July 18, 2008, 6:00 am

The Smith Manoeuvre Affects Your Beacon Score

by: The Financial Blogger    Category: Credit Rating & Credit Bureau,Smith Manoeuvre
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For any Canadians, having a tax deductible mortgage is a real dream. Well this dream is partially realisable through a leverage technique called the Smith Manoeuvre. However, setting up this investment strategy could hurt other part of your financial situation. Since you need to borrow while doing the SM, this will influence your credit score. The Smith Manoeuvre is not really the ultimate responsible of the modifications on your credit bureau. It is the financial product used to borrow money.


The purpose of setting up a SM is to get your mortgage tax deductible. In order to achieve the strategy, you need to leave your mortgage as high as possible and flip the non tax deductible debt (i.e. your original mortgage) to a line of credit account that will be used to invest (leverage principles). Therefore, you will need a Home Equity Line of Credit (HELOC).

About a year ago (maybe it’s two, I am not too sure about the time frame), Canadian financial institutions decided to report mortgages and HELOC to the credit bureau agencies such as Equifax or Transunion. It was previously a regular practice to not declare such information in order to protect your clients from competitors.

However, with the financial crimes increasing, banks had no choice but to report any credit activities in their branch. Therefore, we started to see mortgages and HELOC account our credit bureau. In regards to mortgages, there is not much impact on your credit score as long as you pay on time. On the other side, it is a different story for home based lines of credit.

Actually, making your required payment on time is not enough when it comes down to revolving credit (i.e. credit cards and lines of credit). The amount used compared to the amount granted is important also. Since your HELOC is probably your biggest revolving credit, its weight on your debt to available credit ratio is huge.

If you are using more than 80% of your revolving credit, you start to get seriously penalized. For example, I have my whole mortgage on a line of credit that is maxed out since I do the Smith Manoeuvre. I recently checked my Beacon Score and it dropped about 50 points since last time I checked. Nothing had changed in my situation beside the fact that my HELOC is now reported. Fortunately for me, I used to have a Beacon near 800 points. Therefore, it didn’t change much my financial situation.

I thought you may want to check your credit bureau before doing such strategy or even before transferring your mortgage into a HELOC if you had credit issues in the past. Home line of credits are the most flexible and useful type of mortgage. However, that will surely not help your credit score!

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Comments

Something else to add, you need to keep an eye on your report at least once every 6 months and correct any errors immediately. Although the credit bureaus are ‘encouraged’ to keep accurate information, they usually don’t.

I have multiple inaccuracies on mine that I have tried the official way for the last 6 months. I know it has hindered my score a little bit, and now I need to get a lawyer involved.

Also point of note, if you are able to pay off your mortgage well within the time frame allotted, you will save more money than the tax savings. If you can not, take full advantage of them.

This post has been chosen to be in the 69th Carnival of Money Stories at Almost Frugal, going live July 22nd, 2008. Don’t forget to link back to the Carnival!

Hi TFB,

Given your beacon score will likely be lowered due to implementing the SM strategy, won’t this have a negative effect when your mortgage portion’s term comes to an end? If you have a good score now and are able to get a variable rate mortgage under prime, when the term is over and you need to renew and your score has decreased, do you think the lender will be likely to give you a favorable rate again?

I have been researching the SM for some time now and this was one question that I couldn’t find an answer to yet…

Keep blogging, your site is very useful!

by: The Financial Blogger | July 20th, 2008 (7:52 pm)

Hey Jamie,

The first thing to consider is the fact that mortgage rates are granted mostly based on the relationship and the weight (assets in $ in your portfolio) you have with your financial advisor. Personal loans and lines of credit are definitely influenced by your beacon score.

If you already have a good credit score, the impact won’t be that bad. For example, I had a score of 777 last year and I was down to 718 last month. I am sure that over time, it will go up again.

Therefore, I would not worry too much on your mortgage rate negotiation in the future.

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