“It was impossible to get a conversation going; everybody was talking too much.” – Yogi Berra
The Smith Manoeuvre is a simple concept, but fairly technical to set up. It is easy to do, but also easy to mess up.
The first step is to get the right mortgage, which is why one of the most common questions we are asked is what mortgage is best.
The mortgage industry is really like the investment industry and the insurance industry – lots of people selling all kinds of product with all kinds of sales pitches – but very few unbiased people giving real advice.
We have a unique perspective in that we are not mortgage brokers or bank mortgage reps. But we’ve implemented the Smith Manoeuvre with hundreds of clients using many different variations – and we have actual experience with clients at almost every financial institution that offers a Smith Manoeuvreable (is that a word?) mortgage.
We have found from experience that what banks or mortgage reps will tell you about their mortgage is not always right about details of their SM mortgage. For example, we originally asked all the major banks whether their mortgage allowed investing directly from the credit line. We eventually found that what ALL of them had told us was wrong – with those that said it would work it didn’t, and with those that said it would not work it did!
We don’t sell mortgages. We are the ones figuring out the best SM strategy for each of our clients, setting it up, making sure we follow all the tax rules and making sure every step works. So, we know which mortgages really work.
We use a number of mortgage contacts, because nobody has access to even ½ of the best SM mortgages. Of the 7 SM mortgages available, 3 are available from mortgage brokers, one from financial planners, and 5 directly from a bank. Nobody provides more than 3 of the 7.
A mortgage professional can, of course, refer you to a bank for the best SM mortgage, but would not be paid anything for that. Mortgages are their business, so you can’t expect them to refer you to a bank that won’t pay them. We have not been paid by any financial institution for the mortgage, so we are not biased by compensation.
To do the SM, you need a readvanceable mortgage – a mortgage that is linked with a credit line so that the credit line increases as the mortgage is paid down.
There are 7 SM mortgages available in Canada that readvance every dollar paid down on the mortgage. We have been told about many others, but only these 7 checked out. There are 4 main ones we would recommend and 3 that we essentially would not use (if we have the option):
SM Mortgages we recommend (depending on the client situation):
- BMO Readiline – From BMO only.
- Royal Homeline – From Royal only.
- TD Flexlline – From TD only.
SM mortgages we do not recommend:
- Manulife One – From financial advisors or Manulife.
- Scotia STEP – From Scotiabank or mortgage brokers.
Manulife One can work for someone with little or not mortgage, that tends to have high bank account balances and that does not mind the $14/month fee. But we would not recommend it generally.
Manulife ONE is a completely different animal. It is an Australian mortgage that is your chequing, savings, mortgage and credit line all in one. It is a concept so simple that it is hard to understand for us Canadians used to having many different accounts. When you take $100 cash, it says your chequing account balance is $-247,000!
By way of full disclosure, I have a Manulife One myself, but have not recommended it for any clients. With no mortgage, we use it as an investment credit line so we get high daily interest on our chequing accounts. As an advisor, I get a break on the $14/month fee.
Manulife does not negotiate their mortgage rates and tends to not be competitive with the other banks’ fully discounted rates. They also do not offer a variable below prime rate. You set it up quite differently from other SM mortgages. Your main mortgage is a credit line, but you can lock in a fixed rate for much of it or for the deductible part.
Scotiabank STEP is much more complicated as an SM mortgage because it does not advance automatically. You need to go to the branch to have them increase the credit line. Nobody wants to go into the branch every 2 weeks to request an increase to their credit line. You also cannot invest directly from the credit line, so you need to manually transfer to a separate chequing account.
Our clients there have essentially found it too complex to do the SM, so we just fake it as best we can until their STEP is due and we can move it to an automatic readvanceable mortgage.
This leaves 4 SM mortgages. One of these 4 is generally the best for every client. In Part 2 of this article, we will look at them.
The best SM mortgage, of course, is not the same for everyone but depends on your specific situation. We’ve found that the best SM mortgage, for any situation we can think of is one of:
- BMO Readiline
- Royal Homeline
- TD Flexline
What should you look for in a Smith Manoeuvre mortgage? We prefer to use a readvanceable mortgage that:
- Readvances automatically (not manually).
- Variable rate at prime -.5% to -.6% or better (at today’s rates).
- Fully open. (Flexibility can be extremely useful in future years.
- Allows investing directly from the credit line.
- No fees at all – no legal, appraisal, broker, or administration fee.
- Allows multiple credit lines (add one for emergencies or for the Cash Dam).
While you would think mortgage brokers would have the big advantage here because they are independent and have access to many mortgages, none of the mortgages available to mortgage brokers have more than 2 of these 6 features. And only one mortgage available to mortgage brokers is in our top 4.
We’ve found that in every situation we have encountered or can think of (except for the odd case where Manulife One might be best), one of these 4 is the best. However, working out the best choice among them can be somewhat complex and depends on quite a few variables.
I started to write down all the details of these 4 and exactly when we would use each one, but ended up with pages of detail. Here is what it depends on:
- Do you have the 20% down (to avoid CMHC)? What is your existing mortgage balance and the value of your home?)
- When is your mortgage due?
- How quickly are you paying your mortgage down? (What is your payment and amortization?)
- Where do you do all your regular banking?
- How good is your credit rating?
- Are you good at details? Would you take a mortgage that required more manual transactions each month if it saved you money?
- How long do you expect to be in your existing home?
- Is your mortgage paid off or almost paid off? (If so, then is your cash flow relatively even or does it come in large lumps?)
- Is the mortgage on your home, a rental property or a cottage?
- Are you stuck in an existing non-SM mortgage? (More on this in Part 3.)
If you call or email us with answers to the 10 questions above, and leave your email address and day phone number, one of our advisors will contact you to tell you which SM mortgage is best for you and why, tell you what terms you should expect and give you our contact person to get that mortgage. Ask for “Ed’s Mortgage Referral Service” when you call or in the subject of your email.
Because we refer a high volume of mortgages and try to negotiate with our contacts the best possible deal, people we refer often get a better deal than if they contact the bank themselves. We have not been paid anything by any of our mortgage suppliers (except TD has a points for merchandise program), so our advice is completely objective. By contacting us, you can be confident that you have the best SM mortgage for your situation.
Please do not use this service unless you are serious about implementing the SM in some form (either with us or by yourself). We recently had someone call us for an SM mortgage referral, started the mortgage process and then changed his mind – so he will now have to pay the bank’s legal and appraisal fees. We usually get all fees absorbed – but only if you actually take the mortgage.
We are asking all the questions and for your email and phone so that only those serious about implementing a Tax Deductible Mortgage strategy will request it and so this free service does not take more than 5-10 minutes of our time.
What should you do if you want to implement the SM, but your mortgage is not due now? If you are just buying your home or your mortgage is due now, you can just go get the best SM mortgage and start. But what if it is not due?
Some financial advisors or mortgage brokers would encourage you to always pay the penalty to refinance, citing the huge tax benefits you will get. However, you can get most of these benefits anyway if you wait, and you could pay significant penalties to get out of your existing mortgage. Replacing your mortgage now may or may not really benefit you. It is worth doing the math.
Fortunately there are a few options:
- You might be able to convert your mortgage to an SM mortgage at your current institution without penalty. Some will and some won’t.
- You might benefit from paying the penalty to refinance your mortgage and roll in other debt. There is a benefit to starting the SM sooner and you could save on refinancing other debt, all of which may or may not justify paying a penalty. It is worth it to do the math.
- You could get a 2nd SM readvanceable mortgage and simulate the SM as best you can until your mortgage is due.
Some general guidelines:
- Today, with interest rates having risen in the last several years, if your existing mortgage interest rate is much below today’s rates, getting a 2nd readvanceable mortgage is most likely the best choice. Why? Because creatively setting up a 2nd readvanceable mortgage can usually mean you can get most of the SM benefit now anyway, so why pay the penalty and higher interest rate?
- If you have more than 2 years left in your mortgage term and the rate is lower than today’s rates, it is better to pay the penalty and move even to a higher rate if you would otherwise not do the SM at all. However, getting a 2nd readvanceable and doing the best SM you can is usually the best option.
- If you have more than 2 years left in your mortgage term and the rate is NOT lower than today’s rates, in most cases it is better to pay the penalty and start the SM in full now.
The best SM mortgage, if you are stuck in a non-SM mortgage, depends on:
- Where is your existing mortgage (if it is not due) and when does it come due?
- What is the rate on your existing mortgage and how does it compare with today’s rates?
- How much is the penalty to get out of your existing mortgage?
- What is your marginal tax rate? (We can tell you if you tell us what your taxable income and your spouse’s taxable income are.)
- Do you have other debts at rates higher than your mortgage? What are they, how much do you owe, at what interest rates and how much are you paying on these debts now?
For example, the Parkers have a $400,000 home with a $200,000 mortgage at 5.2% for 4 more years and paying $500 bi-weekly. They owe $10,000 on a Visa at 19% and $10,000 on a credit line at prime +2% on which they are paying $600/month ($277 bi-weekly). They are in a 40% tax bracket. They can get a new readvanceable variable mortgage at prime -.6%.
Their existing bank will not convert their mortgage to readvanceable for no charge. Therefore, they have 2 options:
- Pay the penalty to convert their mortgage to a readvanceable mortgage. They can roll in their $20,000 of other debt and then increase their mortgage payment by the amount they have been paying on this other debt, which would increase it to $777 bi-weekly. This could allow them to invest a lump sum of $100,000 plus $103 bi-weekly with the Smith Manoeuvre.
- Keep their mortgage and add a 2nd readvanceable mortgage for $120,000. They will not be able to access their principal from their 1st mortgage payments, but they can still roll in the $20,000 of other debt and make it a fixed portion or their new readvanceable mortgage and pay the same $277 bi-weekly they pay on this amount now. With this option, they can still invest a lump sum of $97,500 with the Smith Manoeuvre (no bi-weekly amount).
The Parkers would pay a penalty of $2,600 plus $3,600 in the difference in mortgage interest rates for 4 years. The projected benefit including the tax refunds of investing $100,000 instead of $97,500, plus $103 bi-weekly with an 8% return would be $1,514 over 4 years. In total, they are $4,686 better off getting the 2nd readvanceable mortgage and doing as much SM as possible until their mortgage comes due.
Note that they would also save $6,400 over the 4 years by refinancing all their other debt into their mortgage, but they can do that either way – with a new 1st mortgage or by getting a 2nd readvanceable mortgage. Therefore, replacing the mortgage is better than not doing the SM at all, but getting the 2nd readvanceable is far better than either of the other options.
Some financial advisors or mortgage brokers would recommend breaking the mortgage anyway, saying that the tax refund of $2,500 each year is much more than the penalty. However, this is over simplistic and ignores all the other factors, such as the interest that is paid (in order to get the refund), a reasonable expected return on the investment & the tax-efficiency of the investment, and the interest rate difference between the old and new mortgage rates.
On the other hand, if the Parkers existing mortgage has a rate of 5.9% instead of 5.2%, then they will benefit by $564 taking into account all factors by breaking their mortgage now and paying the penalty. In that case, they should replace their mortgage now.
If you are not sure what to do with your existing non-SM mortgage, you can contact us with answers to the 10 questions in Part 2 about your situation and the 5 questions above about your existing mortgage, and we will do the math for you to figure out your best strategy. We call it the “Ed’s Mortgage Breaking Calculation”. As you can see from the examples, it can be a very complicated calculation.
If you would like us to do this calculation for you and you are serious about implementing the SM (either with us or by yourself), you can call or email us leaving your name, email address and day phone number, and ask for “Ed’s Mortgage Breaking Calculation”. One of our financial advisors will phone you (so leave your daytime phone #) within a week to tell you which of the 3 options is best for you, which SM mortgage is best for you and why, and then refer you to our contact to get that mortgage.
Planning With Ed
Ed Rempel has helped thousands of Canadians become financially secure. He is a fee-for-service financial planner, tax accountant, expert in many tax & investment strategies, and a popular and passionate blogger.
Ed has a unique understanding of how to be successful financially based on extensive real-life experience, having written nearly 1,000 comprehensive personal financial plans.
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