Free Money! Make your Mortgage Tax Deductible – Intro to the Smith Manoeuvre
First of all let me tell you that I do this.. and in the words of Barney.. it’s Awesomely Legen… wait for it…….. dary.
Seems like all you hear about nowadays in the news are about the problems with ‘subprime’ mortgages in the states where banks and lenders offered up cheap payments at low rates to millions of people.. whom got screwed when rates went up. Foreclosures abound.. creating the beginning of the economic mess we’re in right now.
However.. one large difference between Canadian mortgages and our US brothers is that all the interest they pay on their mortgages are tax deductible. Ours aren’t.
That is.. until now. * (not 100% deductible.. read on)
What if I could tell you a relatively simple way of getting a nice tax deduction every year from the government doing nothing other than something you may already doing with RRSP loans every year, and also paying off your mortgage YEARS faster..
As I mentioned in the beginning.. I currently do this.. so I feel that I may not be an expert in taxation, I do know what I’m doing with regards to the Smith Manoeuvre.
Basically there are 2 parts to this.. and with interest rates the way they are right now.. I feel this is a great thing to get into sooner rather than later. The first part is getting a mortgage which is “re-advanceable”. What this means in lamens terms is that every time you make a mortgage payment, you can immediately borrow the ‘principal’ portion of that payment back and put it into something. For example.. say you’re early on in your mortgage and you pay $800 a month and only $300 goes onto your mortgage every month (sad eh?).. however that is the reality. Anyhow, what a re-advanceable mortgage does is allow you to actually take out that $300 and do whatever you want with it.
Got it so far?
So now every month there’s $300 sitting open for me to do something with it.. and what do we want to do with it? We want to invest it.. put it into some funds.. or put it into some stocks.. or put it into some real estate. You can put it into anything you want for the most part, however when you borrow money for investing purposes, you are able to write off the interest you pay on it as tax deductible. Just like an RRSP loan you are pressed to get every year at the end of February (*note – the loan itself isn’t tax deductible, but the contribution is).. the only difference is that this is built into your mortgage.
I always like examples, so let’s say I have a mortgage for $100,000. After year one.. I have paid off $5,000 of the principle… %5. What I am able to do is take that $5000, and invest it into some mutual fund I like for example. And just like an RRSP, there is a tax deduction on that amount. And what do you do with that tax deduction or extra money you’re getting back?? PUT IT ON YOUR MORTGAGE AS A PRINCIPLE PAYMENT! And then what happens?? Well, you end up starting year 2 of your mortgage with a nice lump sum paid off your mortgage.
Now having said that, you have to realize that this means that instead of paying off your mortgage and being debt free.. you will always have that $100,000 you borrowed and be paying interest on it. The difference is, as you pay off more of your mortgage, you are getting more back every year.. since more of it is in a tax deductible loan (investments) and not in a non-tax deductible loan (mortgage). So say in 10 years you now have $50,000 paid off of your mortgage (this isn’t out of the question with this strategy by the way), and a $50,000 line of credit with investments. Two points:
- The $50,000 loan for investments.. well, all the interest you’re paying on it is tax deductible
- Hopefully unless you suck at investing, that $50,000 you’ve been investing is worth a LOT MORE than $50,000.
You see what I’m saying? It’s basically a kick start to your retirement as well! Instead of slaving away to pay off your mortgage and then start your retirement savings, you are starting when you first get into your mortgage!
So let’s fast forward to the end of say year 15 when you have your mortgage completely paid off.. you still have a $100,000 loan however, but with lots of fun investments you’ve been making money on. Plus, the interest of that huge loan is tax deductible! Every year you’re getting a nice cheque from the government due to that big loan you have invested in hopefully something great. In fact, taking this a step further.. say you are just reading this now.. and thinking, “I’ve already got $20,000 paid off on my house.. am I too late?”.. Heck no, what you can do in your case is go out and get a re-advanceable mortgage product (there are lots out there at each bank), and even better.. get one for the original assesment of your house. Use the excess equity to put a down payment on maybe a rental property! Start building your empire! Muuuu ha ha ha!! Ok.. got a little out of hand there.
So I’m going to stop there as there are lots of good resources out there which teach about the Smith Manoeuvre, and also lots of critics. I will say that I have been doing this for 2 years, and I now have over 14% of my mortgage paid off so far. That said, I also that 14% of my mortgage in investments… in a loan which is tax deductible… (well that’s a lie actually.. I still have a considerable amount of money which is available to me, but I don’t have it ‘working’ for me in investments yet.. but that’s part of that 14%).
So yeah, this is working out for me quite well I’d say… if I’m sitting here in 2 years and have 30% of my mortgage paid off.. and in 8 years have 60%, that would logically mean I would be mortgage free in 12 years… with a huge investment loan which hopefully is worth much more than the loan itself. At that time I would be 42 years old with a house in which I own. Yep.. I like that idea.. I’m on my way.
I love talking about this stuff, and would love to field your questions.. or have a conversation about this with you if you’re interested.. shoot me off a message (on the right if I’m online), or leave a comment.
Cheers!
