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Using the Smith Manouver to Payoff Your Mortgage Faster

Several years ago Ellen Roseman of the Toronto Star wrote an article about "The Smith Manouver".  Still to this day the book continues to be popular and clients ask questions about the effectiveness of the strategy.  Here is a bit of informaion about it.

 

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Fraser Smith has written a bestselling book on personal finance by telling Canadians not to pay off their mortgages.

He wants people to convert bad debt (a mortgage) to good debt (an investment loan) by swapping one for the other.

By using something called a "readvanceable mortgage," you can get a tax deduction for the interest paid on a mortgage (which is generally not tax-deductible).

The strategy to convert a negative to a positive is called the Smith Manoeuvre.

Here's how it works: (1) Make your regular mortgage payments. (2) Borrow back the principal reduction that occurs as you make each payment. (3) Create an investment loan that is tax-deductible.

After the first year, you will get a big tax refund. Use this money to make an extra payment against your mortgage, then immediately borrow back and invest the same amount.

What's interesting about the Smith Manoeuvre is that you never reduce your debt. Borrow $250,000 to buy a house and pay off that loan over 25 years. Guess what? You still owe $250,000 at the end.

But now you have investments that are worth more than $250,000 – or so you hope. You can sell these investments to discharge the loan.

What about the time-honoured strategy of contributing to a registered retirement savings plan? Doesn't that offer a hefty tax saving?

In many cases, Smith says, you would do better to cash the RRSP, pay the tax and use the money to make a lump-sum reduction of the first mortgage. Then, you immediately borrow back that money and invest it outside the RRSP.

Only after converting all non-deductible mortgage debt to tax-deductible investment debt should you resume your RRSP contributions.

As you might expect, you won't hear much about RRSP alternatives from your friendly banker or investment dealer.

They're too busy asking you which mutual fund you want to buy before March 1, the deadline to invest in an RRSP and save taxes on your 2006 return.

Despite a lack of support from mainstream financial institutions, the Smith Manoeuvre has taken off through word-of-mouth and vigorous debate at online discussion forums.

"I've passed 30,000 books sold and I'm printing 10,000 more this week," he told me about his The Smith Manoeuvre: Is Your Mortgage Tax-Deductible?

These are amazing sales figures for a self-published book, not terribly user-friendly, that first came out in 2002. I picked up a copy of the seventh printing recently at a Costco warehouse store for $12.99 (half the cover price).

So, who is Fraser Smith? As a financial adviser in Vancouver, he came up with the idea in 1984 and pitched it to Canada's largest credit union.

The Vancity credit union attracted many new customers by working with them to make their mortgages tax-deductible and helped secure a dominant position in the B.C. market.

Smith, now retired and living in Victoria, has been working with partners to start a new company, Smith Manoeuvre Financial Corp. They opened an office last month on Bay St. in downtown Toronto and set up a website, www.smfc.com.

He has names and numbers of about 450 financial planners and mortgage brokers who can help put the plan into action.

"It's a great strategy, but it's not for everyone. You have to consider your risk tolerance," says Elisseos Iriotakis, a certified financial planner and vice-president of mortgages for Saferidge Financial Group in Toronto.

He finds clients are split. Half welcome the idea of swapping bad debt for good debt, while the other half worry about borrowing to invest and possibly losing money.

"It's not good for the average person. Most of my clients wouldn't understand it because it's very complex," says Gary Newby, a certified financial planner in Toronto.

Newby took a course on the Smith Manoeuvre, which explains why his name is on the list of advisers who endorse the strategy. But he says his request to remove his name was not honoured.

David Trahair, a Toronto chartered accountant, wrote a book urging Canadians not to invest in RRSPs before paying off mortgages and other non-deductible debt. He disapproves of swapping one loan for another.

"I recommend the total opposite, paying off your principal residence and not borrowing against it," he says.

"It's a high-risk strategy because you're betting the farm that some investment adviser can do better than you can. You have a guaranteed return from getting rid of the mortgage."

Love it or hate it, the Smith Manoeuvre is a runaway success. It appeals to those who want the best of both worlds, paying off a mortgage while building an investment portfolio at the same time.

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Here are a few of my favorite past articles from my Lethbridge real estate and mortgage blog you might have missed or wish to recommend them to a friend.

WANTED: Single Women: - Single women are a hot mortgage market
Common Financial Problems - Avoid these financial mistakes
Get Your Credit Score UP - Invaluable insight into your credit score
Mortgage Guidelines Get Tighter - Harder and harder to borrow money
Is Your Mortgage Company Out of Business in 2009? - What to do when your bank goes broke
What is wrong with MLS - Is your info being abused?
Survivor - Real Estate Edition - Let's vote a few more off the island

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Robert May is a Realtor, as well as the broker and owner of Rainbow Realty of Lethbridge Alberta. He is also a licensed mortgage broker   and mortgage financing expert with Canada First Mortgage of Calgary Alberta. He has been in the lethbridge real estate industry since 1993 and offers full MLS services to the Lethbridge real estate market and surrounding area.. He can be found online at www.LethbridgeLoans.com

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Robert W May is a Real Estate Broker in Lethbridge Alberta, having now been in the industry for over 23 years. . He was also a licensed Lethbridge mortgage broker and financing expert with Canada First Mortgage of Calgary Alberta for the past 10 years.  He is an industry leader always willing to help train and educate others in how to improve their business models for financial and personal benefit.




 

 

Comment balloon 4 commentsRobert May • March 25 2009 10:53PM

Comments

I have heard many variations of this since I started in the business. I remain skeptical at best.  But, I'm willing to learn.  You have at the very least piqued my curiosity.  I may be back to learn more. 

Posted by Don Sabinske, Sabinske & Associates Inc. (Don Sabinske, Sabinske & Associates Inc.) almost 9 years ago

I think that as the article said it's not for the everyday person and not because it's to complex but because life happens and the money that's suppose to go into an investment may be needed and then it sets the whole manuevre off.  I won't sell it to many people because life happens and it's just to easy to need the money elsewhere.

Posted by Lynn Meldrum (Lynn Meldrum with Verico Canada First Mortgage) almost 9 years ago

Robert--I guess I am too conservative to buy into something like this.  As Lynn said in her comment 'life happens' and I prefer to be debt free.  I am sure that there are investors out there who would buy into the idea or at least buy the book or DVD.  I will continue to pay extra each month on my mortgage.

Posted by Mary Yonkers, Erie/PA Real Estate Instructor (Alan Kells School of Real Estate/Howard Hanna Real Estate) almost 9 years ago

I have not tried it myself, but do have clients who swear by the concept and have had success in eliminating their mortgage at a much faster rate doing so.

Posted by Robert May, Real estate consulting (Robert W May - Lethbridge Real Estate) almost 9 years ago

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