Should I implement the Smith Manoeuvre?

I’ve got a bunch of debt – mostly from my mortgage.  I wish there was a way to convert this mortgage debt into a tax-deduction, you know, like the Americans can, to kill off my mortgage faster.  Sounds like fiction in Canada right?  Well, this can happen to you and me if we follow The Smith Manoeuvre.

While The Smith Manoeuvre is tricky to set up and takes some significant financial discipline to keep it going, it is perfectly legal and complies with our Canadian tax code.  I’ve been considering this approach for my portfolio for some time and a recent conversation with someone piqued my interest again, pun intended.

This manoeuvre has already been described across the blogosphere quite a bit; Google-it and you’ll find these great posts over at Canadian Capitalist and Million Dollar Journey.

Canadian Capitalist and Million Dollar Journey links:

Smith Manoeuvre Part 1.

Smith Manoeuvre Part 2.

Smith Manoeuvre Part 3.

Smith Manoeuvre Part 4.

Canadian Capitalist also reviewed Fraser Smith’s book here.

Million Dollar Journey links:

Smith Manoeuvre – Part 1.

Smith Manoeuvre – Part 2.

Should I Start the Smith Manoeuvre?

The Smith Manoeuvre Money Flow.

Million Dollar Journey also paid tribute to the late Fraser Smith here.

Smith Manoeuvre Facts and Flow

The idea is to convert your existing mortgage debt into tax-deductible (investment) debt and use the tax deduction and income, if you choose from investments made to pay down your mortgage.

To make the idea a reality:

  • You need a readvanceable mortgage whereby you can tap into your Home Equity Line of Credit (HELOC).
  • As you pay-off the mortgage principle, like you’re doing today, the amount of equity available in the HELOC goes up over time.  Mortgage goes down; available credit to borrow goes up.
  • That available HELOC can be used fund investments.  Refer to the figure below courtesy of National Bank:

National Bank All-In-One Smith Manoeuvre

Take available money out of HELOC and invest it – preferably into solid income-producing investments in a non-registered self-directed discount brokerage account.  When you borrow money for investment purposes, the interest paid on the loan is tax-deductible.

Use the tax-deductions and investment income (e.g., dividends) to pay down your non-deductible mortgage debt.

So, mortgage debt does down; available HELOC keeps going up, as you use the HELOC to buy more income-producing investments.

Smith Manoeuvre Considerations

This type of leveraged investing is not for the uninitiated investor.  This process has tax, investment and more than a few psychological risks.

On the tax-side, you must present a clear audit trail of your investment approach in case Canada Revenue Agency comes knocking.  Simply taking money from your HELOC and using that money to invest is NOT the Smith Manoeuvre.

On the investment-side, you better ensure your income-producing investments are in your non-registered account.  Using money from your HELOC to invest in your RRSP or TFSA will NOT give you a tax deduction.  Also, be mindful, the essence of borrowed money – it must be repaid at some point.  So, make sure your income-producing investments have the potential to exceed the interest burden you are taking on.

On more of the psychological-side, you must be aware you are re-borrowing money to pay down your mortgage.  Canadian Capitalist, Million Dollar Journey and other prominent bloggers have stated time and time again when discussing this strategy, you need to be very comfortable with leveraging to perform this trick.  What happens if your income-producing investments don’t cover your loan?  What happens when house values drop and you need to move?  What if you need money in an emergency?  What happens when interest rates change and/or borrowing costs go up?  Investing is not just about buying assets it is very much about psychology and planning for the unplanned too.

You must also consider the time and maintenance this process takes.  Probably most investors who have a decent income, to perform this trick don’t need to do it anyhow.  Check out what Michael James on Money said:

I suspect that the Smith Manoeuvre is too risky unless your income is high enough to pull you out of any problems with your investments or a drop in the value of your home. But, if your income is high, why not just go for the low risk strategy of paying down your mortgage and investing some of your excess earnings?”

Smith Manoeuvre Conclusions

The Smith Manoeuvre is tricky to set up and take some smarts to keep it going but it is a perfectly legal and an accelerated way to kill your mortgage debt while growing your investment portfolio.  For those investors ready to take it on, great stuff and I wish you well but personally I’m not ready to take this leap yet.  Although I’m very intrigued about using this strategy myself, it’s just not the right time for me.  I want to thank my brother-in-law from inspiring me to write this post and I look forward to hearing from him if, when, how and how long he intends to use this process on his own journey to financial freedom.

Have you used The Smith Manoeuvre?  Are you considering taking it on?

Want to read even more about this strategy?  Check out an outstanding post by fellow blogger The Passive Income Earner.

Filed in: Debt, Investor Behaviour, Smith Manoeuvre

21 Responses to "Should I implement the Smith Manoeuvre?"

  1. Wow, that sounds.. complicated? I guess they don’t let Canadians write off mortgage interest because our mortgages are so much higher than those of most Americans. This looks intimidating to me, but it might be worth looking into.

  2. Nice article. Very balanced with lots of useful links for more information. I was very tempted for a while to try borrowing against my house to invest. Fortunately I didn’t do it because this was not too long before the 2008-2009 stock market crash.

  3. Bill says:

    I was reluctant to start but after reading quite a bit about it decided to start it a little over 2 years ago. I have a Scotia Total Equity Plan. Overall I am pleased with it. My current yield is a touch over 4% and my LOC is at 3.5% (for now).

    I have deliverately NOT maximized my LOC relative to my house price. That’s a choice. And I split off a separate LOC for true emergencies to keep the paper trail very clear.

    Tracking the paper trail and record keeping is probably the hardest part in my opinion. However, I get a nice summary of interest paid from Scotia and a trading summary/T5’s from my broker (Questrade), so taxes are pretty simple.

    At the moment I am “ahead” if I had to liquidate everything. My worst case so far has been a couple of thousand under. It won’t (yet) make me rich but it will not wipe me out either. I am happy with that balance. Mortgage is on track to be fully paid off in 6 or 7 years, and then my dividends can start paying the loan principal off.

  4. Yield just over 4% is tidy Bill.

    If I go there, maybe years down the road, I too will not maximize my LOC relative to my house price. No way I could leverage that much and sleep at night!

    You’re in a good place with rates being so low. If rates climb, it could be a different story for you…don’t you think?

    Our mortgage should be done in about 9 years. 9 years too long IMO. I will continue to work at it.

    Thanks for your comment Bill.

  5. Thanks Michael, always appreciate your comments and insight. I enjoyed what you wrote about the SM. You have a very logical perspective, makes it very easy to side with you :)

  6. It can be (complicated) Daisy.

    I don’t know why we cannot write off mortgage interest. Our house prices in Canada are definitely higher than the U.S. The average house price in CDN $ is approaching $400,000. That could be thousands in taxable interest deductions for most Canadians…


  7. @My Own Advisor
    While the interest on a mortgage is tax deductible in the US, when you sell your house, the capital gains are taxed, unlike Canada where the gains on your sale are tax free if it is your primary residence. You do get your tax advantage up front in the US, but it’s not the entire story.

  8. You raise an excellent point…capital gains on primary residence do not exist in Canada. Which way is better? Thoughts? I suspect staying in your primary residence is an incentive and avoids speculation (too much) on real estate?

    Thanks for your comment.

  9. LoonieLover says:

    I would like to implement the Smith Manoeuvre some day, but not until I most of the house is already paid off. I may use it to speed up the end of paying for the house, as opposed to the main way to get the job done. I need to know that if I end up getting myself in trouble, that I’ll be able to dig myself out.
    Also, I think it would be imprudent to start this now, when interest rates are so far below normal. You know for a fact that rates _will_ move against you sooner or later. If dividend paying stocks fall out of favour at the same time, you could get caught with your pants down.

  10. I’ve used the Smith Manoeuvre for a while and it was working very well. Unfortunately, I had to stop using this strategy because my wife quit her job and we have 3 kids. I was unwilling to take additional risk at that time.

    I will definitely start this strategy again in a few years once my finance are more stable. I think it’s a great strategy when you have space in your budget to “wait” for the market to grow.

  11. I did lots of research on TSM even reading Million Dollar Journeys go at it but we weren’t prepared to do this. Since we’re just learning about investing it didn’t make any sense for us to risk what we have. I think for all the reasons that you listed above if someone has a well paying income and is confident and can handle the ups and downs give it a try.

  12. Alex says:

    We are currently using the Smith Manoeuvre to finance the purchase of our rental property. Both our rental property and our primary residence are financed using Scotia’s STEP. I use the Rental property income to pay for the interest only on the HELOC.

    Any extra cash goes to paying down on non-deductible interest (car loan ad primary residence mortgage).

  13. I am considering the strategy once my mortgage reaches a level where I am confortable with creating a separate loans for investment on the side.

    Like any investments, I believe you need a few years for your investments to get the benefits of growth. Any dividend investors is probably ahead of the game for building such portfolio as you need to buy qualifying investments

  14. @Bill With Scotia, you can’t be doing the real Smith Manoeuvre since it doesn’t offer a re-advancable line of credit. I too have the Total Equity Plan with a HELOC. You must just be borrowing to invest. Still a strategy but not the SM in the true sense.

    With that said, if you have plenty of equity in your HELOC compared with your mortgage, you might just be simulating it. I would be very curious to hear how you set it up.

  15. Le says:

    Interesting to see a SM article pop up now that the equity markets have been on a tear. Didn’t see as many of these during the past 5 years.

    Interest being deductible on our primary residences would just inflate housing prices further, which is not something that we want.

  16. Good point Le, interest being deductible on our primary residences could inflate the RE market. We don’t need any more air into the balloon!

  17. You’re like me Passive. Once my mortgage hits around $100k, I will consider it. Unfortunately, I have a significant ways to go before that figure it reached. At least 5 years of debt payments. I really hate mortgages.

  18. Hey Alex,

    I’ve heard good things about STEP. How long have you had the account?

  19. Alex says:

    I’m debating doing the smith maneuver after another few months. Current salary is 225k, house value is 145k & mortgage owing is 94k. Ideally the dividends would accelerate the payback of the mortgage allowing me to pay 10% of principle yearly.

    I’m currently paying myself as dividends from my company which my company pays 15% on first before I pay personal taxes. Should I switch this to salary & not have the company pay dividends if I start the smith maneuver?

  20. Tough questions Alex!

    With your current salary, it might be worth the risk.

    I don’t make (nearly) that much and because my job is only somewhat secure, coupled with a fat mortgage, I’m just not ready to pull the trigger on the SM. Like I wrote about in my post….on the tax-side, you must present a clear audit trail of your investment approach in case Canada Revenue Agency comes knocking. Simply taking money from your HELOC and using that money to invest is NOT the Smith Manoeuvre.

    On the investment-side, you better ensure your income-producing investments are in your non-registered account. Using money from your HELOC to invest in your RRSP or TFSA will NOT give you a tax deduction. Also, be mindful, the essence of borrowed money – it must be repaid at some point. So, make sure your income-producing investments have the potential to exceed the interest burden you are taking on.

    If you have a stable job, and low(er) mortgage, it might be worth a try but I understand it takes some time and patience until you see the dividends flowing in enough to make a dent in the mortgage.

    Paying yourself in dividends is a low form of taxation, that’s a good thing. Switching to salary, I think you’re increasing your personal tax burden. I’ve have to run some math to be sure, but it certainly seems this way with your scenario.

    The thing I keep coming back to is this…for all the work involved in the SM, isn’t it just easier to make some lump sum payments on the mortgage and invest in a bunch of stocks or ETFs with the money leftover?

    Thanks for writing Alex.

  21. KevinL says:

    Bill, would you please tell me how you dealt with “readvanceable” part of the mortgage where your credit in LOC increases as you pay down your principle. I asked couple of scotia bank mortgage specialists. They both informed me that I have to increase the credits by calling. It is not automated. Thanks


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