As a recap, the Smith Manoeuvre is a wealth strategy that converts a non tax deductible Canadian mortgage into a tax deductible investment loan. As promised from Part 1 of this series, I will be going into more detail regarding the Smith Manoeuvre(SM) and some common questions that people have. I am by no means an expert in the SM where I’m not even using it myself. I do, however, plan on implementing this technique in the near future and I’m usually pretty analytical when it comes to big financial decisions.
One popular question I often read about is how a person is supposed to pay for both the mortgage AND the HELOC at the same time?
- This is a probably among the biggest concerns as the borrower will be responsible for BOTH payments while implementing the SM. This includes your primary mortgage (principle + interest) along with your HELOC (interest only). Seems a bit steep hey? Say you get a $100k HELOC @ 6% (prime), that’s an extra $500/month on top of your existing mortgage payment.
- I’ve actually emailed Fraser Smith about this issue and he said to “capitalize the interest” on the HELOC. Scratching your head yet? Capitalizing the interest simply means to withdraw the monthly interest due from the HELOC account and redeposit the amount as a payment. Apparently, most credit unions will allow this but some banks will not. You’ll have to check your specific lender for the details.
- If you capitalize the interest, you will never make the extra interest payments out of your own pocket while your primary mortgage exists.
- You will only start paying the HELOC interest out of pocket/cashflow when the primary non-deductible mortgage is paid off. So as you can see, using the Smith Manoeuvre, you will always have a payment. It never goes away. However, the payments are now tax deductible.
Another popular question is why would you need 25% 20% down to start the Smith Manoeuvre?
- The reason is that most of the re-advancable mortgages out there REQUIRE 25% 20% down. The mortgages that do NOT require 25% 20% down will charge an extra CMHC fee. The Canadian government has introduced legislation that will reduce the 25% down payment requirement to 20%.
What are some investment options for the Smith Manoeuvre?
- As you already know, I’m just some obsessive compulsive personal finance guy who is NOT a financial planner. So take my advice at your own risk. However, with that said, when I start using the Smith Manoeuvre I plan on using the money to purchase steadily growing dividend paying stocks/mutual funds/ETFs.
Why dividend stocks do you ask?
- I believe that investing in mostly Canadian dividend paying stocks/mutual funds/ETFs is the most efficient way to implement the SM. The reason being is that Canadian dividends of strong companies (like the big banks) have a history of increasing dividends that can be used to pay down the non-deductible mortgage. Why not just buy interest bearing bonds or GICs? Publicly traded companies that pay dividends in Canada are eligible for the enhanced dividend tax credit which results in a substantial tax break for dividends compared to interest bearing income.
- To summarize, the strong dividend company (if history is any guide), will increase their dividend on a regular basis AND you will receive a tax credit for any dividend income that you receive. Putting the dividend income and the annual tax refund towards the non-deductible mortgage will make the conversion from bad (non-deductible) to good (deductible) debt even quicker.
So that’s my strategy for my next home. Sell off my non-registered portfolio, put >20% down, obtain a re-advanceable mortgage, take the HELOC money and invest in dividend paying stocks (mostly Canadian).
If you are currently using the Smith Manoeuvre, I would appreciate any comments that you may have regarding your experiences and if my strategy is sound.
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