Using The Smith Manoeuvre On Cottages And Investment Properties

With Robb on vacation, I am honoured to have the opportunity to guest post on Boomer and Echo and meet some new readers! For readers here who don’t know me, I’m the blogger behind MillionDollarJourney.com. In the early days (the blog started in 2006), I wrote quite a bit on the Smith Manoeuvre and continue to get questions about the wealth building strategy to this day.

Let’s rewind a little and get back to the basics. What is the Smith Manoeuvre and how can it help build wealth?

What is the Smith Manoeuvre and How Does it Work?

The Smith Manoeuvre is a leveraged investment strategy made popular by Fraser Smith. Leveraged investing is where you borrow to invest in income-producing assets. The long term goal is for the assets to appreciate faster than the interest owed on the loan. A major side benefit is that the interest you pay on the loan is tax deductible – as long as you have invested using a taxable account (ie. not RRSP/TFSA/RESP etc).

Why leveraged investing? For starters, it’s a way to supercharge your gains, but leverage can also supercharge your losses. Needless to say, leveraged investing is only for those with the highest risk tolerance. After all, you’ll be using your home as collateral on the investment loan.

While leveraged investing has been around for eons, the differentiator is that the Smith Manoeuvre uses the equity in your house (usually through a home equity line of credit) towards investments in the stock market.

The Readvanceable Mortgage

To dig a little into the details, the strategy involves using a special type of mortgage called a readvanceable mortgage (offered by most of the big banks).

This type of mortgage is made up of a combination of a regular installment mortgage and a home equity line of credit (HELOC). As the installment mortgage portion is paid down with every payment, the HELOC credit limit increases by the same amount (minus interest).

As money from the HELOC space is made available with every mortgage payment, the new credit is used to invest in the stock market, businesses, and/or real estate.

For homeowners with lots of equity, the HELOC can be used right away in a lump sum to invest. For new home buyers with little equity, you can invest small amounts per month as it’s made available in your HELOC.

So really it’s a two (maybe three) step process:

  1. Obtain a readvanceable mortgage on your home
  2. As your HELOC limit increases, use the balance to invest in income-producing assets (ie. the stock market, rental real estate, a business).
  3. *Bonus: This step is not really the “Smith Manoeuvre”, but more of a Smith Manoeuvre accelerator (maybe the MDJ Manoeuvre?). In this modification, you invest in dividend stocks and use the dividends to further pay down your non-deductible mortgage. The extra mortgage paydown will further increase your HELOC limit, which will allow you to buy more dividend stocks. The snowball will result in paying down your mortgage and building your portfolio faster.

Personal Example

In my own personal example, we built our house in 2008 and obtained a readvancable mortgage on the property for the purpose of investing the HELOC. With a large down payment from selling our starter home and liquidating our non-registered portfolio, we were able to put a large down payment on the house and maximize the starting point for the HELOC.

I used the credit available in the HELOC to invest in Canadian dividend stocks with the plan to use the dividends to help pay down the mortgage faster. It turned out however that with a focus on savings, and selling our rental property, we were able to pay off our installment portion of our mortgage in about three years.

Related: Why Don’t I Pay Off My Mortgage?

Throughout the years, I have continued to invest in dividend stocks (started before the crash of 2008). While investing in my leveraged portfolio has slowed down over the years, it continues to grow and generate dividends every year. In fact, in my most recent financial freedom update, I revealed that my Smith Manoeuvre portfolio generates $7,500 in eligible dividends annually.

Using the Smith Manoeuvre with a Cottage

Having explained the background on the Smith Manoeuvre, one question I get often is if the strategy can be used with a cottage or rental property instead of investing in the stock market.

Before I get into this, let’s talk a little about the tax deductibility of the HELOC, which is one of the big attractions of the Smith Manoeuvre.  Who doesn’t want another tax deduction?

The rule with the tax deductibility of interest is that the loan proceeds must be invested in income-producing investments (or the potential to produce income). So that can be equities, business and/or income-producing real estate.

Can this strategy be used with a personal cottage? As the tax rules state, the proceeds to be put towards income-producing investments. So unless the plan is to Airbnb or rent it out via other means, the strategy would not be feasible – at least not in a tax efficient manner (ie. the interest would not be tax deductible).

Using the Smith Manoeuvre with Rental Real Estate

What if you are not a believer in the stock market and would prefer rental real estate instead? This strategy can work, but you may be super leveraged.

As mentioned above, you can use your HELOC towards purchasing rental property and the HELOC interest (along with the rental mortgage interest) will be tax deductible. What some really aggressive real estate investors do is when their rental properties obtain enough equity, they leverage those properties to further grow their real estate empire.

For example, an investor can use a HELOC for a 25% down payment on a rental property and obtain a mortgage for the remaining.  Hopefully, the cash flow from the rental is enough to cover the mortgage and HELOC payments. As time passes and the rental property gains value/equity, the property can be re-mortgaged with proceeds invested towards another rental property.

As tenants pay down the mortgage, in the long term, you’ll have large paid off assets that pay a healthy income stream during retirement.  Although direct real estate investing is not for me (I own REITs instead), I personally know a number of investors who have funded their retirements through investing in rental real estate.

Final Thoughts

Leveraged investing is a risky strategy and requires the ability to take and have faith in the long term view. If market crashes with 50% corrections (like 2008) scare you, then leveraged investing may not be the best strategy for you. However, if you can tolerate the ups and downs of the market, then a following a proven investment strategy over the long-term can be lucrative.

I have written quite a bit on the Smith Manoeuvre over the years and have compiled all the articles into a resource post. Check it out if you are interested in learning more about the strategy.

The Smith Manoeuvre Resource

About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on MDJ, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. After achieving the big net worth milestone, his focus has shifted to building his passive income sources (up to $45k+) towards achieving financial freedom.

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18 Comments

  1. Dale Roberts on June 20, 2019 at 5:08 am

    Great post. Always found this an interesting move. This would have worked great over the last 10 years given the market moves.

    We paid off our mortgage the old fashioned way 🙂

    • MDJ on June 21, 2019 at 8:49 am

      Congrats on the mortgage pay off Dale! When I first started this strategy, I was probably a bit more aggressive than I am now, but it has paid off over the years even though we started at the peak of the market in 2008! 🙂

  2. John on June 20, 2019 at 6:59 am

    Great article! I have been using something similar for nearly 30 years (no HELOC then) and made a good living at it (since I retired from the regular work force at age 55). I had a few bumps along the way which might have been avoided had I had you as a mentor, but the high’s made up for it. One thing for sure, as you say, you need a good risk-level tolerance and you also need some hard nose objectivity. Being a good planner, having a plan, and updating your plan regularly are also paramount.

    Thanks for publishing this, I will pass it on to my son who keeps saying he will do this but somehow never quite gets started.

    • MDJ on June 21, 2019 at 8:50 am

      Congrats on your success over the last 30 years! Do you plan on holding onto the line of credit through retirement? I can see it as being a nice tax deduction during retirement.

      • John on June 22, 2019 at 10:50 am

        Somehow could not reach this from the link in your email, which led me to post the one below. However when I did it then all the comments popped up So here is a repeat of my answer.

        The answer to your question is definitely yes. I have used it in my retirment years. I am now 83 and in fact it is likely that I will end this phase of my investment as we plan on selling our house and close our HELOC in the process.

        It`s been a great ride, including this year.

        • MDJ on June 23, 2019 at 9:38 am

          Congrats again on the financial success John!

  3. John Zosh on June 20, 2019 at 8:32 am

    My personal opinion is it is way too risky. We found it better to save and build investments maximizing RRSP’s and TFSA’s. The RRSP’s give us 30% to 40% boost every tax year contribution. Those RRSP tax refunds can add 4% to 5% annual returns over 25, 30, 35 years. This is key because even if someone is conservative or cautious and makes 3% to 4% a year an extra 4% to 5% yearly rate can make all the difference by retirement.

    You have to be careful trying to do too much with others money, and saving aggressively is what our friends and family does. Debt paid off in short periods of time maybe be worth it but having it deduct interest every year looks good tax wise but we could not sleep at night having debt all our lives. Patience is the key to making and keeping money.

    • MDJ on June 21, 2019 at 8:51 am

      Totally agree that leveraged investing is not for most people. Investors will get by just fine with using savings and reinvesting the distributions and tax refunds.

  4. Fred Sheppard on June 21, 2019 at 12:13 pm

    What are the chances of CRA or some new government changing the tax laws so you can’t deduct interest from investments in non-registered accounts that earn a profit or income?

    Another question if someone can answer me, why do we in Canada not have accessibility to tax free bonds like in the U.S.? This might be a worthwhile topic that nobody ever talks about.

    • MDJ on June 23, 2019 at 9:40 am

      Hi Fred, hard to know what CRA will do, but technically the rule is to borrow to invest in “potentially” income producing assets. I guess they could throw in an exception of “except public markets”, but then they would make the big banks very angry. 🙂 Personally, I don’t see that happening.

  5. John on June 22, 2019 at 10:42 am

    Hi MDJ,

    I`ve reproduced your email reply to my comment but try as I might I could not find my original post nor your reply in the comments section of boomer&eco or your site. Am posting this here hoping you get it.

    The answer to your question is definitely yes. I have used it in my retirment years. I am now 83 and in fact it is likely that I will end thsi phase of my investment as we plan on selling our house (and our HELOC in the process.

    It`s been a great ride, including this year.

    New Reply to Your Comment on Using The Smith Manoeuvre On Cottages And Investment Properties

    In response to your comment:
    Great article! I have been using something similar for nearly 30 years (no HELOC then) and made[…]

    This reply was posted 19 hours ago by MDJ:
    Congrats on your success over the last 30 years! Do you plan on holding onto the line of credit through retirement? I can see it as being a nice tax deduction during retirement.

    Continue Reading | Reply to MDJ

  6. Gus on June 25, 2019 at 7:24 pm

    Hello
    I loved this article and it’s so informative but for a guy like me who lacks the knowledge in finance it was a bit complicated so i wanted to ask you a question and i’m hoping to get an advice from you.
    My current residence is paid off and two years ago we bought a presale condo that we’re moving into in the next few weeks , since the market is a bit slow at the moment here in Vancouver we decided to rent it out , we currently have a Heloc on this property for a 250k and there’s a balance on it for about 100k , so my question is once we start paying a mortgage on the new property can i withdraw the 150k remaining on the Heloc and pay down part of the mortgage and claim the interest as a tax deductible ?
    Thank you so much for your time .

  7. MDJ on June 26, 2019 at 5:27 am

    Hi Gus, the tax deductibility of a loan depends on what the loan is used for. If the heloc is used to pay the mortgage on your new condo (principal residence), then it will not be deductible. However, if you used the HELOC to invest in a diversified portfolio of equities, then it would be. Make sense?

    • gus on June 26, 2019 at 6:58 pm

      Thank you so much for your reply , I was thinking that since the HELOC is borrowed against the property that I’m going to rent out I could claim the interest as a tax deductible .

      • MDJ on June 27, 2019 at 6:18 am

        Yes, a number of people make that mistake and find themselves with questions from CRA. Best to stay onside when it comes to tax-deductible loans.

      • Katherine Maccarone on August 4, 2019 at 12:04 pm

        I believe if you take that 150 equity from the rental and pay is on your principle residence condo , then set up a HELOc on the condo and pay back the 150 on the rental, you can then deduct that interest from your condo and the interest on the rental mortgage.

  8. Cris on July 26, 2019 at 6:56 pm

    Hi, There is another strategy called Cash Dam which came from Smith Manoeuvre strategy.
    Cash Dam, not that allows you to get the down-payment interest for a rental property tax deducted but, even in time, transfer your personal residence mortgage interest in tax deductible interest. It is a slower strategy which require a clear financial administration of your money, personal and rental.

    Anyway, it is the best to implement the Smith Manoeuvre when the market is down as your risks are lower.
    Cash Dam strategy works all the time quite the same.

    Mostly, the wealth accumulation consist from three factors, in equal amount in my opinion:
    -how much you save to invest
    -how much return you get on your investments
    -how do you use the tax system in your advantage

    Thanks

  9. Jason K on August 1, 2019 at 11:21 pm

    “Can this strategy be used with a personal cottage? As the tax rules state, the proceeds to be put towards income-producing investments. So unless the plan is to Airbnb or rent it out via other means, the strategy would not be feasible – at least not in a tax efficient manner (ie. the interest would not be tax deductible ”

    That is incorrect.

    Any loan used to buy income producing assets in a non tax sheltered account is tax deductible. Makes no difference if it’s your primary residence HELOC, a 20% unsecured LOC, or a second property HELOC that is being used for AirBNB or personal use.

    Interest on the income property mortgage is tax deductible. Principal and additional cash flow is not. Interest on HELOC on the income property will be tax deductible if used for SM.

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