To properly execute a Smith Manoeuvre, you need to have a readvanceable mortgage such as Scotiabank’s STEP or BMO’s Readiline. With this form of mortgage, your Home Equity Line Of Credit (HELOC) increases with every dollar paid down on your mortgage principle. With a Smith Manoeuvre, you then use this credit line to invest in income producing stocks, preferably in the form of Canadian dividend-paying companies. For this loan to be tax deductible, you must invest in a non-registered account. RRSPs, RESPs, and TFSAs do not qualify. You also cannot make any non-investing purchases with the HELOC. This is to keep a clean paper trail for the CRA and to show that the entire loan is for investment purposes.

On top of your regular mortgage payment, you also make additional payments from the dividends paid out as well as the tax credit received from your investment loan’s interest paid. All these payments to your mortgage will provide new room in your HELOC to borrow for investing.

By continuing this cycle, your mortgage will be paid off sooner and you’ll have a much bigger portfolio than if you waited until the mortgage was paid off to invest. And of course, the debt you now have is tax deductible, where your mortgage was not.

This strategy does leave you with a large credit line debt, but once the mortgage is paid off you’ll have some options:

• You could sell a portion of your stocks, equal to the debt, to pay it off.
• If the dividends are more than covering the interest, you may be better off never paying off the debt.
• My favorite is a bit of both. Leave the portfolio untouched. Continue paying an amount equal to what your mortgage payment was, but use it to pay down the HELOC. This could be further accelerated by also using dividend proceeds remaining after covering the interest payment.

If you’re interested in doing a Smith Manoeuvre, it’s recommended that you speak to a financial planner. This can be a complex strategy and you need to be comfortable with a large amount of leverage, even as the prices of your stocks jump up and down in value.

I have a readvanceable mortgage and will likely be starting my Smith Manoeuvre in August. If the Smith Manoeuvre is right for you, it just may be the best financial move you make, allowing you to pay off your mortgage and start an investment portfolio at the same time.

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The Basics Of The Smith Manoeuvre originally appeared on Canadian Finance Blog on June 9, 2009.

First off, housing prices have come down considerably here in Edmonton. While that also means that we had to sell our townhouse for $70,000 less than the highs of the last couple years, we were able to buy a house for $100,000 less than it’s comparable peak price. I realize prices could continue to drop, but there were other incentives to make this move.

Selling the townhouse, then subtracting the current mortgage (and penalty), real estate fees, lawyer fees, left us with enough money to have a 20% down payment and eliminate all our current debt (student loans, credit line from wedding). Having the 20% down saved us from the extra expense of CMHC insurance. Paying off our debts frees up enough money to pay for the larger mortgage payment. We are however borrowing money to fund our renovations so that we can get them done this year to meet the Home Renovation Tax Credit deadline.

With the new mortgage, we went with the Scotia Total Equity Plan (STEP) from Scotiabank. While our penalty for breaking our current mortgage was over $4,000, we’ll come out ahead with this mortgage, at 3.79% for the next 5 years. The STEP plan will also allow me to start a Smith Manoeuvre. This is a strategy where, as you pay down your principle, you can borrow it back through a home equity line of credit (HELOC) to invest. Not only does this allow you to invest early, this new loan is tax deductible. The STEP just recently added the ability to have your credit line automatically increase back to 80% of your equity. So if you pay $500 off your mortgage principle, $500 is now available for investing from your HELOC. I’ll be discussing the Smith Manoeuvre more as I get it up a running in a couple months.

There were also other little savings, like no longer paying condo fees and being closer to work. In fact my gas bill will be cut in half after this move! While some people may be waiting for prices to decrease some more, for the reasons above now was the right time for us.

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Moving Day! originally appeared on Canadian Finance Blog on May 26, 2009.