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."
