Where does the mortgage interest go? Is your mortgage going down by exactly your payments or is the interest showing up once the payment is made? The easiest way to tell is to log on the day before the payment and note the balance and then log in after the payment has been made.

From my way of thinking, the interest MUST be added on to the mortgage portion of the Readiline or else you end up having the interest being piled onto the LOC which is at a higher rate.

Does your Readiline mortgage balance grow daily (i.e. when you log in, do you see the accrued interest added to the balance)? What I have seen for the first month and a half was that interest was only evident when the mortgage payment was applied and the principal went down by less than the mortgage payment.

Now, for the month of September, every time the mortgage payment was applied, the mortgage balance went down by the entire amount! No interest!

I don’t know what is going on. It isn’t being added to the HELOC as far as I can tell.

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Oh, that’s your issue. All kinds of games can be played with insurance policies, so I can see why policy loans would have to meet higher standards. There are investments inside the policy you borrow from, so there is a different standard to make sure it is actually interest borrowed for investments.

This is not an issue if you borrow from a bank and buy normal mutual funds.

There is no doubt that accrued interest and capitalized interest are deductible. Just read IT-533 about interest “paid and payable” being deductible, allowing the “accrual method of accounting” and “compound interest” being allowed.

The quote you used is about “contingent interest”, in which the interest is not actually payable for some reason. That is not relevant to the Smith Manoeuvre (unless you borrow against insurance policies).

Forget about investing and borrowing with insurance policies and you won’t have all of these problems, Sandor.

Ed

They are so strict about interest deductibility that in the case of interests on policy loans, borrowed from life insurance policies, they only allow the deduction if the insurer issues a certificate about the payment of interest. What’s more, there is a specific form that the insurer must certify.
I don’t think the unpaid interest to be dedutible.
In fact, the paragraph below the one I sent before also tightens the screw even further, saying, that if the interest is paid in the following year it is still not deductible retroctively.

Sandor

You are referring to contingent interest, not accrued interest. IT-533 about deducting carrying charges consistently refers to interest that is “paid or payable”.

Often interest is paid the month after it is billed by your bank. It is acceptable to use the accrual method (based on date billed) or the cash method, as long as you use it consistently.

Capitalizing interest IS paying it. Capitalizing only refers to where it is paid from. So capitalizing interest is definitely deductible.

With the Smith Manoeuvre (not the Smith/Snyder), all the interest is fully deductible, even though you capitalize it all.

Ed

In the early years of the SM you may forgo the tax refund, since it is small, but in later years you better take advantage of it by paying the interest, since that doesn’t grow unlike the tax refunds.

Sandor

I reconsidered it.
You should pay the interest if it gets you more tax refund then it would make in the investment. If however, you could earn more by investing it, then it is worth forgoing the tax refund. Each individual case has to have its own calculations.

Sandor

I am afraid you and FT are both mistaken.
If I may recommend CRA’s lovely bulletin IT533 for a closer look, there you will find the following:

“Contingent interest

¶ 6. Where an amount computed as interest expense is not payable in respect of a year because of an unsatisfied contingency, the provisions of paragraph 20(1)(c) are not met as the interest is not paid or payable since there is no legal obligation to pay (as was the case in Barbican), and accordingly, the interest is not deductible in that year.”

Bad news. Pay the interest and be done with it.

Sandor

FT is correct. Capitalizing interest still means you are paying it. And it is not true that you have to pay it – accrued interest can also be deductible.

Capitalizing interest is part of the Smith Manoeuvre, which fully fits the tax rules if implemented properly.

I might add that the Smith/Snyder may not meet tax rules. Most of the presentations I’ve seen promoting the Smith/Snyder will likely result in you losing your next tax audit. This is because a distribution is paid out from the fund and not applied fully to the investment loan.

You don’t have to worry about tax with any steps that are part of the original Smith Manoeuvre, though, if they are properly implemented.

Ed

It seems silly, but although I do contribute the odd letter to the SM debate, I just discovered this page.
So, like a newborn baby, for whom all jokes sound funny, I would like to address your original article about your own prospects.
The only caveat I am making is that instead of disputing your cenario, I just ask about an alternative.
Namely, the first alternative is paying the HELOC interest instead of capitalizing it. It does sound distastful, but unless you pay it, you cannot deduct it from your taxes. Only the actually paid interest is deductible.
The other alternative would be the RRSP contributions. I think your house would be paid off even sooner if you redirected your RRSP contributions to the SM. Also, your portfolio would benefit from it too. Since you would give up the tax benefir of the RRSP what would be the benefit, you may ask. Well, it is up to you to calculate the alternatives, but you would get an other tax benefit instead and the money invested in the portfolio wouldn’t be burdened by the limitations of RRSP.

Sandor

Play around with the Rent vs Own calculators — there are numerous ones on the ‘net, and see what might work for you. Just remember, for most folks, a house is just somewhere to live, not an investment, unless you can move to a cheaper place in the future.

A house can be a money pit, so be aware of the potential for regular, extra costs of ownership that will eat into your $4800!

David

2)with respect to purchase of a condo it’s relatively easy to even get 100% finance..
would you or anyone here know of means to relatively get large leverage on equities(all i could get right now is 50% margin)..would there be any financial planners helping clients get large leverage on equities…

i understand that unlike in SM manoeuvre i don’t have a house/property to back my loans..

If as Ed said, you purchased a loan with your $4800, you could have a portfolio of $120,000, which might appreciate at a compounded 10%. In the first year you would see a $12,000 return. Here’s where it really makes the difference — if you are in a changing job situation, where you might move to another location in a few years — people today are VERY mobile, the rental makes a lot of sense, as the ease of departure remains. Your portfolio moves easily with you where ever you go.

If, like many of us, you are more comfortable with leveraging to purchase your home than other instruments, then you’ll likely follow that route. If on the other hand, you’re willing to take the jump into leveraged equities, then a whole new set of options appear.

My rental experience was the best financial decision I ever made. When I was reduced to one salary, the house became a financial millstone, in a flat market. The apartment was half my mortgage payment, and included heat, hot water, laundry and taxes. I had to pay hydro, phone & internet. It was within walking distance of my workplace, and near all other daily necessities such as groceries, post office & liquor store! In addition to clearing all my debts, the 18 months I stayed there enabled me to add some $25,000 to my RSP. Were a similar opportunity to present itself, I’d jump at the rental in a heartbeat.

David

I postulated this in the original Anti-Smith Maneuvre and on Canadian Capitalist’s site. Ed indicated how the SM could improve my suggestion. I also believe that your proposal matches that of Garth Turner, as discussed inteh Smith Manoeuvre book.

Have a look at the earlier posts.

“Keep renting and put this $4,800 into an equity fund and you are ahead of buying. This is 2.4%, which is about the same as your benefit of buying.”

let me recap…
choice1- i buy a condo for $200,000 fully leveraged at 6% int..
interest cost – $12,000
rental saving- $ 7,2000

so my negative outflow is $4,8000

if instead i rent i save the $4,8000 agreed..

but in choice 1 would not i benefit by appreciation of around $10,000..around 5%
…how would the $4,800 saved be better than $10,000 appreciation…thanks in advance..

and hi ed from your website i know you are knowledgebale about insyrance too…if you have a spare moment can you educate us about universal life..it might be useful for most of us here..i read a little about them..but the Management fees scared me of…

My comparison was with fully-leveraged real estate compared to un-leveraged equities. If you compare them with both full-leveraged, then of course the equity benefit is much higher.

The historical return of equities is over 12%, while real estate is only 6% (although both will likely be lower going forward in this lower infation environment.)

If we use the historical returns, $200,000 in equities would grow $25,000 in the first year while real estate would grow $12,000. If you collect $1,200/month rent (about $15,000) and pay 2/3 of this for property taxes, condo fees, repairs & maintenance and whatever, you gain about $5,000, but are still about $8,000/year behind.

Compound this for many years with the “magic of compounding” and you have a monstrous benefit to equities.

This is still extremely favourable to the rental property, since it excludes all the other costs – legal fees to buy, CMHC fees, commissions and legal fees to sell – and of course all the PITA of collecting rent, finding tentants, having vacant months, having to fix it up between tenants, etc., etc.

Even in your situation, you say the interest will cost you $12,000 and you save $7,200 in rent less condo fees & property taxes, that means it is costing you $4,800 more to own than to keep renting.

Keep renting and put this $4,800 into an equity fund and you are ahead of buying. This is 2.4%, which is about the same as your benefit of buying.

I notice you omitted utilities, CMHC fees (if there is no down payment), costs of buying and selling, and the PITA factor. And you won’t be tempted to waste all kinds of money on renovations.

What’s more, we should go back to comparing both leveraged. This $4,800 could make the payments for you on an investment loan of $120,000. Assuming you are in a moderate 33% tax bracket, you should pay $7,200 in interest and get a refund of $2,400.

Now if this $120,000 equity fund grows by 10%, that’s a gain of $12,000 – quite a bit better than owning.

Bottom line – rental real estate is a PITA and has a low return. Owning your own home, however, gives you the pride of ownership, which might make up for the additional cost over renting.

Now if you do the Smith Manoeuvre on your home or rental, this might make up the difference (depending on how you do it).

Ed