March 25, 2007, 2:34 pm

The Smith Manoeuvre (1st part)

by: The Financial Blogger    Category: Smith Manoeuvre
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In a recent post, I explained why you should not be in a hurry to pay off your mortgage. Actually, with some good financial planning and careful follow up, you might end up never paying it. Did I really write that? Seriously? A mortgage for life? Yep! Fraser Smith, who is a well known financial planner in British Columbia, developed a very smart technique. In this post, I’ll explain the necessary components to achieve this plan. Then, I’ll explain the technique at a later date.

All you need to put this plan in place is a home equity line of credit, a good accountant and a good financial planner (unless you are comfortable in the investment industry).

First things first, you will need a special line of credit feature offered by most financial institution. Your HELOC must be divided into at least two accounts. You will have account “A” where you have your mortgage balance and account “B” which you will use to borrow to invest. The two accounts must have variable limits. The HELOC has a global limit which is the amount of your mortgage, let’s say $250,000. Then the established limits must fluctuate over time in order to never exceed the global limit of 250K. For example, account “A” may have a limit of 100K et account “B” 150K. After a month, the limit must be able to change for 99,5K and 150,5K. We will explain why later.

This technique was first created for Canadian residents in order to switch a non tax deductible debt (the mortgage) into a deductible debt (debt swap). For US residents, the Smith manoeuvre seems useless because their mortgage is already tax deductible. However, the investment part of the technique alone represents an important way of making money out of your property.

A good accountant will help you out to keep track of the interest that will be tax deductible in order to reduce your declared income in your tax report. By having two separate accounts in your HELOC, you will just have to keep your account “B) year end interest statement. Basically, the bank will take care of all calculation. The accountant will be useful to integrate the tax deduction in your tax report and also to verify if the technique is well implanted for maximum tax deduction at the end of the year. I definitely recommend consulting an accountant before setting up this financial technique.

Then again, the help of a good financial planner or financial advisor will assure less volatility in your portfolio. As you are using a leverage technique, you must be aware of all the risk that it incurs. The financial planner will develop a plan according to your risk tolerance and your time horizon. If you are well aware of the risk of any leverage techniques and you are a well advised investor, you may invest on your own. Some people have better results than professional financial planners. It all depends on where you at in your investment knowledge.

Before going into the technique itself, I would suggest you read about leveraging strategies, tax deduction related to investment loan and portfolio building strategies. The Smith Manoeuvre requires several skills in accounting, credit and investing.

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