Wednesday, April 4, 2012

Is Your Mortgage Tax Deductible: The Smith Manoeuvre by Fraser Smith

Would you like to make the interest on your mortgage tax-deductible? This book can show you how (or more precisely, how to convert your mortgage into an investment loan). Using a very creative approach, Fraser Smith explains how a reversible mortgage can be used to reduce one's taxes. In a nutshell, a reversible mortgage is a financial instrument that is comprised of two parts: first, the mortgage on the house; and second, a line of credit that allows a homeowner to borrow from the equity in their house. The line of credit increases as the principal on the house is paid down. For example, if you pay off $600 of principal in a month, then you can borrow $600 from the line of credit.

The trick to this strategy is found in the tax rule that allows Canadians to deduct interest from investment loans. Using this rule, if a homeowner uses their line of credit to purchase investments (e.g. stocks, mutual funds, investment properties, bonds, etc.), then they can deduct their interest payments on this line of credit from their taxes. As such, the strategy does not allow a person to deduct the interest on their mortgage per se from their taxes, but rather to deduct the interest on their credit line that is based on the amount of principal that has been paid off.

In the first step of the Smith Manoeuvre, a homeowner will use all of their tax refunds to pay down their mortgage as quickly as possible, and then borrows an amount equal to the paid-off principal to buy more investments. Through this process a person can convert their mortgage from a "bad debt" (i.e. a loan in which interest cannot be deducted) to an investment credit line that is a "good debt" (i.e. a loan in which interest is tax deductible).

In the second step, once the mortgage is paid off, the homeowner can either use the tax refunds on their investment line of credit to buy more investments, or decide to use their now sizeable investment portfolio to pay off their line of credit.

I liked this book because it proposes a very creative approach to investing. As long as you are comfortable with having the same amount of debt, (this strategy doesn't reduce debt, but  rather converts it from a non-deductible mortgage to a deductible investment line of credit), you can use the Smith Manoeuvre to build up an investment portfolio much faster than you could have otherwise.

On the downside, I found this book to be very, very repetitive, with the same point being recycled numerous times. As well, the rates of return that are projected are highly unrealistic. In several parts of the book examples are given with a rate of return of 10 per cent. In this economic climate, it is highly unlikely -- if not delusional -- to expect an investment portfolio to grow by 10 per cent per year. It is also unfortunate that Fraser Smith does not acknowledge the risks in his strategy. For instance, in 2008, anybody using this strategy could have found themselves holding onto an investment portfolio that was worth less than the value of their house, while still having to pay interest on an investment line of credit. Most people in this scenario would not be calmed with the knowledge that interest paid on this line of credit is tax deductible. That being said, this is an interesting concept and the book does prevent food for thought.

3 out of 5 stars