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Setting up The Smith Manoeuvre – The Blueprint


I've written about The Smith Manoeuvre since the inception of this blog but I haven't been practicing what I preach.  That is, until now. 

As you probably know, this strategy is composed of 3 main parts

  1. The mortgage
  2. The automatic readvanceable HELOC
  3. The underlying investments

Lets get started with my blueprint for setting up a slightly modified Smith Manoeuvre.

The Readvanceable Mortgage

We have written a lot about readvanceable mortgage options available.  For the DIY investor, my favorites include:

  1. BMO Readiline
  2. Firstline Matrix Mortgage
  3. RBC Homeline

When it came down to it, I chose the BMO Readiline as their rate was best along with the mortgage being fully open.  The biggest downsides of the BMO product is that the HELOC gets reported to credit agencies along with the need to open a BMO branch account in order to get online access.  I will be writing more about this in the near future and how exactly the money flows between accounts.

The HELOC 

How much of the HELOC do I plan to use to invest?  I plan to use the "Rempel Maximum" formula without using an additional investment loan.  That is,  I'll use as much as my mortgage principle payments will support.  I estimate that with the mortgage payment schedule that we chose, we'll pay off around $6,000 in the first year.  Dividing that by 6%, will result in a maximum loan of $100,000.  Since my HELOC amount is approximately $60,000, I'll use that as my investment amount.

The Investments 

With a new readvanceable mortgage setup, I'm currently in the process of setting up a new joint brokerage account.  Once that is setup and ready to go, what stocks will I buy?  Will I index?  Buy mutual funds? Or pick stocks? 

I know that the general advice around the pf blogosphere is to index. I agree that it's a sensible and easy way to get market exposure with less risk than stock picking.  I even recommend indexing to most people who ask me "what to invest in".

However, my plan is to implement The Smith Manoeuvre and use the investment loan proceeds to generate dividend income.  I plan on using the dividend distributions to accelerate the mortgage pay down.  I've done calculations where if I invest in strong/growing dividend stocks, that the dividends will outgrow the interest payments by year 5.  

Ultimately, the plan is for 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 reliable and growing income stream.  Perhaps just in time for early retirement? :)

On to the actual investments that I'm considering.  The leveraged portfolio will primarily consist of dividend paying stocks but with a sprinkle of high growth small caps.  I've written about strong dividend stocks before, but here are some that will remain on my watch list:

Banks/Financials

  • Royal Bank – RY
  • Canadian Imperial Bank of Commerce – CM
  • Toronto Dominion Bank – TD
  • Bank of Nova Scotia – BNS
  • Bank of Montreal – BMO
  • IGM Financial – IGM

Insurance

  • Power Financial – PWF (owns IGM, GWO)
  • Manulife Financial – MFC
  • Sunlife – SLF
  • GWO -Great West Life

Energy/Utilities

  • Husky Energy – HSE
  • Enbridge – ENB
  • Fortis Properties – FTS
  • TransCanada Corp – TRP

Transportation

  • Canadian National Railway – CNR

Real Estate

  • Brookfield Asset Management – BAM.A

I also like a few income trusts like Canadian Oil Sands and Riocan, but will not include them in the leveraged portfolio as they pay out Return of Capital.  Trying to separate the ROC distributions from the dividends would be an administrative nightmare.

There you have it, my complete plan for converting my bad mortgage debt into an income producing dividend portfolio from start to finish.  Any thoughts or questions?

As a side note, I've had many readers email me about the new version of The Smith Manoeuvre Calculator.  Unfortunately, the newest version is commercial only.  I have been in contact with the creator and he has agreed to do personalized calculations for MDJ readers for a very reasonable price.  Please contact me if you are interested.

photo credit: Thristian

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

{ 58 comments… add one }
  • The Financial Blogger March 6, 2008, 8:26 am

    The advantage about going with indexes is that you have a passive approach and you can benefit from the full potential of the market.

    However, in your situation, it seems that you can beat the market so I would consider stock picking :-)

    Good luck with your strategy! (mine finally shows positive results!)

  • Daniel March 6, 2008, 10:51 am

    Would it be easy to change (reduce) the income tax deduction from a paycheck and apply the saving directly to the mortgage part?

  • FourPillars March 6, 2008, 11:37 am

    I think Canadian dividend stocks are a perfectly valid way to do leveraged investing. It won’t be as diversified as worldwide ETFs but you have your rrsp and other non-reg accounts for that.

    Your timing might be pretty good – the financials are getting killed this year.

    I’m wondering if the market is pricing in the possibility of a dividend cut for CM and BMO? CM is yielding 4.82 percent and BMO is yielding 6.34 percent.

    The BMO yield is just too high…

  • str8jkt March 6, 2008, 11:41 am

    So without using an additional investment loan to cover the remaining 40k to completely cover the Rempel Max amount, are you planning on investing the entire amount available in your HELOC then ($60,000)?

    If so are you planning on paying for the interest on the HELOC out of your own pocket, since I don’t know if the increases from principal payments will be enough to cover off capitalizing the interest in the HELOC?

  • Derek March 6, 2008, 12:01 pm

    I like and agree with what your saying. I may take out some home equity to get my portfolio more even with RRSP to Non registered content. I would look at the dividend achievers from Claymore and the div fund from ishares as core holdings. I would then add more of funds like PWF and and MFC than should be more stable and have lower payout ratios.

    I agree with above. BMO may take a hit like C in the US, but that would be an opportune time to buy i would think. I get more excited as the market falls. Who else wants to see the market sell off 25-40%?? What an opportunity that would be! We could all have the chance to be Wanna be Derek Fosters! lol.

    I don’t like using lots of leverage, but the low cost of borrowing combined with markets selling off make it almost too good to pass up. If you could buy say PWF and have no Dividend cut it should be able to cover all interest costs (since after taxe writeoffs it should only cost about 3.5% to borrow).

  • FrugalTrader March 6, 2008, 1:50 pm

    str, yes i plan on investing the full $60k as my principle payments will support $100k. It’s a conservative version of the Rempel Maximum.

  • telefantastik March 6, 2008, 9:34 pm

    Daniel: that’s an interesting question: the T1213 (http://www.cra-arc.gc.ca/E/pbg/tf/t1213/t1213-04e.pdf) form does have a section on “interest expenses on investment loans”, so it appears that you can indeed reduce related tax at source. It would be interested to hear what others think/know about that possibility: it would allow you to apply tax savings against mortgage to increase HELOC room right away, instead of only at year-ends – meaning more time for compound growth.

    FT: sorry to pry, but by investing the full 60k right away without the additional loan – do you mean this is the initial LOC amount you will have on your home-equity when you start? The reason I ask is: with your ongoing payments down the road, as you pay off interest on that 60k, and unlock more room in your HELOC over and above the original 60k – how would you invest the little additional room left over each payment period? It would not be economical to invest these small amounts into stock because of brokerage commissions. Or do you intend to leave the 60k portfolio alone for a few years, until the additional room in HELOC grows to another chunk that can be invested at once to add to the devidend-stock portfolio?

    I’m planning to implement SM within a year’s timeframe as well, but haven’t yet figured out best approach to investing the initial sum vs. the small increases with each mtg payment. Seems like one option is to build the initial portfolio, and then “plug” the growing holes with small mutual fund purchases in similar holdings; when the mutual fund side grows enough, switch it to equivalent stock/ETF holdings, to cut on MERs. This approach triggers capital gains tax though, so it’s not perfect either.

    • FrugalTrader March 6, 2008, 10:39 pm

      telefantastik, the initial $60k is the amount in the HELOC. I plan on deploying the money as I find stocks that I like. I plan on paying down the mortgage in lump sums, so as long as I have enough to buy a lot of shares, then i’ll purchase. To answer your question, no, I don’t plan on buying a little bit at a time with every principle pay down.

  • Bay Street Rookie March 6, 2008, 11:09 pm

    Hi all,

    I’ve been reading this blog for quite some time but to make this comment I’ve had to change my name to preserve my identity. Working at an investment bank on Bay Street, I’ve got to advise caution on these bank stocks.

    Being on the inside of the bank, and we’re talking about the securities side, we get a very different perspective on the inside functionings of the banks. I would just like to remind you all that Citigroup had to cut its dividend. FourPillars has it down pat. The market is a little skeptical about BMO and CIBC’s dividends.

    Judging by the capital restrictions on traders at my own bank (and its apparent the same is happening across Bay Street), alot of banks are trying to shore their balance sheets up for more turmoil.

    For instance, alot of you don’t realise but Scotia just did a $300MM preferred share deal today. RBC did $1 bln in subordinated debt and CIBC did $1 billion in deposit notes. A week ago, TD did nearly $2 billion in funding through Deposit notes and Preferred shares. These are all means to shore up capital and provide funding.

    Be wary that BMO suffered at one point, its largest one day drop in 25 years until it rallied a bit. The rally meant it only has the dubious distinction of having its worst day in 5 years.

    I’ve followed alot of your blogs and I have a high regard for many of you… Some of you clearly are very talented and to an extent, it’s inspired me to consider blogging as well.

    So keep off CIBC, should this stock go below 55, it could well cut. As for BMO…40 bucks is probably NOT the floor!

    Just thought I’d throw in my 2 cents.

    Best regards,

    Bay Street Rookie

  • Cannon_fodder March 8, 2008, 4:45 pm

    FT,

    My mortgage with BMO is a 5 year term that ends in September. I’m able to move it to a Readiline mortgage within 90 days of my original mortgage’s end date without penalty.

    I’m not clear as to what the interest rates would be for this product – how did yours relate to prime and was it broken into two main sections (e.g. the mortgage and the LOC)?

    • FrugalTrader March 8, 2008, 6:16 pm

      Hi Canon, the actual readiline HELOC is at prime. However, I have a mortgage portion and a HELOC portion. They should be able to set something up for you in the same manner.

  • Cannon_fodder March 8, 2008, 7:13 pm

    FT,

    So is the mortgage portion at prime – 0.45%? I was trying to remember about some statements regarding the interest rates vs. being able to only pay the interest.

    Are you able to only pay the interest costs on the HELOC or do you have to guerilla capitalize the interest?

    • FrugalTrader March 8, 2008, 7:52 pm

      Canon, i locked in my rate a while back so I got prime – 0.85%. In my situation, I could potentially pay the interest servicing costs of the HELOC out of pocket, but I think I will be capitalizing the interest. More on this Monday.

      bj, if you’re looking for a good stock screener, I sometimes use the microsoft online screener that includes email updates when stocks reach a certain price. I basically wait for the stocks on my list to get “cheap”.

  • bj March 8, 2008, 7:23 pm

    How are you screening for the stocks in your short list? Looks like many are part of Mergent’s Canadian dividend achievers list. Have you used value line to narrow down the results? Other tools?

  • cnidog March 9, 2008, 8:56 pm

    FT,

    In this post, and your previous posts on the SM, it seems like you advocate using your dividend payments from your investment to pay down your mortgage. This expands your HELOC, which can be used to purchase more investments.

    This seems sensible, however, I noted that in Comment #113 of the Anti-Smith Manoeuver post, Ed Rempel says, “This is the #1 most common error in the SM. If you take a distribution, you must pay 100% of it onto the tax deductible credit line or investment loan. If you pay any onto your mortgage, you have messed up your tax deductions.”

    Am I misunderstanding something here or are you setting yourself up to mess up your tax deductions.

    Thanks in advance for any clarification.

  • cnidog March 9, 2008, 10:34 pm

    FT,

    Ah, right. Looking back at comment #112 in the Anti-SM post, I see Acorn was referring to a return on capital.

    Thanks for the clarification.

  • Acorn March 10, 2008, 4:51 pm

    About FirstLine mortgage… When I was refinancing my old mortgage, the First line offered me the best deal. They easily waived the Proof of income requirements and I’ve got the largest possible mortgage+ HELOC amount based on my property value in oppose to my monthly income. However, the give me 70% of my property value vs. 80% that usually is being offered by banks. Remaining banks I’ve contacted had no idea about SM and possibility to capitalize the interest from investments to support a large HELOC. An amount of HELOC they offered was 3 times smaller than the First Line’s one.
    Somebody told me that First Line doesn’t report HELOC to the credit agencies. Is it a true statement?

  • Cannon_fodder March 27, 2008, 4:23 pm

    I borrowed Tim Cestnick’s book “101 Tax Secrets for Canadians” (2007 Edition) and found a few interesting tidbits, one of which relates to SM. (Although not a new book, I think it would be a great subject for review and giveaway since everyone could get something out of it.)

    So as not to plagiarize, he provided an example of the effective returns from leveraging.

    Let’s compare 3 scenarios: what is common to all is that the borrowing rate is 5%, the MTR is 40% and the amount invested is $100,000. In one of the scenarios (#1), the $100k assumes no leverage and the investments grow at 8%. In the other two scenarios, you put up $50k and borrow the additional $50k but in one case (#2) the investments gain 8% while in the other case (#3) they lose 8%.

    Let’s assume that this runs only 1 year, that you cash out (thus triggering capital gains/losses), your interest costs are deductible and that you have capital gains previously that you can use to offset the incurred losses in scenario #3.

    Since I can’t easily embed a table the summary is that the effective returns are: #1 – 6.4%; #2 – 9.8%; #3 – (15.8%).

    As others have stated, leveraging can amplify returns but it can GREATLY amplify losses.

    With that in mind, Tim Cestnick goes on to include 8 Rules of Leveraging. I happen to be leaning toward FT’s way of thinking with respect to NOT using tax efficient mutual funds but rather blue chip Canadian dividend paying stocks.
    Like FT, I will be tapping in to the large amount of equity built up in my home to provide a “Big Bang” SM.

    I’ve run various scenarios through my calculator and there is a certain appeal to having a portfolio that is net cash flow positive from the beginning (factoring in tax deductions from borrowing and income tax from dividends). I believe a self-funding HELOC/Investment Portfolio would allow one to sleep a little easier and it satisfies four (almost 5) of the 8 rules:

    Rule 3: You need stable cash flow. If for some reason you need to scale back your mortgage payments due to loss of income, that would also scale back the principle paydown and amount to reborrow to service the HELOC. The self-funding setup where your dividends (after tax) cover your HELOC interest costs (after refund) remain unaffected.

    Rule 4: Have a long time horizon (> 10 years). There should be no need to sell during tough times because even if the market value < book value, the dividends will usually (although not always as we have seen very recently) keep up with interest costs. This should allow one to keep the same structure for a long time.

    Rule 6: Structure your leverage so that interest costs are deductible.

    Rule 7: Ensure you take on the right kind of loan, and a HELOC is the preferred one (vs. margin loans at a brokerage that could suffer from margin calls at the worst time).

    Ultimately, this may not be the ideal investment portfolio for net worth improvement, but perhaps it is an appropriate choice when borrowing heavily upfront. Certainly, investing in individual stocks is really only an option when working with large lump sums. A typical SM scenario involves investing only hundreds of dollars at a time and that is where mutual funds would be at an advantage.

    • FrugalTrader March 27, 2008, 4:32 pm

      CF, I should have pointed out in my SM blog post that my strategy for the SM is a MODIFIED version as you stated. I like mine better. :) Great comment btw, i’ve read most of Tim Cestnick’s books and find them all very useful. The great thing is, they can be picked up at the library.

  • LookingForAdvice April 6, 2008, 3:36 am

    Hi all. I’ve been reading your blog about the The Smith Manoeuvre and I found it very interesting and informative. However I can’t fully understand, perhaps I’m a little slow lol. I’m also fairly young (27 years old) and new when it comes to financial planning. I will eventually seek out a financial planner, but I’m a self learner and enjoy trying to learn by example. If someone wants to give me their input on my situation I would love to hear it. I guess the question is: With the situation below, what would be the best way for me my 1 million dollar goal?

    Current Home Value: 425K
    Purchase Price: 400K
    Current Mortgage: 230K 4 Year Fixed Rate @ 4.8% with 2 years left.
    Remaining Amortization: 14 Year(s) 11 Month(s)
    Bi-Weekly Mortgage Payments: $826.00
    Current Non-Registered Portfolio: 100K
    Current Non-Registered: 26K
    Liabilities: 20K

    Thanks in advance for all the input. I’d also love any other kind of recommendations like literature, websites and etc…

    Tom

  • Cannon_fodder April 17, 2008, 2:30 pm

    FT,

    How are you planning on avoiding certain clawbacks when you retire considering that dividend income accelerates (due to 145% gross up) this possibility?

    I’m playing devil’s advocate of investing in dividend producing equities vs. tax advantaged mutual funds which only would result in capital gains. The dividend producing equities would, in my opinion, lessen the risk that the CRA would deny interest deductibility. On the other hand, their income would not be as favourably treated as capital gains.

    • FrugalTrader April 17, 2008, 3:07 pm

      Hey CF,

      The only clawback that I would be concerned with is OAS which would occur @ 65 and older. I’m not particularly concerned with this clawback as it is 35+ years away. Who knows if it will still exist at that time.

  • Ed Rempel April 23, 2008, 3:05 am

    Hi Tom,

    Here are some ideas of how you might implement the SM. You can borrow up to 80% of your home value or $340,000. With a mortgage of $230,000, you could borrow up to $110,000 to invest.

    Your mortgage payment of $826 bi-weekly would pay $406 bi-weekly of principal. You will need $200 bi-weekly to cover the $110,000 investment (at 4.75% prime), which would still leave you $206 bi-weekly to invest. In total, this could give you $110,000 plus $206 bi-weekly to invest – all without using your cash flow.

    You will probably be best to break your mortgage and replace it with a readvanceable mortgage at a lower rate. Calculating all the variables to see if this is better than any other option (such as just getting a top-up credit line until your mortgage comes due) can be complicated. We have an in-depth spreadsheet to calculate this. It is probably worth it for you, though, since you can now get a mortgage at 4% or less.

    Looking at all parts of your finances can also yield a lot of other opportunities. For example, you could do the “Singleton Shuffle” by selling all of your non-registered investments and paying them down on your mortgage. Then you can immediately reborrow to buy back the investments, which would immediately make $126K of your mortgage tax deductible.

    Also, we have a strategy called the “Debt Miracle” to combine other debts into your mortgage, including the payments you are making. It can accelerate the SM to roll all of your $20K liabilities into your mortgage.

    The risks of the SM relate almost entirely to the investments. The key is to invest effectively and tax-efficiently – and to always look at is as a long term strategy. Looking at the SM as a part of your retirement goal can help to make sure you always keep it as a long term strategy.

    Ed

  • Curious April 28, 2008, 1:48 am

    Ed(and others),

    I have been reading this blog and I am impressed with the information you provide about the SM and also about 1 year or variable rate mortgages ending up better in the long run.

    I am going to refinance my house and start the SM in the next couple of months. The house value is $400,000 with a mortgage of $180,000. This leaves me with $140,000 of equity to invest.

    My plan was to refinance so I have an outstanding mortgage of $320,000 at P-.75% using the Scotia Step mortgage so I will have a starting LOC of $0.

    I will be paying a lower rate of interest on the initial $140,000 of equity I am using to invest. Besides a bit of hassle claiming the interest from my year end mortgage statement can you see any other issues arising ?

    Thanks for your input.

  • Ed Rempel April 28, 2008, 2:13 pm

    Hi Curious,

    You are mixing the tax deductible and non-deductible amounts in one mortgage, which means that you can only claim the proportional amount of interest as a tax deduction. Any mortgage prepayment will also pay down the tax deductible debt the same amount.

    If you want the lower interest rate, you can have 2 separate mortgages within the STEP, so that they are separate. You can then pay over 40 years on the deductible mortgage, but much faster on the non-deductible.

    I understand why you are looking for the lower interest rate, but that means you are also paying down your deductible debt, which means your tax deduction is dwindling. It will take more cash to cover a principal and interest payment, as well. We looked at some scenarios like that and found that keeping the tax deductible amount as an interest only credit line almost always ends up with a higher long term benefit. The reasons are the higher tax refunds and that you can allocate more cash to paying down your mortgage.

    You seem to still believe in the Sacred Cow and want to be debt-free, including your tax deductible debt. That is nice, but will have only a fraction of the long term benefit of the SM.

    It sounds like you are not looking at any form of readvance, so the disadvantages of the STEP over all the other banks may not be an issue for you.

    Ed

  • Curious April 28, 2008, 2:33 pm

    Thanks Ed,

    Your message did clear some things up. I will set up two mortgage portions to properly track the interest. I was also intending on getting the LOC with the STEP to readvance further funds to invest, so I wouldn’t lose out on the power of the SM.

    What are the disadvantages of STEP?

  • Acorn November 7, 2008, 11:17 am

    Hi Ed,

    Let’s say I’m mixing the tax deductible and non-deductible amounts in one mortgage (50/50 for example). Does it mean that any mortgage prepayments have to be “divided” 50/50 (for taxation purposes) between these two amounts?

  • FT FrugalTrader November 7, 2008, 11:21 am

    Acorn, as you know, i’m not a financial advisor, but i’ve been told to keep the investment loan portion and the non deductible portion separate in case of audit. I would suggest that you work on separating the two.

  • Acorn November 7, 2008, 11:50 am

    FrugalTrader,

    Yes, I know that it is better to have two separate accounts (in fact, I do have two). I’m just trying to squeeze some additional money from my house before it is too late and one of the pre-approved by a bank options I’m currently considering (mainly due to combination of penalties, fees, rates and etc.) is to have one large L/C with embedded non deductible portion. Due to time constrains I have to decide quickly, so I really need to understand how the mortgage prepayments will work.

  • Ed Rempel December 14, 2009, 1:49 am

    Hi Curious,

    I just noticed your post. Until recently, Scotia STEP did not readvance automatically. Now there is a new version out, but they seem very confused about it. Each of our clients that have a mortgage there are told something different – some readvance automatically now, some readvance only after the first one is $5,000, some still can’t readvance, and some readvance only at monthend.

    You also cannot invest directly from the credit line in the Scotia STEP.

    Those are the main 2 disadvantages, which can just mean you have a few manual things to do each month to make the Smith Manoeuvre work.

    Ed

  • Ed Rempel December 14, 2009, 1:56 am

    Hi Acorn,

    Could you not just have 2 credit lines instead of one, so that you can keep the deductible amounts separate? Better yet, many bank credit lines products allow subaccounts, so you could separate the non-deductible amount within the same credit line product. The separate non-deductible portion could be setup either as a credit line or as a mortgage with PI payments.

    Ed

  • Adam Stanley January 1, 2010, 3:21 pm

    Hey FT,

    In February, I will be getting a readvancable mortgage and starting the Smith Manoeuvre… now I have to figure out what is the best way to invest? Any advice??

    Thanks,

    Adam

  • FT FrugalTrader January 1, 2010, 5:48 pm

    Hey Adam, congrats on taking the initiative. My advice would be to make sure you understand the risks/benefits of leveraged investing. For example, I held onto stocks in my SM portfolio right through the 2008 down turn. At one point, my portfolio was down at least 30%. Is that something you can stomach?

    With regards to investing, it depends on what type of investor you are. If you don’t have time (or interest) to constantly watch and research companies, then I would highly suggest that you look into indexing with either mutual funds or ETF’s.

    Let me know if you have any questions.

  • Ed Rempel January 23, 2010, 12:40 am

    Hi Adam,

    If you have not invested before and are not knowledgeable about investing, it is best to get professional advice. If you invest yourself, you are very likely to end up making the same amateur mistakes made by most amateurs – following the herd, buying high and selling low, not researching their investments, not understanding the risk of their investments or the risk they can tolerate, etc.

    Even though the stock markets always go up in the long run, most investors lose money over the long run because they follow their gut.

    Try getting educated with the quiz on “Stock Market Risks” on this site.

    Ed

    P.S. If you are just getting your readvanceable mortgage, don’t fall into the “5-Year Fixed Mortgage Trap”.

  • James November 10, 2010, 3:22 pm

    I just started down the SM path… mortgage and HELOC are being funded next week. Anyone have any recommendations on what I should buy with my $50k HELOC with the current market conditions? I like FT’s choice on dividend paying vehicles to help pay down the mortgage but would also like to see some growth.

    Any ideas?

  • Ross January 17, 2011, 1:57 am

    I have an idea that just kind of hit me, and I would like to get some feedback on it. It combines the SM, leveraged investing, with margin, increasing the leverage through your brokerage account. I understand this is risky if you get called on your margin, but if you are investing in strong dividend stocks, you have a good chance of covering your costs and staying above the call. What do you think?

  • FT FrugalTrader January 17, 2011, 5:47 am

    @Ross, although it could work, as you mentioned, it does have added risk of margin call. Not that I have the risk appetite for this but instead of using margin, you could seek another investment loan from the bank (ie. Rempel Maximum)

  • Jayboard August 22, 2011, 11:06 pm

    Can I use a heloc to secure a down payment on a house I plan to use as rental income?

  • Ed Rempel January 28, 2012, 1:37 pm

    Hi Jayboard,

    Yes. I assume you mean using a HELOC against your home to make a down payment on a rental property. If you do, you should keep it separate, since the interest would be deductible against the rent. You should keep it separate from a Smith Manoeuvre credit line.

    Ed

  • Ed Rempel January 28, 2012, 1:41 pm

    Hi Ross,

    I agree with FT. If you are thinking of getting into significant leverage, you need to avoid a margin call at all costs. Being forced to sell at a major market low even once is probably a disaster.

    You should either:

    1. have a fool-proof way to cover a margin call that would have worked in 2008 or a worse time.
    2. keep your leverage small.
    3. Use a “No Margin Call” investment loan, similar to the Rempel Maximum strategy.

    Ed

  • Mark August 7, 2013, 4:29 pm

    Hi,
    Love your blog!
    I have a question. You say:

    I plan on using the dividend distributions to accelerate the mortgage pay down. I’ve done calculations where if I invest in strong/growing dividend stocks, that the dividends will outgrow the interest payments by year 5.
    Read more at https://www.milliondollarjourney.com/setting-up-the-smith-manoeuvre-the-blueprint.htm#ZdxGBudzsJjM3Svg.99

    However, in the table where you show the dividends outgrow the interest payments, you are reinvesting the dividends in the portfolio, not using them to pay down the mortgage. How are you implementing it, then? Are you reinvesting it in the portfolio, or paying down the mortgage with the dividends?

    • FT FrugalTrader August 8, 2013, 2:43 pm

      @Mark, thanks for the kind feedback. In that case, my savings were enough to pay down the mortgage (been mortgage free sine 2010), so I never did use dividends for those purposes. So yes, I am reinvesting the dividends to further grow the dividend portfolio.

  • corey September 12, 2015, 9:56 pm

    Hi Ed,

    Great work here. Love reading your site. One question. If my house is paid off do i just approach any bank and acquire a secured line of credit and carry on from there? Does this put me at the end state of your SM where the regular mortgage is pain off and only the tax deductible investment loan remains?

    Cheers,

    Corey

  • Mike September 13, 2015, 12:21 am

    Hello,

    Awesome blog. Wish I had found this 7 yrs ago. Quick question. If I have a HELOC on an investment property where the primary loan interest is already tax deductible does anything change?

    Mike

    • FT FrugalTrader September 13, 2015, 12:40 am

      Hi Mike, thanks for stopping by and for the kind feedback. Providing that you use the HELOC to invest in an income producing asset, it will remain tax deductible.

      • Mike September 13, 2015, 12:01 pm

        Tks for the quick feedback. Does this change one step in your flow chart though as there is no benefit in moving the dividends over to the primary loan as it is already tax deductible? I’m thinking I would just take the dividends out to the chequing account, then once interest is recapitalized the remainder could either be reinvested or used to reduce the HELOC?
        I feel like I almost understand this and Tks for your patience.

  • Ed Rempel September 13, 2015, 2:59 pm

    Hi Corey,

    Yes, mechanically you are right that you would be jumping to the end of the Smith Manoeuvre. Whether it’s a good idea for you or not is another question. Remember that borrowing to invest is a risky strategy.

  • Ed Rempel September 13, 2015, 3:19 pm

    Hi MIke,

    Both the mortgage and credit line are tax deductible in your case, but paying down the mortgage and reborrowing is not exactly the same for 2 reasons.

    The first is the interest rate, because mortgage rates are normally lower than credit line rates. There is a disadvantage to paying down the mortgage and reborrowing at a higher rate.

    The other difference is the reason for the tax deductibility. The mortgage is deductible against rent, while the credit line is deductible against the investments. This might make a difference in the future, depending on your plans.

    For example, if you move into the rental property or sell it at sometime in the future, you would lose the deductibility of the mortgage, but not necessarily the credit line. You could keep the credit line or refinance it with different security to maintain the tax deductibility. If either of these might be in your plans, then paying down the mortgage to reborrow might benefit you.

    Ed

    • Mike September 13, 2015, 6:35 pm

      You are a saint for answering questions on a week end.

      For context — no plans on selling or moving in. And you are correct the primary loan (395k) is at 2.3% currently and the credit line (85k) is at 3.2%.
      Based on that I guess after recapitalizing the interest, whether I apply the balance against the credit line or reinvest it is ying yang? I’m thinking initially to reinvest the balance for awhile and then down the road start to pay off the heloc.
      Tks again.
      Mike

  • Ed Rempel September 14, 2015, 9:32 pm

    Hi Mike,

    Actually, it’s YIN & yang. But yes, you are correct if you mean they are opposites. It depends on your objectives.

    Have you defined your objective for this strategy, Mike? Are you trying to make a bit of money to try to become debt free sooner? Or are you trying to build as much wealth long term as possible? Or is your objective somewhere inbetween?

    Reinvesting or paying off the loan are likely very different in terms of long term return after tax. The best strategy in your case depends on your goal.

    By the way, is your question about what is left of the dividend after paying the interest? Or are you capitalizing the interest and your question is about the entire dividend?

    Ed

  • Mike September 16, 2015, 1:15 am

    Hi Ed,

    I’m trying to build as much wealth as long term as possible although my term is shortening as I am 4-8 yrs from retiring.

    Yes, my question was about the remaining dividend after paying the interest payment but I’m not sure my question was valid. In your Money Flow chart you have dividends flowing into your chequing account and from there into your primary mortgage. As my primary mortgage is already tax deductible this would disadvantageous for me as you pointed out.

    In a earlier post you recommend leaving a buffer in the HELOC to service the debt. What would you recommend as a buffer for an 85k HELOC? Until the HELOC is maxed in my situation I would not need to take any dividends to my chequing account?
    Once the HELOC is maxed out then at that point there are several options, one being to apply the dividends against the interest payment. Initially I don’t believe the dividends would cover the annual interest cost so at least until the investments grow to a certain size it’s a non issue?
    I guess a further consideration would be the taxes to be paid on those dividends. I’m in the highest ON MTR.
    I am making any sense at all?

    Financially challenged Mike

  • Ed Rempel September 17, 2015, 5:53 pm

    Hi Mike,

    Yes, you are making sense.

    The traditional Smith Manoeuvre strategy involves capitalizing the interest. The principal portion of your mortgage payment probably already provides enough credit in your credit line so it can pay it’s own interest. There is probably a bit of credit left over each month that you could also invest.

    The buffer is really just so that you don’ accidentally go over your limit. Perhaps it could be 1 or 2 credit line payments, or if you are using all of the principal portion 1 or 2 times that. The SM is quite an efficient strategy, so it is not necessary to leave much of a buffer.

    The dividends are not really helping you and are costing you 34% income tax at the higest marginal tax rate in Ontario. Dividend investing is a strategy used by FT , but dividends were not part of the traditional Smith Manoeuvre. Credit line interest is traditionally capitalized, meaning the credit line pays its own interest. There are pros and cons of dividend investing as an investment strategy, but the dividends are not helpful for the Smith Manoeuvre in your case.

    Once you get the end of the SM (which is a long time from now for you), then you could pay the credit line from your rent, since you will no longer have a mortgage to pay.

    Ed

    • Mike September 18, 2015, 12:27 am

      Hi Ed,

      That actually clarifies a few key details which now seem rather obvious.

      To skirt the MTR issue on any dividends could I select DRIP only stocks? I know this would limit stock selection but it’s probably not a big deal when we’re only talking about 84k or so. Then after I retire (and in a lower MTR) I could cancel the DRIP and start taking the dividends which I might need anyways?
      If that isn’t feasible would you recommend a different class of investments ?
      Thanks for taking the time to set me straight ED, I appreciate it.

      Mike

  • Ed Rempel September 19, 2015, 11:40 pm

    Hi Mike,

    A DRIP won’t help you with that. When you buy a DRIP, you pay tax on all the dividends. They are automatically reinvested, but still fully taxed.

    Your focus should be on long term total return after tax given your risk tolerance. If you receive dividends, you would need to make a somewhat higher return to offset the dividends.

    In my case, I invest only in corporate class mutual funds with top fund managers. Corporate class mutual funds tend to defer most or all the tax for many years because the include several effective tax strategies – loss carryforwards, transferring taxable income between classes to offset any realized taxable income, allowing non-taxable switches between funds, and the “Capital Gains Refund Mechanism”.

    Ed

    • Mike September 23, 2015, 11:03 pm

      Hi Ed,

      Ok, got it. dividend paying stocks would not be ideal. What about tax efficient ETFs?
      Some quick research on corporate class mutual funds indicted that they have higher MERs than regular mutual funds. I loathe MERs with a passion.
      Would corporate class mutual funds Any of the big banks be ok? I.e. RBC?

      As always, thanks

      Mike

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