Posted by Tim Stobbs on August 28, 2007
Yesterday I got a question from our long time commenter Will, on a topic I have yet to really touch on.
Q: I was wondering if you’ve heard of the Smith Manoeuvre and, if so, what your thoughts on it were.
A: Yes I’ve heard of the Smith Manoeuvre. For those who are not so familiar let me do a short review of the basics involved. The Smith Manoeuver is a Canadian thing on changing out your non tax deductible mortgage interest debt into a debt that is tax deductible. For US readers: in Canada we can’t deduct our mortgage interest on our taxes (in exchange we have no capital gains on our primary residence when we sell), but we are allowed to deduct interest on loans used for investments.
So the idea is as follows. You take your mortgage and make sure you get a line of credit that is linked to it. Depending on your bank they will call it something else, for example Scotiabank calls it a STEP plan. Then you pay down your mortgage as fast as possible, after you reach the point where you can pull out equity from the line of credit (typically this is at least 10% of your home value or more depending on what terms you get when applying). Then you take the money out and invest it in a taxable account and write off the interest on your taxes (Note: you can NOT invest the money in a RRSP as that loan interest would not be tax deductible). You keep doing this until you end up with a large line of credit balance that used to be your mortgage which you can write off the interest on. You also end up with a sizable investment account. The theory is with making your loan tax deductible and having a investment account you will be further ahead that a standard mortgage.
In theory this is a good idea. The issue of course is your are really leveraging yourself out hugely which means your really going to magnify your returns or your losses in the market. This also only really works well if your going to do it for an extended period of time (10 years +). For me personally, I would think that could be a bit too much risk. Why? I don’t have the correct personality to take on $100,000+ of leveraged investments. I know I would worry about them going down and potentially do something stupid.
Instead, in my case, I would be willing to do a small Smith Manoeuvre of around $10,000 to give it a try. I would suggest doing your homework on this to make sure you completely understand what you are doing and ensure the CRA (Canada Revenue Agency aka: our version of the IRS) does not come back at you with questions. I’m personally very close to be able to do this myself since I almost have 25% of my original house value paid off which was the agreement I made with my line of credit on my mortgage. Yet you should be aware that the government changed the rules on mortgages and you can now easily do this at the 20% level as well since that is now the limit to avoid CMHC fees. I would likely buy several dividend paying blue chip stocks to provide some low taxation income to pay off the interest on the investment loan.
That’s my thoughts on it all. Has anyone given this a try? If so what are your thoughts on it?