I am starting a new thread on this even though there have been a few remarks regarding this on other threads. Any financial advisor/mortgage consultant or other who wishes to contribute his or her experience, please do so.

I am starting by giving a link to it in the granddaddy of Toronto's newspapers- The Toronto Star.

http://www.thestar.com/article/174167

January 24, 2007
Ellen Roseman

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, http://www.smfc.com." rel="nofollow">LINK

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 Safebridge 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.

Can someone please explain the process with an example assuming figures?
Where the money will be invested and what will be the return? How tax refund will work. An ‘example calculation’ will be more helpful in understanding.
Thanks in advance.

Ben

Here is a primer copied from another thread also posted by me.

Let us say you take a 25 year mortgage for $200,000 at 5.1% on monthly payments.The amortizations for the first year are as follows.

1 01/29/2007 1,167 337 831 199,663
2 02/28/2007 1,167 338 829 199,325
3 03/28/2007 1,167 339 828 198,986
4 04/28/2007 1,167 341 827 198,645
5 05/28/2007 1,167 342 825 198,303
6 06/28/2007 1,167 344 824 197,959
7 07/28/2007 1,167 345 822 197,614
8 08/28/2007 1,167 347 821 197,268
9 09/28/2007 1,167 348 819 196,920
10 10/28/2007 1,167 349 818 196,570
11 11/28/2007 1,167 351 817 196,219
12 12/28/2007 1,167 352 815 195,867

When you pay the first installment of $1,167- $337 is the principal and $831 is the interest.
1. Asa this is paid, the bank advances you a secured line of credit (LOC) at prime equal to the principal i.e. $337. This is then invested.
2. When the 2nd payment is made, the principal is $338. Your line of credit is increased by this amount to $337 + $338 = $675.The new amount of $338 is again invested.
3. And so on continuously for the length of your mortgage. Your LOC keeps increasing accordingly and so does the book value of your investments
4. Let us say that at the end of the year you have a LOC of $4,133 invested in say mutual funds. This over the long run of 25 years should give you a positive return based on historical performance.
5. On the LOC of $4,133 you will pay a certain amount of interest. Let us say that amount is $200. If you are in the 40% bracket you will get back $80 from the CRA. If further it is invested in a labor-sponsored fund (LSIF) you will get a further tax break.This latter tax break of LSIFs will be phased out by 2011.
6. Every year this effect is compounded as the principal part of your mortgage payment increases and the LOC increases accordingly and your investments increase and the interest you pay on the increasing LOC goes up and the tax returns from the CRA goes up. At the end of the situation you will have a hefty LOC invested in investment vehicles and you will keep on getting tax refunds from the CRA on the interest you pay as long as you carry this loan.
In theory it is very very cool, provided you have the necessary amount to keep making the interest payments on the LOC. There are currently investments that give you a monthly dividend to help you pay the interest.

It is really a neat manner of paying down your mortgage loan and building your savings. Those who have availed of it are really content, esp in light of the fact that global markets, incl Canada, are smoking.

There you guys have it in a nutshell.

There are plenty of add-ons and enhancements.

Just FYI, if investments are made into segregated funds, gains can be locked in, but keep in mind these management expenses ratios are higher than normal mutual funds.

There are also guaranteed returns mutual funds as well that automatically lock in your gains every month with the MER decreasing over time. Extremely few in the Canadian market though. I can only think of 4, but there may be more.

If any body wishes to add, correct or make any comments on the basic outline, please feel free to do so.

Perhaps the mods of the forum would wish to make the explanation of the Smith Manoeuvre a permanent feature. If so, I can give a more complete rundown of it as I have done several such presentations with graphs and the like. Other planners on the forum may wish to modify until we have a flawless version. I have also engineered several such deals, even for people who have only paid 10% of their mortgage.

Thanks Investpro;

Now I can go and discuss better with my financial adviser. She is pretty helpful but works for the bank who gave us mortgage. I hear, normally bank people won't let you know such things- ways to pay your mortgage fast. In the discussion to pursue, either of us will win over other.
I will keep you informed.

Ben

1. What is difference between getting interest only loans and instead of paying of principal investing that amount compared to the Smith thing? (I know Canada don’t have interest only loans but some lenders are coming up. Now they have 45 year loan which nearly interest only)

2. When you pay off you mortgage it already coming from after tax dollars.

3. You can always get an unsecured LOC and use that to invest for which the interest is tax deductible. So if you get interest only loan and get LOC loan for investment, then what is the purpose of Smith thing?

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

In the calculation table “interest portion paid on mortgage” is not touched. In fact the equity or principal is used to borrow money. Interest on this borrowed money is shown as tax deductible. Then one needs extra money to pay this interest.

Sample table shows that interest each month is coming down and so principal is going up. With equity used each month; the interest will stay same all 25 years and will not come down.

This is yet another fact that interest lost is 5.05 %; where as interest earned may or may not be higher than payable on mortgage.

Ben

Quote:

---

Originally posted by jayaram

1. What is difference between getting interest only loans and instead of paying of principal investing that amount compared to the Smith thing? (I know Canada don’t have interest only loans but some lenders are coming up. Now they have 45 year loan which nearly interest only)

2. When you pay off you mortgage it already coming from after tax dollars.

3. You can always get an unsecured LOC and use that to invest for which the interest is tax deductible. So if you get interest only loan and get LOC loan for investment, then what is the purpose of Smith thing?

---