National Post Article
Make your mortgage tax deductible
Homeowners shown how to put 'bad' debt to work
Monday, February 06, 2006
The Smith Manoeuvre is both the title of a bestselling
Canadian book and the enigmatic epithet
for a cunning approach
to simultaneous debt management and wealth creation. The clever "how to" book describes the steps required to
make
non-deductible mortgage interest fully
and legally deductible by regularly re-borrowing
monthly principal payments for
investment
purposes.
This ingenious system is the brainchild, and
handiwork, of Fraser Smith, a "retired" British
Columbia-based financial
consultant. Far from
retiring, the energetic 67-year-old has kicked
into high gear in recent months with a second
career
-- lecturing on his tax-saving/wealth
building techniques and selling books and
calculators on the strategy.
Conventional wisdom advises you to pay off
your mortgage before you start saving for
retirement. The rationale is that
since you are paying your mortgage with after-tax
dollars you should make it go away before you do anything else. This
would give you a
financial cushion -- the free and clear equity in your house -- as a starting point from
which to apply
future earnings to amassing your investment nest egg.
Smith, on the other hand, advises you to swap the "bad" debt for a deductible source of
investments that puts the equity
in your house to work.
Smith's system requires a mortgage that permits re-borrowing of the paid-down principal
seamlessly and regularly --
what Smith refers to as a "re-advanceable mortgage."
A survey of Canadian financial institutions and mortgage banks, with Vancity Credit Union the pioneer back in the 1980s, indicates that almost all of them offer many of the features required to put the Smith Manoeuvre into effect.
The main feature is the ability to re-borrow principal repayments right away to invest,
but Smith would also like the
"perfect" Smith Manoeuvre mortgage to capitalize interest,
at least on the investment portion, track interest costs monthly, particularly on the
deductible portion, and have credit limits up to 100% for dedicated and qualified
investors.
Ed Rempel, a Brampton, Ont., financial planner and a dedicated proponent of Smith's
system with "about 70" Smith
Manoeuvre clients, gives a powerful example of how he
has used it to help one average Canadian family break out of
the debt cycle and get ahead.
"Last year I met a delightful couple in their mid-40's with a combined income of less than
$80,000 who were struggling
to meet monthly mortgage payments of $964 and
payments on other debt of $1,300, including several credit cards, two
credit lines and an
RRSP loan," explains Rempel.
"Without the Smith Manoeuvre it would be difficult for me as a financial advisor to help
them very much. We had them pay
a penalty to refinance their mortgage at a lower rate
and then roll in all their other debt. The credit line linked to their other mortgage still had
$55,000 available credit. With the Smith Manoeuvre we were able to invest a lump sum
of $55,000
plus $1,335 a month [by re-borrowing monthly principal payments from their
credit line], throw in the annual tax refund on
the deductible interest,
and still contribute
to annual RRSP's!"
Rempel describes how at the same time they reduced the amortization of their "bad" (non-deductible) debt from 19 years
to seven years.
"The result for them was truly miraculous," says Rempel. "They went from struggling
with debt and hardly saving to being
on a fast track to a significant investment portfolio
and a fully deductible mortgage."
The key to the long-term Smith Manoeuvre, however, is that incremental equity is put to
work for you rather than just
accumulating, regardless of any other investments you may
be able to make. Without having to spend any more money
monthly, anyone can
potentially harness the power of compounding tax-efficient investments and deductible
mortgage
interest. The difference between the after-tax mortgage interest and the
average investment yield can clearly grow quite dramatically over time, if historical
spreads continue into the future.
Importantly, Smith has provided an "open platform" approach to his system, providing
access to everyone. He also offers,
via his Web site (www.smithman.net), access to
financial planning professionals like Ed Rempel who understand and
can apply his
Manoeuvre for individual clients.
Getting a professional involved will spread the responsibility between client and advisor
for maintaining discipline in
paying down non-deductible debt, prepaying principal with
tax rebates, and for investing in solid prospects.
It also reinforces what I believe is the real payoff of the Smith Manoeuvre: it will turn an
average borrower into an active
investor years ahead of the traditional route. In my
humble opinion it is far better to be an experienced investor with a
portfolio and a
deductible mortgage than an inexperienced investor with neither.
Tony Humble Financial Post
© National Post 2006