountant about that.

CRA wise, there is something called GAAR, general anti-avoidance rules. Basically you better have a business reason for the transactions in place, not just reduction in taxes. There have been cases however of some lawyer who paid his mortgage off with a partnership loan, making it indirectly a loan for non-business purposes. The court stated that you can do whatever you wish with your personal finances, if it reduces your tax liability and doesn’t violate any ITA, you’re good to go.

Hello there I have couple Smith manouvre related question. Before I get to the questions here is my background: I have read the book and online opinions about the subject (thanks to FT and others in the blog community for all the commentary). I have also consulted a couple financial advisors and one accountant. I have started the smith manouvre by making my SM portfolio the same size as my existing non-deductible debt. Things seem to be going fairly well considering the current environment.

My questions are when or how is asset appreciation calculated in to the equation for both the portfolio and the house? If there is significant appreciation in your portfolio shouldn’t you cash out a portion, take the tax hit, lump sum it to the mortgage debt and borrow back into the investment account. And if your house’s value has risen over a period of a few years shouldn’t you be going back to the bank for a re-assessment to use that extra cash for your investment account?

These answers may have been in the book but I could have just glazed over that part. Because I just borrowed it from the local library I don’t have it as a reference. Any insight would be appreciated.

Csplice

FT, Thansk for the reply.
I am aware that when withdrawing from the investment account the correct percentage must first be payed back to the HELOC and only then can the rest be used as you see fit. Since the end result is more tax deductable debt and less non-tax deductable debt, won’t any capital gains hits be offset by this larger income tax deduction in the long run.

I am not suppporting frequent trades in a SM account but adjustments to be made every 3-5 years seem appropriate given the rise in home prices and the expected rise in investment portfolios.

I was just thinking this should be a more significant aspect ofthe SM.

Csplice

In the book, Smith only compares the SM to a common mortgage situation. His thesis is that without increasing the debt, or leverage, beyond that of a normal mortgage holder, you could accumulate a sizeable portfolio. If you increase your HELOC by reassessing your home’s value, you have stepped beyond Smith’s manoeuvre. Smith indicates this in his example of the couple who are in the hospitality industry, as they take on additional leverage beyond that of the normal SM.

DAvid

Csplice,
If you make these changes, you are not discussing a Smith Manoeuvre, then. The Smith Manoeuvre does not increase the HELOC amount in the manner you describe in any of your posts. While you may be looking at other investment strategies that better meet your investment goals, these are not the SM.

SM does not increase your initial mortgage amount
SM does not include any reappraisals of your home
SM does not add interest on top of the HELOC, increasing it in size.
SM continues for the full (25 year) amortization period of the initial mortgage

Your example therefore does not flow, as you are not including any increase in the amount of the HELOC as the mortgage is reduced. Smith would keep your level of debt at $200,000 over the life of the SM, with the HELOC portion only increasing by the amount the mortgage is reduced. Your proposal to allow the HELOC to grow by the compounded interest rate is a very different strategy.

Smith is using the strategy to convert the non-deductible mortgage loan to a deductible investment loan over time, while at the same time
building a portfolio where none would have existed before.

You may wish to re-read the book to refresh your memory. If you wish to discuss other investment strategies, I’m happy to do that also; just call them by some other name than ‘Smith Manoeuvre’

DAvid

Csplice,
Smith capitalizes’ the interest, he does not compound it. When you look closely at the process of ‘guerrilla capitalization’ you see that he first pays the interest from the following month’s mortgage transfer to the HELOC. The amount you can invest is reduced by the cost of interest. This becomes very clear if you look at Cannon_fodder’s excellent spreadsheet on this site.

DAvid

Hi Cannon!

It is very praiseworthy of you to expire, the HELOC unpaid. But if I may suggest a second layer of tax exempt manoeuvre on top of the SM, I would suggest a UL policy, paid by a small portion of your investment returns, for a few years. If you choose the type and size of the policy properly, this will pretty well double your returns and cut your risk practically near to zero.
You can see on my website how it works : http://www.falconaire.com

is anyone thinking of taking their money out of the sm and waiting to see if the market is going to continue to slide and then reinvest or are people mostly gonna ride the storm. i’ve been in a sm for a year now and i’m getting a bit nervous. thoughts?

Hi Les,

I assume you also claim the interest deduction 50/50 with your wife, since you are claimng the investment income 50/50?

Also, since you are getting interest income, I assume there are no tax refunds?

What kind of mortgage holder have you invested withh? How risky is it loaning money to someone that will pay 12% on a mortgage?

Ed

Here’s a silly question: what was the Smith Manoeuvre called before it was the Smith Manoeuvre?

Scott, the SM before was called Rabindranath Tagore. Prior to that it was called Stephan Leacock and before that it was called Sir John A. MacDonald.

HI Blitzer!

I am afraid, you will just have to stick with your decision, that is the best for you.
Never mind that you don’t quite understand the SM, never mind that you are wrong in almost all of your assumptions and never mind that the SM is actually less risky than a conventional mortgage, the main thing for you is, that you are most comfortable with the same old same old.
Had you read carefully enough, you would have discovered Ed’s invaluable technical explanations and some of the others made very useful contributions too, but you were prevented by your prejudice for RRSP from appreciating them.
I just fail to understand why would you express an opinion, if you neither understand, nor like the concept.

Blitzer68,

Just out of curiosity, what would you do if you learned your tax rate on withdrawal from your RRSP would be greater than when you contributed? Might this change your contribution plan?

Would it surprise you to learn that an RRSP outperforms a non-registered portfolio ONLY if you reinvest the tax return into the RRSP.

And finally, have you considered the option of implementing the Smith Manoeuvre even without making any extra payments, except the tax returns? Thus simply converting your non-deductible loan to a deductible one?

There is much information on these topics contained in this and the sister entry on this site, as well as on Canadian Capitalist’s site. If you care to take the time to read and reflect, you will gain far more knowledge than anyone here is prepared to re-type.

DAvid

Blitzer68 said “I have not. I suppose if could contribute the $10k to my RRSP and then use the $4k tax return to pay down the mortgage and then borrow it back as per the Smith manoeuvre. I’ll try running the scenario in a spreadsheet unless someone else already has.”

Sorry, I meant the tax return from the interest deductability, not the RRSP.

So, you plan to retire on 2/3 (or less) of your then current income?

Your plan also seems to miss the opportunities of lower tax rates on dividend and capital gains income. For instance, if you live in BC, and your income is solely from dividends in 2008 (a very real possibility with a well-considered portfolio) you would pay $0 in income taxes (or get a rebate) unless your income exceeds about $70,000. So, I pay 23% taxes in (on a small dollar amount), and 0% out (on a much larger amount). If I “income split” by building two portfolios, we can enjoy the full $139,900 tax free!

Your plan, in my opinion, has the potential to create short-term gain for long-term pain.

DAvid

Blitzer,

You can run some scenarios using the SM calculator I posted about a year and a half ago (as long as you have Excel – google docs couldn’t handle an Excel SS this complicated).

You can check boxes for Step 1 and 2. If you did in fact receive a tax refund due to RRSP contributions not being quite covered by your employer reducing taxes at source (it never worked for me) then you can estimate that amount, and input it into the annual prepayment box.

rk where did you get a variable mortgage for 2.5%?

Sorry that should have read 2007 instead of 200

The last scenario I entered was HELOC at prime + 1 and short-term investment growth rate of 3% . I’m being conservative here because I’m not sure that I can even get a positive return over the next year outside of low interest guaranteed investments. I’m new to investing so please forgive my ignorance if I’m missing something here.

The spreadsheet works on an average annual investment growth rate, so I know that 3% is too pessimitic in the long term but I think anything more might be overly optimistic in the short term. I realize the Smith Manoeuvre will work over the long-term – I’m just trying to decide if now is the right time to start.

I didn’t include dividends . I haven’t done a lot of research into what current dividends are, although my thinking is that dividends will inenvitably decrease next year in many sectors as corporate profits dwindle. Thanks for the pointer though, I’ll try and research that aspect some more.

Thanks Sandor – does anyone know if it’s possible to get HELOC at prime these days?

I agree that investments are at a huge discount right now. I realize it’s a bad idea to time the market, but I’d rather wait a bit for discounting since I think the market will continue to fall into the new year. If I’m wrong prices will go up and I’ll have missed out on good discounts, but I’m willing to take that particular risk. I’ll also hedge some of that risk by buying a few equities next year with after-tax cash.

In any event, you’ve both given me some good food for thought which is exactly what I was looking for so thanks again.

Hi David, I’m not looking for short term gains. I read the book, and understand it’s a long term strategy.I know in the long term the Smith Manoeuvre will be highly profitable, my question was around the pros and cons of starting it now as opposed to slightly later. I think I have some pros and cons to weigh now so thanks again

Hi all,

I need some advice to try and wrap my head around the logistics of my fiancial situation. I currently have a HELOC for my mortgage and a small investment loan. It allows me to track the interest on the loan for income tax purposes. I want to switch back to a conventional morgage but not sure what to do about the investment loan. I’ll use examples to try and explain this better. Current mortgage amount $500,000(all amounts are made up), current investment amount $50,000. New mortgage amount will be $700,000 and investment loan will be included which means it will be paid off. How do I continue to track the interest on the loan even though it will be paid off and I don’t actually need the loan money. Can I get a new loan for $50,000 and just use it to pay down my mortgage?

Thanks in advance.

Hello All, I have just begun to research on SM strategy as I will be moving to a new property with an increased mortgage.
I have also seen some variations of the above including TDMP which I would like to know more about.
As you can see, I would like to take some more time to research, but my closing is in next 35 days.
Can I simply get a standard mortgage with Firstline and then switch it to SM a month or two later?

Thanks.
So if I do get a readvanable motgage to start with, I can implement the startegy later ?

Ok… I’m very new to this. Although I understand the principles (somewhat), I am nervouse. I’m looking at the current market as a “buy/value” opportunity.

Let me describe my situation.
48, 95k mortgage (fixed 5yr, 4.5%) due for renewal in 2010, house value presently around 220k (Manitoba). 70k in RRSP (todays value) 65k in contribution room due to lo/ocom perios and 5k in non registered investment.

My in concern with implementing the SM or variations would be with making payments. I recently had a 20 month period of low to no income (job market).

How can you maintain the SM when you hit periods of low/no income?

During this time I had to (shudder) cash out some RRSP just to make the monthly payments.

I’ve just secured a job 60k/yr which given the previous couple of years seems like alot of money but really isn’t. The first thing done after securing the job was 5k TFSA… safety net.

Given the spotty employmet income scenario and recent job markets where no one seems safe….. I know this is a broad question… but what advise would you give?

Thanks for your time.

Hi Maggie,

I just noticed your post. You need to keep your investment loan separate from any non-deductible debt. You can refinance it within a separate portion of your mortgage, but not within your main mortgage.

I would suggest you get a readvanceable mortgage, have the main mortgage what ever you need it to be and keep the $50,000 investment loan as a separate credit line portion.

Ed

Hi Grant,

I’m originally from Manitoba as well. Keep dry.

How do you keep making your mortgage payments when you have low/no income? The SM takes none of your cash flow. As long as you can continue to make your mortgage payments, you can maintain the SM.

In a worst-case scenario when you cannot make your mortgage payments and have nothing left to fall back on, you can always use your SM investments to keep making your mortgage payments. This will, of course, reduce the tax deductibility of your SM credit line and may be a challenge to fix up, but that is better than losing your home.

In this way, you might be better off if you are doing the SM when you lose your job. You might have trouble borrowing money when you have no job, but with the SM, you have already borrowed and have investments that can help you make your payments in a worst-case scenario.

Ed

Hello All, can someone help me understand what a Matrix Mortgage offered by First Line is?
Is this a type of Mortgage that I need for SM?

Grant,

Is the 5k in non-registered investments the same as the 5k in the TFSA? Does your mortgage allow you to prepay either by upping your periodic payments or by lump sum payments? Have you gone to the bank to inquire about possible interest rates on a separate LOC that is secured by your house?

It sounds like you will be smart enough to do some more research before embarking on this and when you do, you will do it prudently.

If you can get a good interest rate on a LOC now you don’t need to worry about the lack of readvanceability IF you don’t mind the fact that you will need to pay out monthly interest charges from your cash flow (although it may be possible to create a dividend producing portfolio that covers even that).

You can dip your toes in the water without embarking on a SM just yet. If you were planning on putting $200/month into a mutual fund in a non-registered investment portfolio, you could also decide that you don’t mind borrowing $200/month from a LOC and then you have to pay the monthly interest charges instead of coming up with the $200 out of pocket.

It comes down to whether you think you have a very good chance of beating the after tax interest cost on the LOC charges with your investments.

Just another idea if you didn’t want to wait for your mortgage renewal. Hopefully you can find a readvanceable mortgage product from your current lender – that way you probably can renew as much as 90 days early.

I am curios. Wouldn’t it make sense to invest in dividend producing equities which have a dividend reinvestment option? Apply your tax deduction from the interest which you have paid on your heloc, but let your monthly investments create dividends which are then simply reinvested? It might take a bit longer to pay off your mortgage, but you would be growing your investment holdings at a quicker rate because of compounding.

Just a thought.

Hi Curiosa,

Getting a higher tax refund from RRSPs may appear to accelerate the process, but this may or may not put you ahead over your lifetime, when you include all the tax on withdrawing the RRSP after you retire.

The first question is – how effective will RRSPs be for you in general? The critical issue is whether your marginal tax rate is higher or lower now than after you retire. If your tax rate, for example, will be higher after your retire, then RRSPs will probably be less effective over your lifetime than just investing non-registered. Similarly, if you will be in a lower bracket after you retire, then RRSPs will probably work for you.

Many people just assume that retirees are in lower tax brackets, but probably nearly half of all Canadians will likely be in higher tax brackets after they retire than during their career, when you include the clawbacks on seniors.

You are in a 42% tax bracket now with an income of $80,000+, which is one of the higher rates. However, for those over 65, they are usually in tax brackets of 46% or higher at almost all income levels above about $40,000/year. This is only about 1/2 of your current income.

Whether or not you will be in a lower tax rate in retirement depends on many factors, including how large a nest egg you expect to have, how much is RRSP, how much you will have in deductions (such as SM interest deductions), whether you can income split, etc. It takes a proper retirement plan to figure this out.

From what you have mentioned, it is not initially obvious whether RRSPs will be more beneficial for you. If you plan it right, though, you can make it beneficial.

Large RRSP contributions likely won’t work for you, since that would put you into lower tax brackets. This would mean smaller refunds from the same RRSP contribution.

The best strategy is probably a combination:

1. Contribute the maximum RRSP you can witout going to a lower tax bracket.
2. Periodically, convert the RRSP borrowings into your mortgage, since it is the lowest rate and you can do the SM on it.
3. Do the SM, possibly a more aggressive version of it, so that your mortgage can start to come down, even though you keep adding RRSP borrowings to it.
4. Pay your total tax refunds onto your mortgage and reborrow either for RRSP or SM (see step 1).
5. Build up enough SM so that you will stay in a lower tax bracket after you retire.

We are professional financial advisors specializing in exactly your issues. However, we may not be suitable for you because we have stopped taking on fee-based clients. We are only interested in long term clients and have found fee-based clients tend to be short term. Canadians seem to hate paying the cost of a professional, written plan. We’re used to geting our health care free too. More importantly, fee-based means being “on the clock” over the years during reviews or asking questions. We have found this does not promote a long term relationship.

The SM is also considered a risky strategy, since it is leverage. Fee-based advisors normally stick to traditional strategies.

You are in a good position, though, asking the questions you are asking and looking to start an effective strategy at such a young age, Sky.

Ed

Millionareby45

Please check out this article to understand Ed’s contention of high tax rates.

http://www.milliondollarjourney.com/tfsa-vs-rrsp-clawbacks-income-tax-on-seniors.htm

You may fall into the camp that doesn’t look at not receiving the GIS as a clawback because you never considered you’d be in a position of such low income to receive it. For younger people, it will be easier because of the TFSA to set up a portfolio that may allow you to take advantage of the GIS. Using a combination of TFSA, annuities and non-registered portfolios that provide capital gain income could lead to less taxable income than a simple RRSP could.

It’s definitely a though provoking article.

Hello Russ!

You know from hearsay as well as experience that you are getting what you paid for. That free advice is only worth its price.
But I gladly direct your attention to a few areas. Because no matter how much you gave in the way of details, there is somewhat more needed to do any responsible work for you.
However, It is apparent that you are a pretty good candidate for the Smith Manoeuvre. You could not only do one on your present house, but also buy your next one with a Smith.
You could also hold off the cat food if you do the Smith, probably will have even cheese too with your day old bread. In fact I am quite sure, that you would be able to afford some meat and even the occasional shrimp.
Something probably could be done with your business as well, but that needs more questions and answers. (Are you incorporated, are you paying yourself salary, or dividend, are you taking bonus, etc.) Your whole income and taxation should be examined and if possible arranged so, that you can go further faster.

FT,

Perhaps Russ would make a good candidate for another post entitled, “What would YOU do in their situation?”

Russ – any pensions for either you or your wife? You probably would need to list your monthly expenses as well. It would help people get a good idea as to where the money is going and if there are reasonable opportunities to restructure some discretionary income towards saving/investing/debt reduction.

Over a year ago when we first read the SM book, we “accidentally” fell in to the RBC homeline mortgage when we were shopping around to renew.

We chose to invest in rental real estate, as it was something we could easily understand. Other types of Investments were a blurr to us. We have purchased a total of 4 rental properties with a total of 8 units. We reimburse our monthly rental expences from our investment Line of credit to our personal mortgage. This concept is what really excited us about the SM. Transfering the bad debt to good debt.

The tax advantages (or refund) at the end of the year for the first 2 rentals were not a much as we had hoped. It should be interesting to see what the 4 units will do and increased borrowing for investments.

We are very happy with how things are going, we plan to buy one more rental property and coninute to use this type of leveraging to invest.

Currently our personal monthly mortgage payments give us 900.00 a month towards the principal increasing the value of our investment Line of Credit by the same, we hope to reinvest about 800.00 of that.

We just have to figure out how and where to invest.

We find this web site very helpful.

Thanks Andrea

“337. FrugalTrader
falconaire, we do not allow the solicitation of business within the comments of MDJ. Thanks for understanding.”

My dear Frugal, I don’t see how my post would constitute soliciting. I do understand, and don’t mind at all that you discourage that, but as it happens, there is nothing in my post that directs attention to myself. A mere list of things to do that can be done by anybody. I think you are suspicious without justification. A second look at the posting will bear that out.

Russ,

To be blunt, you have the time to educate yourself and become more informed – it is your choice whether you want to put other matters as a higher priority. If you feel the need to get expert advice, since understandably it would take a long time and extensive experience to become an expert, it still is important that you understand the fundamentals.

This way, you can separate the fact from the sales pitch. You can ask the tough questions and see how the advisor reacts. No matter what advice you get, no one cares more about your money than you do.

There is no rush – the markets will still be there months from now. Enjoy the opportunity to learn, take everything you read with a grain of salt (none of us are right all of the time – I hope that I can be right at least most of the time!) and don’t be afraid to ask questions.

These kinds of decisions could very easily be life-altering. Make sure they get the attention they deserve.

Just wondering what are the tax implications of owning “RIOCAN Real Estate Trust” while implementing the smith maneuver? Anyone have an opinion on this?
Thanks

Hello all:

I’ve been impressed with the breadth of information this website and all the helpful comments. I am a bit confused about how to enact this advice for my personal situation here in over-priced Vancouver.

I currently own a house valued at $1.2 million and have a Scotialine HELOC owing $500K and $450K of unused space. We currently pay prime though this will increase to prime +1% soon. The bank will only increase my line of credit limit by a further $50K (total $1 million). In addition, I plan on building a new house on the current lot next year that will cost about $450K and the new home will likely be valued in the $2 million range.

My priorities are to 1. Lock in at least a portion of my current floating line of credit with these low interest rates; 2. Start some sort of Smith Maneuver now while stock prices are relatively depressed (and thus dividends are high); 3. Reserve at least $450K of my unused line of credit space so I can avoid the hassles of a construction mortgage next year.

I was wondering if the following would be good idea:
1. Lock in $500K 10 year 5.25% 17 year amortization
2. Build next year and after spending the $450K, either leave it floating in the HELOC or lock in at a shorter term mortgages depending on the situation at the time.

My problem is how I do I get the Smith Maneuver to fit in this scheme?

Can anybody help me?

Thanks.

so basically, you borrow against home and use that money to invest and yet
you don’t pay off the HELOC? you pay just… the mortgage when you get the tax return?
HELOC debt is growing… what do you do about that?

Hi Frugal and Connan!

What makes the SM so attractive, besides its advantages, is its eminent rationality.
So, I would suggest that the repayment of the HELOC should also be guided by the same sober rationality and not by “feelings.”
I always explain to my clients that keeping the SM in place as long as possible is in their best interest. Mainly because their port folio would probably earn more yearly than their retirement income would be otherwise.
However, the repayment of the HELOC could be justified by two reasons.
First is if the payment of the interest is so burdensome that they can no longer afford it. This is unlikely to happen if the investments are performing well.
The other reason would be if they could not take advantage of the tax write offs. This is also quite unlikely to happen after they accumulated a large port folio, because its income would certainly entail tax obligations that would be at least partially offset by the tax refunds.
So, unless one of these two conditions are met, the HELOC should not be paid back.

Hi there,

I am looking to purchase my first home (a condo in downtown Toronto), and have already been approved for a mortgage with CIBC. As I work for CIBC, I have received a relatively low interest rate. The closing date on my condo is November 1st, and I just recently heard about the SM. I’m trying to do as much research as possible before jumping into this and have a few questions for you; first off, I am only planning on living in the condo for about 3 or 4 years, then buying a larger home in the suburbs. So I’m wondering if my ’short term’ ownership plan makes me an un-ideal candidate for the SM. I realize this will likely subject me to fluctuations in the marketplace (given the investments) moreso than someone with a longer time horizon. Also, my initial plan was to pay down my mortgage as soon as possible – I would likely be able to pay it down within 4 years.

Any advice for someone in my situation?

Thanks!

Hi Mark,

Just to add to FT’s comments, the other advantage of the SM over ordinary leverage is that the SM does not require any of your cash flow. If you have other good uses for your cash flow, then the SM is usually better than ordinary leverage.

We would not suggest your try the SM if you are planning to try it for only 1-2 years. It is borrowing to invest, which is a risky strategy. The risk declines very significanlty with time. To be effective, you need to be the kind of person that will stick with the strategy when the market goes through significant declines.

If you are planning to just “try it”, it is unlikely to work for you. The first time the market declines, you may sell and abandon the SM, and if you sell at a low, you will probably lose money.

If you are concerned about having credit lines reduce your credit score, most SM-type mortgages will show up on your Credit Bureau, but not all. The best ones are mainly with the banks, and those will all show.

What you can do to maintain your credit score is to not max out the credit line portion. Leave 10-20% of the credit limit available. Your credit score may be reduced if you have a few credit lines and all are maxed. So leave some credit available in some, if you can.

Ed

Hi Patch,

The type of loan (HELOC) does not affect whether or not it is tax deductible. Tax deductibility is based on what you used the money for. If you borrow against your condo (rental) to make a down payment for your home, it is not tax deductible because the purpose of borrowing is to buy your home.

If you do that, you can do the SM on this HELOC, on your home, and on your rental condo. That way, you can convert this HELOC to tax deductible over time.

Have you worked out the cash flow on renting your condo? We have seen a lot of peope with rental condos in Toronto over the last few years and nearly all are paying $400-500/month out of their pocket. The rent is quite a bit less than the mortgage payment, property taxes, condo fees, insurance, repairs, and other costs.

Therefore, condos in Toronto are not really a good choice for a rental property. If you want to have a rental property, consider an older, multiple-unit building.

Your other option is to sell the condo when you buy your home so that you can do a larger SM. If you leverage a similar amount into the stock market or mutual funds to what you had planned to leverage by keeping the rental, you can make a far higher profit over time, as long as you invest effectively and for the long term.

Ed

James,

glad to hear you are finding the SS useful. The way I look at the total benefit is to run the scenarios as traditional mortgages first. Once you settle on one then I run some SM scenarios. After choosing the one most appropriate I compare networth and cash flow numbers IN THE SAME TIME PERIOD. If your networth went up by 50k and the cash flow was lower by 25k that to me speaks of a 75k benefit.

The reason the house value growth rate would be in there is a commercial version required a periodic revisit to the maximum LOC value. It is not really used in this free version.

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Hello:
Is CIBC “Home power mrtg” good to implement smith manoeuvre ?

I have approached CIBC branch, I was told that I will not be provided sub-account to withdraw funds for invetment purpose! What I will be having is only one HomePower account, I need to take from there as the principle grows.
Any ideas? Is anybody here with CIBC Home power implemeting SM ? Please advise.
Thanks

Hi Ed,
Let’s say I have 200K mortgage balance (5%, fixed) and 300K HELOC (result of SM, 3.75%,). I can refinance mortgage and get 1.99% variable rate for new mortgage. Also, I can add HELOC portion to my new mortgage (which still will be readvancable) and save even more. But in this case every mortgage payment will reduce a “mortgage” portion and old “HELOC” portion. I don’t see how I can calculate a tax-deductable part of payment. Should I add my HELOC to a new mortgage or it is better to keep HELOC separately (paying higher interest but having clean investment record)?

Wanted to share my experience with doing the smith manoevre and understand if i’m doing anything wrong. Here’s my story:

i basically had a readvancable LOC of $60,000 that i have broken up into 2 segments, one that i am keeping for any untoward expenses ($20K – current balance $0) and the other that is my investment LOC. I have used 30,000 $ current limit ($40K) of the investment LOC and have put it into a margin account and leveraged again (1:3) to invest about $80,000….i started doing this in the latter part of 2008 and invested bit by bit till i reached the $80,000 threshold. My portolio as of yesterday was about $130000 (market value). At this time, i have only being paying the interest charges on my HELOC which are still pretty minimal in my mind (~$80 per month). From what i understand these interest charges as well as the interest i’m paying on my margin account with questrade (about $140 or so) are both tax deductible…is my understanding correct? Can anyone suggest any issues in my interpretation of the smith manouvre?

My plan is to aggressively pay the mortgage by cashing out some of the positions i hold once interest rates start to rise and i feel the stock market is overvalued…at present i think we can see the TSX hitting 13500 ish in the next 2 years and i fully plan on making hay while the sun shines.
Meanwhile I’m eager for the market to correct a bit more so i can dump the rest of my $10,000 ifrom my HELOC….leverage it with my margin account and watch it do wonders….i think i’m getting a bit ahead of myself though, it seems too easy!!

When i read on the smith manoeuvre such as here, it seems that a lot of ppl here invest in dividend stocks and use the cash flow to pay the interest on the mortgage and tax breaks rom smith manoeuvre to pay off the mortgage. Why are people so eager to pay down their mortages in such uber low interest rate situation? Am i missing something?

Ed
Thanks for your response. I’m firmly in the bull camp for stock markets…given how low they have fallen, i see a lot of sideways movement but in general the market going higher. I will have to actually take some money off the table but it is due to the fact that i have to put some money as a downpayment for a house. Luckily my investment strategies have allowed me to pay the sum through my investments. For the next year or two i’m going to invest any surplus dollar i can find and put it into the stock market. I will leverage it as well….as again , i don’t understand what all the hullaboo is about a leveraged investment. Whats the worse that can happen? You get a margin call? So you sell something and take a hit – not the most ideal scenario but oh well, you will probably sell your worst performing stock which wasn’t going to make you much money anyways….just take the tax benefits and invest in something else. That said, I always try to have enough extra cash in my leveraged account to cover off such scenarios. I also have extra equity in my Heloc to replenish my investment account if the market falls. At present time, i believe i can absorb a 20% correction without having to sell anything at lows. However I think this scenario is highly unlikely. If it were to happen, i would most definitely take out some more money from my other LOC and dump it in stocks.

I have also read your articles on the irrational fair people have about the stock market….it is just plain stupid. The market in general grows 10% a year – this is a proven fact and just like the house always wins, and therefore you shouldn’t bet against it – you should not bet against the world economies.

Meanwhile i’m going for a variable mortgage, diminishing my cash flows and put every $ into the market.

No pain , no gain – don’t miss out folks!

Ed,
Good to see that we are in agreement, in my opinion, while everyone needs to be aware of the risks with investing, but it just seems that ‘leverage’ is a taboo word nowadays, and i think you would agree with me, that there is a degree of fear mongering going on to scare the average investor and prevent them of reaching their financial milestones whatever they might be.

I see your point about margin loans. Margin like anything else is a matter of preference based on your risk t