In Canada, if you borrow money to invest in a product that produces an income such as an investment property or a dividend paying stock, the interest on the borrowed money may become tax deductible.
If you borrow against the equity in your home, invest it in income-producing products, then you can use the tax refund to further pay down the mortgage. By repeating that a number of times, you can pay off your mortgage.
The man behind it all was Fraser Smith, a financial strategist based in Victoria, British Columbia. He pioneered The Smith Maneuver, a ground-breaking, legal strategy that lets ordinary Canadian homeowners make their mortgages tax deductible. In his work, he saw that too many Canadians were waiting until their mortgages were paid off before they started to build an investment portfolio, missing out on years of compounding interest, and putting themselves in the position of being house rich and cash poor in retirement, unlike his wealthier investors who used tax strategies to grow wealth. So, he learned the rules of tax deductibility and penned the book The Smith Maneuver for all Canadians.
In a simplified way -- here’s how it works: It starts with a re-advanceable mortgage, which is a mortgage linked with a line of credit. The credit limit for your mortgage plus the credit line is normally 80% of the appraised value of your home, but new rules have changed that to 65% of the value of your home. With each mortgage payment, you pay down some principal, which immediately becomes available credit in the credit line. You can now borrow this amount to invest directly from the credit line. Your investment credit line interest is normally tax deductible and you should receive a refund, which will be small in the beginning.
Use the line of credit portion to invest in incoming-producing products but never in an RRSP – you’ll lose the tax deduction.
At tax season, you can deduct the annual amount of interest you paid on your line of credit against your income. Then apply the tax return and investment income against your non-deductible mortgage and invest the new money that’s now in your line of credit. Repeat this until your nondeductible mortgage is paid off.
By doing this you get to build a large investment portfolio without waiting to pay off your mortgage first; you get to quickly pay down your non-deductible mortgage in a hurry; and your new investment loan is tax deductible.
To learn more about this strategy and to see if it can work in your situation, contact a mortgage broker.
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