Author Topic: Smith Manoeuvre - Canadian Tax Deductable Mortgage  (Read 8205 times)

Canuck.AB

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Smith Manoeuvre - Canadian Tax Deductable Mortgage
« on: May 22, 2014, 03:29:50 PM »
Any Canadian Mustachians out there executed the Smith Manoeuvre? Do you have any tips for the those of us who are considering it?

Background: In the U.S. interest paid on a mortgage is tax deductable; in Canada it is not. However, you are allowed to borrow against the equity in your house and the interest paid on money borrowed for the purposes of producing income IS tax deductable. Therefore, you can effectively make the interest paid on your mortgage tax deductable. One of the main upshots of this is that you can re-build your investments more quickly if you have to decimate them for the downpayment AND you can use the tax refund to pay down your mortgage more aggressively.

From what I've read, it's not an 'easy' thing to do properly, but there can be some significant rewards if you're in the highest tax brackets and are willing to put in the work to set it up properly.

I'm considering executing the Smith Manoeuvre (DIY) for a home I'm planning to buy this summer. I'm in one of the hotter (and crazier) real estate markets in Canada (Calgary) but they pay me a salary that's as ridiculous as the real estate, so I've managed to keep my savings rate over 50% and build up a good sized down payment. I'm planning on putting at least 25% down on a house and borrowing against the equity to re-build my investment portfolio and take advantage of the tax deduction (I'm starting to poke through into the highest tax brackets and my RRSPs and TFSA are maxed out).

Any experiences or stories from someone who has executed the Smith Manoeuvre would be appreciated!

Much more information here: http://www.milliondollarjourney.com/the-smith-manoeuvre-a-wealth-strategy-part-1.htm

You can follow many of the very helpful links on Million Dollar Journey's website for even more information.

Mega

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #1 on: May 23, 2014, 06:52:04 AM »
I am a Canadian that has considered the Smith manoeuvre.

I decided against it as I consider the housing market and stock market too overpriced (e.g. Based on current P/E ratios, the expected return on stocks for the next 10 years is something like 1.8 percent PA)...

That said, I am now at 50% equity based on original purchase price, and like 70% based on current market value (so 160K to 320K). IF the stock market offers me a sufficient margin of safety (think 50% drop), then will do this.

The only problem I see, and it is a big one, is my house price and the stock market are likely to fall at exactly the same time. This will result in massive paper losses if I execute the Smith M. My wife would kill me.

Canuck.AB

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #2 on: May 26, 2014, 07:07:29 AM »
Interesting perspective, thanks Mega. There's certainly a bit of risk involved with leveraging against the equity in your house. A series of unfortunate events such as a drop in the stock market combined with a drop in house prices AND the loss of a job would certainly put a person in a tough spot. My job is stable so I may still go for it, taking the long term view that the market will eventually recover from a correction.

totoro

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #3 on: May 26, 2014, 09:37:04 AM »
The amount you can borrow against your home equity is limited by the HELOC rules.  Do you already own a home with more than 35% paid down?  If not, you will need to wait until you have equity to borrow against to execute this plan.

TD Bank in Victoria is well versed in the SM.  The fellow who wrote the book lived nearby until his passing a couple of years ago.

http://www.milliondollarjourney.com/new-heloc-rules-and-how-it-affects-smith-manoeuvre-mortgages.htm

Peter

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #4 on: May 26, 2014, 10:05:42 AM »
I think it could work if you are in a stable job and don't plan any big career or life changes in the next 10+ years.

The major downside I can think of is that it forces you to be a homeowner even if you don't want to be. Consider:

The stock market goes down. Luckily you are in a high demand field and this doesn't affect your job prospects. You decide to change things up and move to vancouver to for an exiting new position you were just offered. The vancouver real estate is still insane despite the stock market drop, and you decide that renting in vancouver is the way to go.

But you can't. Since you've leveraged your current house into the stock market you have to buy a new house at your new location to maintain the leverage, otherwise you'll take a huge loss when the HELOC is recalled when you sell your current house and not buying a new one.

So you are forced into doing something you don't want to do - Selling at a loss, or buying a house you don't want to buy.

totoro

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #5 on: May 26, 2014, 10:27:54 AM »
No.

If you relocate and sell your home you need to discharge the mortgage and HELOC from the proceeds of the sale.  That is why you can only borrow a max of up to 65% of the equity.

Nothing forces you to purchase again.  Nothing forces you to sell your stock.

Nothing forces you to sell your existing home either.  You could always rent it out and Calgary has a pretty good market for that.


Canuck.AB

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #6 on: May 26, 2014, 03:21:53 PM »
Totoro, you are correct that the new HELOC rules limit the amount you can borrow but there is a workaround and my understanding is that the SM can still make sense.

http://www.milliondollarjourney.com/new-heloc-rules-and-how-it-affects-smith-manoeuvre-mortgages.htm

I don't have 35% equity, but I will be putting at least 25% down. My understanding is that you can start borrowing against the equity once you have 20% down, and the beauty of the re-advanceable mortgage is that your HELOC increases as you make payments on the principle. I'm hoping to use my bonuses (and possibly tax returns generated by using the SM) to pay down the mortgage fairly aggressively meaning the equity would build up quickly.

I think your comment about working with someone who is well versed in the SM is a good one. My inclination is for DIY, but with something like this, it might be good to work with a lender that knows what they're doing.

Peter, I do think the SM limits your freedom a little bit (at least mentally) so that is a con in my book. I'll have to evaluate whether the financial benefits out-weigh the potential decrease in freedom.

Thanks!

Mega

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #7 on: May 27, 2014, 07:04:04 AM »
Please don't forget that HELOCs are a CALLABLE loan. I.e. The bank can make you pay it back on demand... And it has a variable interest rate.

What happens if your house price drops 20% bringing your loan to value below 20%, or whatever the limit is for HELOCs. Does the bank call you and ask for the heloc to be paid down to bring you back into compliance, thereby forcing you to sell your shares at a loss???

The SM is fantastic in a secular bull market... When was the last time we were in a secular bull market... 1999...

The couple percent you will make is for a lot of risk.

totoro

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #8 on: May 27, 2014, 09:29:38 AM »
While HELOCs may be callable, like many mortgages, it is not in a lender's interest to call them.  Generally, as long as you make payments the loan will not be called. 

What did happen in the US during the crash was that additional HELOC borrowing room was suspended, but existing loans were not called.  I would expect the same response in Canada.  A bank will lose money if they force someone into bankruptcy by calling a loan where no equity exists to guarantee it and why would they do this when they are receiving payment?

I agree that the variable rate is a risk, but if, as a result of the investment of your HELOC funds, you have stocks and other investments that could be liquidated if rates rise significantly beyond expected after-tax returns in the market, the risk can be mitigated.

Canuck.AB

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #9 on: May 27, 2014, 12:03:19 PM »
Totoro, I agree and your thoughts are appreciated. The research I've done suggests that some HELOCs can only be called if you default on the payments, others can be called at any time. But as you say, it's not in the banks interest to do so. If you're prepared to be in it for the long term, you should be able ride out bear markets.

Here's a very good summary article from Ed Rempel in case anyone stumbles upon this thread and is interested in the Smith Maneouvre.

http://edrempel.com/smith-manoeuvre

Lews Therin

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #10 on: May 22, 2017, 08:32:47 AM »
Bringing this thread back to life, as 3 years in the future, there should be more details that could come out from TheRichMoose and Lebarbu. What have you used for the SM, and what does other people use?

I'm at the last registered step, so I'm looking at the SM or investing in the registered accounts. I see the difference being the Mortgage interest becoming tax-deductible means that the investment interest (HELOC - tax deduction) is lower than the mortgage interest. Because right now, I'm not sure if there is a large difference between the two, as I can get a 2% mortgage, but the HELOC would be 3%. Is the tax deduction actually worth it, or is it an extremely small difference in final result?

How do you figure out the difference in costs between the SM, and regular investment accounts + mortgage interest?

RichMoose

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #11 on: May 23, 2017, 05:37:06 PM »
Bringing this thread back to life, as 3 years in the future, there should be more details that could come out from TheRichMoose and Lebarbu. What have you used for the SM, and what does other people use?

I'm at the last registered step, so I'm looking at the SM or investing in the registered accounts. I see the difference being the Mortgage interest becoming tax-deductible means that the investment interest (HELOC - tax deduction) is lower than the mortgage interest. Because right now, I'm not sure if there is a large difference between the two, as I can get a 2% mortgage, but the HELOC would be 3%. Is the tax deduction actually worth it, or is it an extremely small difference in final result?

How do you figure out the difference in costs between the SM, and regular investment accounts + mortgage interest?

I'm currently doing a series on my blog detailing the steps of SM as well as the risks vs benefits. So you can see more info there.

If you are in a moderately high tax bracket it is definitely worth it over the long haul. HELOC rates will always be higher than standard mortgage rates. That's the premium for having an open, secured loan. The benefits do not lie in the interest rate, it lies in the tax refund that grows from accelerated payoff of the traditional mortgage and the difference between the HELOC interest and your expected return on investments. The key is to set the SM up correctly to take advantage of the lowest rates possible while paying minimal tax on investment income.

Personally, given my situation, I think it's advantageous for me to invest in a basket of individual stocks rather than the index. It makes tax calculations on distributions easier and my income is relative high (just under $100,000).

I sold my house last year, so the SM is a no-go for me. I'm still on the fence about disciplined use of margin for investing.

Goldielocks

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #12 on: May 23, 2017, 05:51:14 PM »
i seriously looked at the SM over the lifetime of home ownership.   

My rule of thumb -- if you can get 2% more rate of return on the investments (especially as cap. gains or dividends), versus the tax-adjusted (lower) HELOC rate, then it is highly likely to make you money.

Drawbacks Cashflow Risk and Investment Risk

-- this is a leveraged investment, increased benefits come with a bit more risk.  It is much lower risk than a margin call, because it is unlikely to be called and you can carry the loan separately from the stock market,  and you are limited to losing the value of the stock market investments.  Meanwhile property values are a fairly safe risk.

--Need to be able to cash out your investments if your HELOC rate jumps too high, so no locking in with 10 year ladders or other investments that are hard to sell.

--Need (I recommend) that you pay the HELOC monthly interest using cash flow (NOT from the investment income).  The big drawback is that you may lock yourself into a higher cashflow, when you lose a job.  Note, you only get the taxes back after the year ends, too.

We did not do the SM, or not at a high rate (max of $80k invested for us), simply because we did not need to (the first time), and then because of the Cashflow risk in the event of a job loss was too high for us at the time.
« Last Edit: May 23, 2017, 06:05:21 PM by Goldielocks »

Lews Therin

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #13 on: May 23, 2017, 06:01:46 PM »
Bringing this thread back to life, as 3 years in the future, there should be more details that could come out from TheRichMoose and Lebarbu. What have you used for the SM, and what does other people use?

I'm at the last registered step, so I'm looking at the SM or investing in the registered accounts. I see the difference being the Mortgage interest becoming tax-deductible means that the investment interest (HELOC - tax deduction) is lower than the mortgage interest. Because right now, I'm not sure if there is a large difference between the two, as I can get a 2% mortgage, but the HELOC would be 3%. Is the tax deduction actually worth it, or is it an extremely small difference in final result?

How do you figure out the difference in costs between the SM, and regular investment accounts + mortgage interest?

I'm currently doing a series on my blog detailing the steps of SM as well as the risks vs benefits. So you can see more info there.

If you are in a moderately high tax bracket it is definitely worth it over the long haul. HELOC rates will always be higher than standard mortgage rates. That's the premium for having an open, secured loan. The benefits do not lie in the interest rate, it lies in the tax refund that grows from accelerated payoff of the traditional mortgage and the difference between the HELOC interest and your expected return on investments. The key is to set the SM up correctly to take advantage of the lowest rates possible while paying minimal tax on investment income.

Personally, given my situation, I think it's advantageous for me to invest in a basket of individual stocks rather than the index. It makes tax calculations on distributions easier and my income is relative high (just under $100,000).

I sold my house last year, so the SM is a no-go for me. I'm still on the fence about disciplined use of margin for investing.

I'm reading your blog as they appear!

I'm trying to wrap my head around getting a 2% mortgage interest hit and having an investment account VS 3% Heloc which is the investment account. Have you seen anyone showing numbers, or doing the math for the effectiveness on the SM over normal investing?

How much is the deduction for investment interest? I can`t seem to find the tables to see how much you can write off on the HELOC.
« Last Edit: May 23, 2017, 06:14:49 PM by Canadian Ben »

RichMoose

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #14 on: May 24, 2017, 10:12:25 AM »
I'm trying to wrap my head around getting a 2% mortgage interest hit and having an investment account VS 3% Heloc which is the investment account. Have you seen anyone showing numbers, or doing the math for the effectiveness on the SM over normal investing?

How much is the deduction for investment interest? I can`t seem to find the tables to see how much you can write off on the HELOC.

The deduction is the full amount of interest paid on your investment loan portion. It is deducted in Line 221 of your Federal tax return.

The precise calculations are dependant on your personal situation: income per adult, province, value of home, size of mortgage, size of non-registered investments, and savings applied to investing (non-registered only).

Here's an example so you can understand the calculation of mortgage + regular investing vs. Smith Manoeuvre.

Single earner family $80,000, QC, $300000 home, $150000 mortgage @2.6%, $0 investments, $500 savings. First thing is to refinance the mortgage back to 25 years (just to make the calculation easier).

Regular Investing + Mortgage Payoff: After 25 years, you will have a paid off house plus $346,500 investment account ($500 a month @ 6% compounded for 25 years).

Smith Manoeuvre: After 25 years, you will have your house, a $195,000 investment loan (HELOC), and a $736,000 investment account (also returned 6%) for a net investment account of $541,000. Basically you are nearly $200,000 better off and that will continue to grow as your tax deductions keep coming every year.
Here's why, first of all you borrow back the principal portion of your mortgage payment to invest. That means you start investing $773/month instead of $500. Next, you have $1,600 in deductible interest expenses in the first year alone, saving you about $530 in taxes which you can reinvest.

At the end of 25 years, you will have a $6,240 interest expense each year ($195,000 x 3.25%) which saves you over $2,300 in taxes. I've attached a photo of the inputs and a projection of your return. Red line = mortgage, Blue line = investment loan, Yellow line = total loans, Green line = investment account @ 6%.

Lews Therin

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #15 on: May 24, 2017, 11:22:58 AM »

Regular Investing + Mortgage Payoff: After 25 years, you will have a paid off house plus $346,500 investment account ($500 a month @ 6% compounded for 25 years).

Smith Manoeuvre: After 25 years, you will have your house, a $195,000 investment loan (HELOC), and a $736,000 investment account (also returned 6%) for a net investment account of $541,000. Basically you are nearly $200,000 better off and that will continue to grow as your tax deductions keep coming every year.
Here's why, first of all you borrow back the principal portion of your mortgage payment to invest. That means you start investing $773/month instead of $500. Next, you have $1,600 in deductible interest expenses in the first year alone, saving you about $530 in taxes which you can reinvest.


Something is off in your calculation I believe, as using your numbers it would be
646,500 NW Regular account after 25 years (investment account + 300k house)
SM: 645,000 (736000-195000+105,000) NW

I don't think the regular investment account numbers are correct?


dreadmoose

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #16 on: May 24, 2017, 11:45:15 AM »
Something is off in your calculation I believe, as using your numbers it would be
646,500 NW Regular account after 25 years (investment account + 300k house)
SM: 645,000 (736000-195000+105,000) NW

I don't think the regular investment account numbers are correct?

I believe you've calculated the loan twice on the Smith Maneuver values. You can't count the HELOC loan against the house to get equity and also subtract it from the total SM Net Worth.

So:

Normal = 646,500
SM       = 841,000

Lews Therin

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #17 on: May 24, 2017, 11:50:49 AM »
Something is off in your calculation I believe, as using your numbers it would be
646,500 NW Regular account after 25 years (investment account + 300k house)
SM: 645,000 (736000-195000+105,000) NW

I don't think the regular investment account numbers are correct?

I believe you've calculated the loan twice on the Smith Maneuver values. You can't count the HELOC loan against the house to get equity and also subtract it from the total SM Net Worth.

So:

Normal = 646,500
SM       = 841,000

Ahhh I see what I did there, my bad.

741+300k-195; not 741+105-195

That makes sense.!

Huzzah, an example (also amusingly close to my situation, so it's easy to see what the effect would be.) Thanks!

I'm at the last step of filling out my registered accounts, so it'll be SM all the way, TFSA, RRSP, SM!
« Last Edit: May 24, 2017, 11:52:27 AM by Canadian Ben »

Prairie Stash

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #18 on: May 24, 2017, 02:20:02 PM »
Two ideas got mashed into one on this thread :( I have done SM, at the time I wasn't aware it had a name. My first mortgage was at 5%, my HELOC was at 3.5% and I bought bank stock in 2008.

The first idea is the debate about mortgage payoff vs. Invest (separate thread). The second was SM.

The math behind SM is simple for most Canadians. Whenever you have non-registered investments and HELOC room it's easy to set up
HELOC-(HELOC*marginal tax rate)<mortgage rate 
Example: 4%-(4%-0.35)<2.99%

The idea is that after getting a tax refund the interest on the loan is less than it otherwise would be on your original mortgage. It assumes you have significant non-registered investments. Rich moose conflated mortgage payoffs investing with the SM, the math isn't as great as portrayed. He is absolutely correct though that in me sting has better math, but the SM isn't the reason why.

Prairie Stash

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #19 on: May 24, 2017, 02:53:24 PM »
To further the discussion, there are times when the SM will leave you worse off. If you have a rising rate on the HELOC (variable rate loan) and a fixed low rate mortgage it's better to keep the mortgage. If the SM is already in progress it might be beneficial to convert the HELOC to a 2nd mortgage. Currently my HELOC is 3.65% and some people have mortgages at 2%, depending on your marginal tax rate the SM could be ill advised.

Lews Therin

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #20 on: May 24, 2017, 02:59:41 PM »
So if a Heloc is 1% higher than a mortgage, Let`s throw actual numbers - 3% Heloc, and 2% mortgage (for people who are very lucky)

3%-(3*.36)=1.92 effective interest cost (after taxes)

So a .08% gain doing the SM compared to simply investing; which would continue stacking every year.

Is that about right?

dreadmoose

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #21 on: May 24, 2017, 03:59:08 PM »
Is using the SM as only a tax benefit missing part of the larger picture though?

The main purpose I would be using it for would be to take my mortgage principal and invest it in to equity ETF's (long-term).

This has the effect of diversifying one of my larger investments globally instead of hyper-focused on my current real estate market as well as providing historically better returns than real estate has been able to produce. The tax benefit is a bonus to this as the compounding returns due to the increased return should far outweigh what my lowered taxes are.

Basically it's leveraging my house equity to invest with a lower interest rate due to tax breaks.

RichMoose

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #22 on: May 24, 2017, 07:48:22 PM »
Is using the SM as only a tax benefit missing part of the larger picture though?

The main purpose I would be using it for would be to take my mortgage principal and invest it in to equity ETF's (long-term).

This has the effect of diversifying one of my larger investments globally instead of hyper-focused on my current real estate market as well as providing historically better returns than real estate has been able to produce. The tax benefit is a bonus to this as the compounding returns due to the increased return should far outweigh what my lowered taxes are.

Basically it's leveraging my house equity to invest with a lower interest rate due to tax breaks.

Diversification is another benefit for sure, especially if most of your assets are in your house.

Lews Therin

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #23 on: May 25, 2017, 10:53:09 AM »
So here is my issue:

Let's pick a nice round number 250,000 home. mortgage on it would be 2.24 fixed; Heloc 3.7% (BMO) with a taxation rate of 40%.

That would mean that the HELOC portion would be costing 2.3% (after tax deduction); but this is money that would simply be sitting in the value of the home, not making any extra money anyways.

So instead of having each payment going to pay-down the mortgage, it's simply being moved into money that's investing and making gains, rather than simply sitting as home equity. The house 2.24% keeps getting lower and lower, turning into 2.3% HELOC investments that continue growing (since there are multiple safe stocks in Canada that pay out more than 3% in dividends)

Any faults in my understanding? (other than the fact that there are other lower HELOC %; and that this is only valid at our current Prime rate).

Prairie Stash

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #24 on: May 25, 2017, 12:46:28 PM »
Andrew and Ben, the alternative is a second to fifth mortgage. If I wanted to I could have five mortgages all renewing the same month; a laddered mortgage. You can still cash out equity annually but have the lower rates.

I'm not saying SM is bad at all. I'm pointing out that with it you calculate based on the loan rates and marginal tax rates, the basic assumption is you will carry a mortgage and have investments. The SM is an elegant way of turning mortgage interest into a tax deduction; it is not an investment strategy, it's a tax planning strategy. Once you fit the basic assumption, it's up to you to decide if investment loans or extra mortgages are better. In any case though, rich moose has already proven investments are better, we're discussing how to get there.

Ben, If you structure your initial mortgage with a 30 year time frame and minimum payments you will see very little equity payoff. After 5 years you'll have about $10k (guess) to use with the SM. if BMO allows skip a payment, it'll be less. Then all your interest remains at 2.24%, not 2.3% without the tax hassle. It's simpler and more profitable than the SM. Please add your principle payoff for each year, it would add value to this thread to have real numbers. Also check your mortgage for the skip payment option.

Lews Therin

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #25 on: May 25, 2017, 01:17:11 PM »
Right now, since 2.24 is ridiculously low, I'd avoid any extra-repayment other than the lowest possible amount. It would be a 20-25 year mortgage.

My extra savings would go directly into open investment accounts; for the money that I'm slowly putting into the house itself, I'd take it back out with the SM in order to remain at 20% equity (min allowed). That might be low amounts, but an extra 300-500 in investments is still quite good in order to remain not too leveraged, and also to increase my returns.

If I am able to negociate the HELOC lower after taxes than the 2.24, then the more effective strategy would be to put all money into the payments for the house, and then investing it with the SM.

Right?

Prairie Stash

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #26 on: May 25, 2017, 03:02:01 PM »
Ben - yes, if the rate comes out better then its mathematically better...today. Generally a HELOC is a variable rate loan while your mortgage is a fixed rate. If you have a massive investment loan and rates rise you'll end up worse off, if they stay constant you win. Its neither right nor wrong to pursue, as long as you understand the risks and rewards you'll be fine. There is a risk this will leave you open to rising rates and paying higher interest, there is also the risk that doing nothing leaves money on the table.

You have different ways to pursue this. The mortgage way is to keep payments at a minimum and utilize BMO "Take a Break Option" to skip one monthly payment/year. This will minimize your payments over the next 5 years and you'll have about $20K in additional equity, not a large sum. This is the normal way of having money to invest instead of equity, its simple and works well.

If you think the SM is better then you should pursue the max payments, accelerated, with increased payments every year and lump sum annual payments. This will open the HELOC fast and maximize the SM, it also leaves you wide open to rising rates. This option is for when you have lots of savings and want the SM.

If your just starting out you can also have a 5% down payment and take the 4% CMHC fee on the 250,000 loan. It would free up $37,500 on day one at 2.24%, at a cost of $9,500. You wont reach the 80% threshold for a HELOC at all in the first 5 years, you can skip that consideration. If markets rise at 7% then the stock market pays off the CMHC, you get protection from rising rates and everything works out. I haven't checked this strategies math, my gut says not to do it but my gut could be off.

When I received my first loan it had a 35 year amortization, you can have it too as long as you skip the CMHC insurance. This tactic is for people who want a bit more equity initially (avoiding CMHC requires 20-35% depending on the bank), at a constant amount (you really don't pay any principle on these loans in 5 years). This is the closest interest only loan available from the banks, its great if you get a low mortgage rate. I remember getting my first annual statement and being very dismayed at how much interest I paid compared to my equity, rates were higher then. This is the lazy way to achieve the ability to skip the SM, but it limits your options to pay it down quickly (bad when interest rates fall, but right now at 2.24% that's not a worry).

Lews Therin

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #27 on: May 25, 2017, 03:08:50 PM »
Thanks for all the clarifications,

Since the SM would be so small (the payment on my house would be about 500$ per month, and I have more than that being saved outside the SM, I feel pretty confident in repaying even if Prime increases.

Cheers

dreadmoose

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #28 on: May 25, 2017, 03:10:16 PM »
In case my numbers help with any assumptions on what I've been writing here:

30 Year Mortgage (Started Oct 29, 2016 with MCAP)
2.19% Interest Rate (5 year fixed) (Not sure on the HELOC)
$407K Mortgage (Start Date) - now it is $402K ($370 principal paid bi-weekly)

$510K Appraised Property Value
$357K Principal Remaining after 5 years

I am researching to do the SM when it makes sense to get a HELOC (at 5 years? or when TFSA and RRSP are full  at 2 years from now)? do I pay penalty to break earlier or can I add it on anytime?

I have always looked at it as a way to invest the principal / equity paid into the stock market and gather a tax break from the principal portion paid as well.

Prairie Stash, from what you've said the SM is simply an option to make it tax deductible and I could simply take out a second mortgage to invest once I have enough equity built in?

I've yet to run the different scenarios but have it on my to-do list soon.

Prairie Stash

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #29 on: May 25, 2017, 04:37:24 PM »
Andrew - You should fill the TFSA and RRSP before the SM, especially the TFSA. The SM can not be combined with either the RRSP or TFSA.

A second mortgage can't be used for investments, that's a loan to buy a house, it can't be used in the SM. The loan must be made with the sole intent of buying stocks to be legal, if the money is used for any other purpose (house, car, education) its not eligible. If the second mortgage is at a lower rate than the investment loan, factoring in the tax break, then you get the second mortgage just because its cheaper. The SM is awesome, but some people can do better just by doing the really low mortgage option.

Starting out, instead of the SM you can simply pay as little as the bank allows on your mortgage and directly invest the money. Then when you hit the threshold of 80% loan to value (510*.8=$408k) you can set up a HELOC at your bank. Then, for the SM, you are legally required to sell your stocks (that you've bought in the meantime), pay down the loan, pull money from the HELOC and then you can buy stocks. You cannot simply convert money into a HELOC and deduct interest, it must be taken from the HELOC and used to purchase stocks (bonds, ETF, etc.). The paper trail has to exist for an accountant to follow, its really simple to do, but the rules are also very clear about the order of operations. If you fail to sell preexisting stocks you haven't done the SM.

Lews Therin

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #30 on: May 25, 2017, 05:13:58 PM »
Andrew - Whats your income? if you have a high income, it might be RRSP first, then TFSA; lower income TFSA then RRSP, but might not be worth claiming right away (depending on how much you make)

dreadmoose

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #31 on: May 26, 2017, 09:34:50 AM »
Andrew - You should fill the TFSA and RRSP before the SM, especially the TFSA. The SM can not be combined with either the RRSP or TFSA.

A second mortgage can't be used for investments, that's a loan to buy a house, it can't be used in the SM.

Phew, you lost me a few posts ago about the alternative being mortgages number 2 to 5. Thought I was missing something pretty basic there, all good.

The plan is to fill the TFSA, then RRSP, then non-registered. I should be at the non-registered step in close to 2 years so that's when I was going to start the SM (just researching now). As for the investments, I planned on starting up it's own Questrade account for only the SM investments to keep them transparent. I'm still a bit confused from your post as to why I would have to sell my current non-reg investments unless I was hoping to use an already established investment account just to keep things transparent?

Andrew - Whats your income? if you have a high income, it might be RRSP first, then TFSA; lower income TFSA then RRSP, but might not be worth claiming right away (depending on how much you make)

I recently moved jobs into something paying near the top tax bracket (and maybe into it), so this is my last year that TFSA first makes sense. That said, assuming nothing derails me I should catch up on my TFSA and RRSP contribution room sometime next year.

At that point I was looking to put $6K extra a month onto the mortgage, then pull it (and normal payment principal) out to invest in it's own Questrade non-reg account.

Lews Therin

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #32 on: May 26, 2017, 10:31:46 AM »
The plan is to fill the TFSA, then RRSP, then non-registered. I should be at the non-registered step in close to 2 years so that's when I was going to start the SM (just researching now). As for the investments, I planned on starting up it's own Questrade account for only the SM investments to keep them transparent. I'm still a bit confused from your post as to why I would have to sell my current non-reg investments unless I was hoping to use an already established investment account just to keep things transparent?

For the logic of the investment account, If the SM was less costly that the HELOC after deductions, you'd sell all un-registered accounts, use that money to pay down the mortgage (Thus opening more SM space) and then re-invest, but through the SM.

RichMoose

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #33 on: May 26, 2017, 11:13:09 AM »
I should add this for people who are concerned about the interest rate in fixed mortgage vs. HELOC. What you can do is us the National Bank All-in-One account. Basically what you can do is have one account for your traditional mortgage and one account for your HELOC investment loan. Then within the HELOC, you choose a portion of that to be a fixed mortgage loan as well with a smaller revolving portion. For this I would choose 1 year fixed terms though so you can grow the fixed amount regularly.

You will save a bit on interest, but you will have less to invest because you will have to "capitalize" the payments on interest and principal. Another downside is that it is a bit more complicated. Given the difference in rates I think it benefit will be minimal in the long run, but it may ease some fears about extra interest expenses.

Another way to look at this is the interest rate on your HELOC is lower than margin rates at just about every brokerage except IB.

Also, don't focus too much on having dividends "cover" your interest expense. Using the guerilla capitalization process, the SM will NOT increase your cash flow which you've dedicated to your mortgage payment and any extra investing. The dividends from your investments should actually go towards your mortgage, not your investment loan.

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Re: Smith Manoeuvre - Canadian Tax Deductable Mortgage
« Reply #34 on: May 28, 2017, 03:26:07 PM »
So here is my issue:

Let's pick a nice round number 250,000 home. mortgage on it would be 2.24 fixed; Heloc 3.7% (BMO) with a taxation rate of 40%.

That would mean that the HELOC portion would be costing 2.3% (after tax deduction); but this is money that would simply be sitting in the value of the home, not making any extra money anyways.

So instead of having each payment going to pay-down the mortgage, it's simply being moved into money that's investing and making gains, rather than simply sitting as home equity. The house 2.24% keeps getting lower and lower, turning into 2.3% HELOC investments that continue growing (since there are multiple safe stocks in Canada that pay out more than 3% in dividends)

Any faults in my understanding? (other than the fact that there are other lower HELOC %; and that this is only valid at our current Prime rate).

That's it!

Just be ready when, in a few years, your mortgage rate goes up to, say 4%.  If you can't cash flow the new higher payments, you will need to pay down some of the mortgage (using investments).  That may or may not be at the time that you want to sell, and is particularly bad if you locked in your investments, and don't have the ready cashflow.

This is why the SM is best when set up for people with quite a bit of cash flow cushion, it gives you more time to adjust to changes and optimize your result.