In the US, interest on mortgages is tax deductible. It’s a financial boon many of us wish we could have here.

However, it’s a double-edged sword. Last year it was reported that Canadians have an average of 70% equity in their homes while Americans run around 45%. Many people think this write-off helped contribute to the mortgage meltdown in 2009. Think about it: if your mortgage is a deduction, why pay it off?

You can actually achieve a similar tax break here in Canada by pulling what’s known as the Smith Manoeuvre. It was created in 2004 by BC financial strategist Fraser Smith, and uses existing, legitimate tax rules.

As a benefit, this move encourages you to pay off your mortgage faster — unlike the US rule — and gives you a tax break on the thousands of dollars you pay in interest over the lifetime of your mortgage. (On a $300,000 mortgage rate at 5% for 25 years, making monthly payments, you pay an astonishing $223,443.02 in interest!)

But on the downside, it’s a complex scheme that requires a good grasp of the financial system and a hardy stomach for investing.

Here’s what you do: sign up for a so-called readvanceable mortgage. This is the kind of mortgage that has a line of credit attached to it, the idea normally being you use the credit line for other needs, usually renovations. And every time you pay down the principal of your home, the credit limit on your line of credit goes up. Most Canadian banks have these mortgages: I have the RBC Homeline Plan. BMO has Homeowner ReadiLine and Scotiabank has the Scotia Total Equity Plan (STEP).

So you take one of these mortgages and get as large a line of credit attached as possible. You take that line of credit money and invest it. Why? Because if you borrow money to invest, you can deduct the interest on that loan from your income tax. The money must be invested in a dividend paying stock or investment property, not an RRSP or TFSA (tax free savings account).

Then, you take your tax savings and your dividends and you use them to pay off your mortgage — along with your regular payments. Every time you eat away at the principal of your mortgage, you gain more space in your line of credit. You use that additional space to make more investments, socking away more money and increasing your tax write-off.

So, long before your 25-year mortgage is complete, you will have paid off the principal on your main mortgage. And you’ll have a considerable nest egg of investments accumulating more wealth. Once that mortgage is paid, you can use your investment savings to pay off the line of credit all at once, or gradually, depending on your situation. In theory, you should have more than enough money in your investment accounts to do this, and there will be no penalties for making lump sum payments. Mind you, some doing this move keep the loan, as it continues to be a write off.

I like that this is called a manoeuvre because it really does feel like a complex thing to pull of. It’s only for investment savvy folks who know the market and are comfortable moving money around. When the market dips, you can panic. You also need to have great equity in your home and a stable income to withstand the risk.

If you’re still interested in learning more, you might want to pick up Smith’s book Is Your Mortgage Tax Deductible.

Or, you can do what many experts suggest: forget the deduction, just pay down the mortgage as fast as you can. That $300,000 mortgage I mentioned above? If you were to pay your mortgage on an accelerated weekly program, you’d end up shelling out $185,471.03 in interest over the life of the mortgage and have paid it off in 21 years. Or if you put down an extra $100 each month, you’d spend $165,130.04 in interest and be finished in 19 years. As long as your mortgage plan sees you saving money and building equity, it’s a good plan.

Diane
Writer for RateSupermarket.ca

What if you had access to additional funds at great mortgage rates that you could borrow at your leisure? Believe it or not, the money you put into your mortgage every month can not only work to pay off your home but can provide you with the ability to contribute to any investment you wish. You can actually make the equity you have built in your home work for you now, rather than later.

How? With a readvanceable mortgage.

A readvanceable mortgage works like this: as you pay down your principal, your home equity line of credit HELOC increases, providing you with additional funds whenever you need it. In other words, as soon as you make a mortgage payment you can then borrow the principal you have paid off back from the lender. What better way to take advantage of the equity you have built up in your home? And with the current low mortgage rates available, now may be a better time than any to take advantage of this type of loan.

While this type of mortgage is perfect for finally completing home renovations and saving for possible emergencies such as job loss or health care expenses, it may also be a good idea to use it to build your investment portfolio. If you use your equity to pay off an investment loan, the interest is then tax deductable, where a mortgage isn’t. You grow your investment portfolio at the same time as paying off your mortgage, essentially making your mortgage tax deductible. Your line of credit can be paid down with the help of your tax credits, making more room to borrow and continue investing at the same time as paying down debt. This is referred to as The Smith Manoeuvre. While it sounds like a great plan, this revolving strategy can be confusing and involves some risk. Therefore it is important to speak with a financial planner before going ahead.

Home owners have been taking out lines of credits, separate from their mortgages, to pay off debts, invest and renovate for many years. But as many of us are juggling paying off our homes with investing for the future, many Canadians may not realize the flexibility and benefits a readvanceable mortgage can provide. As Elisseos Iriotakis from Safebridge Financial states, “A readvanceable mortgage provides consumers with the opportunity to use the equity they have built in their homes to make financial investments they may not otherwise have had the opportunity to make. In addition, if you are using the line of credit to invest in a “qualifying investment”, you can also enjoy additional tax refunds. We advise our clients to apply the tax refund towards their mortgage so they become mortgage free sooner. This is a great strategy, but it isn’t for everyone, and a proper risk profile must be completed before proceeding.”

So, is a readvanceable mortgage right for you?

Well let’s first explain the difference between this type of mortgage and a standard traditional mortgage. Traditional home financing can build up equity but it is only when you pay the loan off or downsize that you can benefit from the equity built. With a readvanceable mortgage, you gain access to that equity built up in your home as you are building it (up to 80% of the home’s current appraised value). And because it is a line of credit, you only pay back what you have used.

Here are some more advantages of a readvanceable mortgage:

• This type of mortgage loan is ever revolving. You have the ability to continually borrow and re-borrow up to your available limit without having to pay new loan costs. So when you pay the money back, you still have the option to use your loan again.
• Interest on investment loans will generate a tax deduction. Therefore debt accrued will be good debt rather than bad debt and you can use your tax deduction to further help pay off your mortgage.
• You can more quickly pay down other, non tax deductable debt with the tax deductions you accumulate.

Of course, switching to a readvanceable mortgage may make more sense than taking out a regular, non tax deductable line of credit or refinancing your home; however, as with any type of credit loan, it is important to explore the possible disadvantages associated with it, including:

• In order to qualify you must have built up 20% of equity.
• Interest rates are not guaranteed for the life of the loan term.
• Your credit score needs to be high (close to 700). You could risk gaining a tarnished credit score if you do not keep up with repayments. Therefore, it is important to treat this loan as you would a credit card.
• You have to be confident that your property value will appreciate in order to benefit from the equity you build in your home.

Switching from a traditional mortgage to one of the readvanceable mortgage products on the market today can have quite a powerful effect, not only on your future financial portfolio, but also with unexpected emergencies, and home upgrades. Each lender will provide different readvanceable mortgage products (i.e. Scotiabank offers STEP, BMO offers Readiline, etc.) so it is important to speak with your mortgage broker and/or lender to learn about monthly fees, maximum loan amounts and interest options before making the decision to switch over.

Caroline
PR@RateSupermarket.ca