The Smith Manoeuvre: After the Mortgage is Gone

Smith Manoeuvre Loan Options

What happens though when our mortgage is paid off and we're just left with the investment loan?

There are two main options:

  1. Pay down the loan to reduce risk, or
  2. Keep the loan for its tax advantages.

There are important considerations for each option. The right choice depends on your personal financial situation, your aversion to debt in a general sense, and your current stage in life.

Completing the Smith Manoeuvre is a great time to sit down, analyze your situation, and possibly bring on an accountant or fee-only financial adviser.

Regardless of the choice concerning the loan specifically, I would still make regular investing your first priority. With the mortgage principal paid off (Portion 1 of the HELOC), you now have additional cash flow freed up for saving and investing. Make sure your retirement investing and savings plan is on track.

As long as you have the SM loan in place, keep your joint SM Cash/Margin account separate from any other investments. If you have money to invest in a non-registered account, make sure you open a new joint Cash/Margin account for that purpose.

1. Wind Down the Loan

Loan pay-down is a good choice for low-income people and those who are anticipating retirement in the near future who have no other debt. It's also the best option if you are more risk-averse and you want to cut down your overall expenses.

Since its fully tax-deductible interest feature, the Smith Manoeuvre investment loan is the last loan you should pay off. After you've ensured you are on track to retire when you want to and have all your other debt paid off, then consider paying down the investment loan.

Wind down the SM investment loan slowly. Do not sell the investments in your SM Cash/Margin account to pay off the loan! It will trigger substantial tax costs.

Instead, use the dividend income from the Smith Manoeuvre investment account to pay down the loan principal. You can increase it by throwing extra cash at the loan if your dividends are not sufficiently large enough to make a meaningful dent after interest costs.

2. Keep the Investment Loan

Once Portion 1 of your HELOC is paid off you are no longer really executing a Smith Manoeuvre. At this point you simply have an investment loan secured by the value of your residence. There is nothing wrong with this when done responsibly.

If you have a high income, still anticipate working for the foreseeable future, or are looking to maximize your wealth you should keep the investment loan for its tax advantages. You would likely have chosen a lower dividend investment strategy for your SM investing. Keep this going so you can deduct the interest expenses from your income at your marginal tax rate.

Keeping the investment loan is also a good option for retirees with large RRSP accounts. RRSP withdrawals are taxed at your full marginal rate; offsetting that high-tax income with interest expenses can be advantageous and significantly reduce your overall tax rate.

If you can handle the ups-and-downs of the market, consider growing your investment loan as your home value increases. You can do this by applying for a HELOC limit increase with your bank every few years and getting an appraisal done (if required).

Maintaining 35% equity is important as it implies your house value would have to drop 35% before you are underwater on your house loan. Though not impossible, it would be a substantial drop.

Since your loan is also backed by the value of your investments, it is still nearly impossible that you would experience a negative equity situation.

Housekeeping

If you are not going to increase your investment loan, you can save all the statements from your Smith Manoeuvre chequing account in a safe place (in case of an audit) and then close down your Smith Manoeuvre chequing account.

You can rearrange the account settings so that dividends remain in the SM investment account instead. Just use your regular income to pay the interest on the investment loan.

You will still need to make the necessary adjustments to your loan at tax time for Return of Capital income, but you can make those adjustments with your normal income. This means your investment loan will slowly shrink over time by the amount of your RoC distributions.

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