Friday, February 8, 2008

How To Make Your Mortgage Tax Deductible

You've heard about the Smith Manoeuvre and you want to make your mortgage tax deductible. Here's an example of how the Smith Manoeuvre works...

Assume you take out a $250,000 mortgage at 5.84%. On a 25-year amortization, the monthly payment on this mortgage would is $1576. Let's also assume that for 25-years, you don't have any extra cash to invest and all you pay is the monthly mortgage payment of $1576.

Scenario A: No Smith Manoeuvre -- After 25 years you'll have paid off your mortgage at which time you'll own your house free and clear but you have no savings.

Scenario B: With the Smith Manoeuvre..
Your monthly payments are still $1576. At the end of each year however, you re-advance on your mortgage by the amount of principle you've paid down, take the money and invest it. You need to have a re-advanceable mortgage or a line of credit to effectively make this work.

You have started to build your investment portfolio, and are still only spending $1576 per month.

In Canada when you borrow money to invest, the interest cost on the money you borrowed is tax deductible, so you get a tax refund. When you get that refund, you use it to pay down your mortgage principle further. At that point, you readvance again and use that money to invest. The cycle continues. You are building your investment portfolio and still only spending $1576 per month. All the while you are replacing the original mortgage debt with debt that is tax deductible.

If you employ the Smith Manoeuvre, here's what your financial picture could look like after 25 years ~ you have $250,000 of investment debt (on which the interest cost is tax deductible), but you also have an investment portfolio worth $602,000. That means you are ahead by $352,000!

* Assumptions are that your marginal tax rate is 46%, you pay 6.25% on the money you borrowed for the purpose of investing (that's the current prime rate) and you earn 8% on your investments.

If you would more information about the Smith Manoeuvre, contact Greg Holohan, CFP at Scotia McLeod. (If you want to use the Smith Manoeuvre, get help from someone who is qualified to advise you on it). Greg's website address is http://www.gregholohan.com/ and his phone number is 905.479.8238.

If you would like more information about the type of mortgage you need to make this strategy work, or if you have mortgage questions of any kind contact me.
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