From———————To—————–DJIA——S&P500– NASDAQ
January 2, 2001 – January 27, 2012 1.56% 0.23% 1.88%
January 3, 2002 – January 27, 2012 2.16% 1.22% 3.24%

Source http://www.measuringworth.com/DJIA_SP_NASDAQ

While I would agree that a self-directed RRSP mortgage is not for everyone, I disagree with your comments which make it sound like it never makes sense. Here’s how I use it and make it work for me.

1. Most expensive mortgage in Canada ( perhaps you can explain why you believe this is so). My mortgage is only a portion of my RRSP (35%) and I treat it like the fixed income/bond/preferred share portion of my portfolio.
2. Dreadful return. The return is 6.5% which I believe you would have a hard time saying is a ‘dreadful’ return for a fixed income/bond/preferred share type investment. I chose the posted rate rather than the best possible rate that I could get to have a high return.
3. High fees. Yes, there are fees involved. One-time legal fee to setup the mortgage, one-time Canada Mortgage and Housing Corp (CMHC) insurance fee, and on-going annual trustee fee. The size of the mortgage and the amount of equity which you have in your home determines if the cost of these fees is high, medium, or low. General rule of thumb, if less than say 50,000-100,000 the fees may be too high. Also, if you do not have significant equity in your home, the CMHC insurance premium will be too high. However, in my case, the mortgage is larger than 100K, and I have 65% equity in my home so the CMHC premium was low. So, your comment about high fees, while it is a factor, is not always the case.
4. I am well aware that I still have a mortgage. Coincidentally, I recently adjusted the payments on the mortgage to ensure that I will be mortgage free before we become empty-nesters.
5. Risk management — which you do not list — I sleep better knowing that the fixed income portion of my portfolio is extremely low risk, highly flexible. I am not worried about the safety of government bonds, corporate bonds, changes in interest rates as it pertains to my fixed income portfolio. I am not chasing higher bond/preferred share income while increasing my risk.

I recently did a check on the CAGR of the TSX Composite, S&P 500, and the DJI 30 over the past ten years. The GIC investor likely earned more over that 10 year period and slept a lot better than those who have gone through the Financial Crisis in the markets.

Lastly, if your clients have earned 10% per year on your recommendations over the past 10 years, you have served them very well indeed.

You may have lucked out by avoiding the 2008 crash, but it is important to look at these strategies based on reasonable long term expectations.

We are not fans of the RRSP mortgage strategy. In general, it is a combination of:

1. The most expensive mortgage in Canada.
2. A dreadful return on your RRSP investment.
3. High fees.
4. A mistaken belief that you have no mortgage.

In the long term, I expect my RRSP investments to make at least 10%/year (I’m an aggressive investor). I don’t have mortgage, but our clients’ mortgages have all been at rates between 1-3% for the last several years. Normally, the have no mortgage fees at all.

The RRSP mortgage strategy cannot come close to any of these. I think the RRSP mortgage only makes sense for GIC investors.

Ed

Given the circumstances, the portfolio has done relatively well.

Frugal Trader, looks like you completed the SM in Spring 2007. In Oct 2007, TSX Composite was 14,000. Four years later TSX Composite is at 12,500 (-10%) and in between hit a low of 7500 (-50%). The US has fared worse.

I’m a newbie, and forgive for being forward, but are you willing to share your experiences in this time period. Did you go thru the SM worst case scenario where investments were less (or significantly less) than the HELOC amount owed.

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.

[...] my annual growing dividends to comfortably exceed the loan servicing payments when I'm finished paying off the non-deductible mortgage in about 10 years time.  That way, when the non-deductible mortgage is paid off, we'll have another [...]

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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