The Smith Manoeuvre

[Cool Dood]

Financial planning manoeuvre allows deductibility of home mortgage interest

(Long excerpt)

Quote:

Fraser provides an example of the manoeuvre, supposing a homeowner has a $200,000 mortgage at 7 per cent mortgage rate for 25 years. If this is a readvanceable mortgage, as the homeowner pays down the principal with monthly payments, he or she then immediately has that amount readvanced in order to invest in stocks, bonds or other real estate. The interest on the amount that is readvanced is tax-deductible because it is used for investing purposes. It amounts to splitting the mortgage into two sides; as the principal on one side is lowered, the principal on the other side goes up, keeping the total principal outstanding at $200,000. Every time you get some extra cash to invest, especially with the tax refunds coming to you as you claim more and more interest as an expense, you first pay down the non-deductible side of the mortgage and then increase the deductible side as you funnel the money into investments. Smith calculates that at the end of 25 years, assuming your investment rate of return came to 10 per cent annually (equivalent to the long-term return on Canadian stocks), you will have an investment portfolio of just over $509,000 and an "investment loan" mortgage of $200,000 on which interest being paid is fully tax-deductible. (Your investment return would have to be only 3 per cent to build the investment portfolio to match the $200,000 mortgage.) "All that is required is that you arrange to have your financial planner reorganize the way your mortgage operates," Smith states, although he acknowledges that many financial planners still don't know about the Smith Manoeuvre. If you wait to invest until after you've entirely paid down your home mortgage, which most people now are doing, you lose valuable compounding time for your investments and you won't build your retirement funds as fast as you should, he says. Smith claims the Smith Manoeuvre is legal, having "been reviewed by Canada Revenue Agency and endorsed by economists, financial planners and financial institutions. It is a legal and common practice to deduct interest when you borrow to invest to produce income."

I don't know if the same tax deduction exists in the US.


Is anyone familiar with this? Or do any of the financial geniuses on the board have any thoughts on this?

[FinanceDude]

I have a few questions:

1)What is the interest rate charged on the readvance? If it's like margin interest, and tied to short-term rates, could be nasty.

2)Like all "variations on a theme", Where's the study where people made it work...........

Bottom line, it doesn't sound all that different from the US< where people took out HELOCS to buy tech stocks, believing that their banker was going to "make them rich"...............

[Gumby]

Is this driven by the fact that mortgage interest is not deductible in Canada?

[FinanceDude]

Quote:

Originally Posted by Gumby Is this driven by the fact that mortgage interest is not deductible in Canada?

I wpuld say with reservation..................ABSOLUTELY!!!

[Gumby]

So it is not entirely like speculating on tech stocks with money drawn from a HELOC. In fact, I suppose if you put the money in bonds with a tenor similar to the mortgage, it wouldn't necessarily raise your risk but would boost your returns due to moving the payments to the tax deductible side of the ledger. The key question is, as you noted, what is the rate on the readvance.

[FinanceDude]

Quote:

Originally Posted by Gumby The key question is, as you noted, what is the rate on the readvance.

The average rate on margin interest has increased from 6-9% in little more than a year............

The cost of money could negate the investment return significantly...........

[kumquat]

For those posters who are Canadian, this topic has been discussed on what I think is Canada's best financial forum. This specific thread talks about more creative methods but does describe the original premice.

http://www.financialwebring.com/foru...opic.php?t=122

[FinanceDude]

Quote:

Originally Posted by kumquat For those posters who are Canadian, this topic has been discussed on what I think is Canada's best financial forum.* This specific thread talks about more creative methods but does describe the original premice.* http://www.financialwebring.com/foru...opic.php?t=122

Doesn't look like most of them are fans.............