The Smith Manoeuvre: Step 1

Step 1: Obtaining a Readvanceable HELOC

Having Sufficient Equity

The first critical factor in starting the Smith Manoeuvre is having sufficient equity in your home. While you can borrow up to 80% of the value of your house, only 65% of your house value can be borrowed in a revolving-style loan. The revolving loan is a true Line of Credit where you can make interest-only payments and never actually pay off the loan as you would in a traditional-style amortized loan.

To properly implement a clean Smith Manoeuvre, you must have at least 35% equity in your home. Simply multiply your estimated house value by 65%. That's the maximum amount you can borrow (including the mortgage portion).

There are ways to get to 80% loans while you still have a mortgage, but for simplification down the road and added risk management through the entire process, we will stick to 65% for now.

If you don't quite have the 35% equity, don't forget to add in money you have in a Cash/Margin account, savings account, or chequing account that you could potentially apply to your mortgage balance.

To obtain a new loan, you will probably need to get an appraisal done—especially if your home value has changed a lot since you purchased it. Don't rush this on your own though, the bank you choose will likely absorb the cost of the appraisal in exchange for giving them your loan business. A good mortgage broker can also help you with this.

Loan Structure

To keep a clean paper trail for tax purposes, the Smith Manoeuvre demands a very particular HELOC loan structure. Your HELOC account must have two distinct portions (two loan accounts as part of one secured loan).

Portion 1 of the HELOC is for your home mortgage. This portion is not used for investing and the interest expense is not tax-deductible. Typically you want a variable rate mortgage with generous prepayment privileges. This should include doubling-up monthly payments and large annual prepayments.

You will be paying down this mortgage portion quickly. If your expected payments are higher than 2x your regular mortgage payment, you may opt to go with an Open Mortgage that has limitless prepayment privileges but a higher interest rate.

Portion 2 of the HELOC is your investment loan. This portion is used for investing only! The interest on this portion will be fully tax-deductible so there must be clean accounting for all transactions involving this portion.

As you pay down Portion 1, the available credit amount in Portion 2 should automatically increase proportionally. That means it is a "re-advanceable" loan. This portion will also have a variable interest rate (should be Bank Prime + 0.5%).

Although they will be tied together, each portion of the loan will have its own distinct account number to make payments and accounting easy to manage.

Good Loan Options

Here is a list of options available in the Canadian market which can meet the above stated requirements at a low cost.

  • RBC Homeline Mortgage
  • TD HELOC
  • BMO Readiline
  • National Bank All-in-One
  • Vancity Creditline

You should consider using a good mortgage broker when setting up these HELOCs. They can help guide you through the process, set it up for you correctly, negotiate better prepayment and interest terms, and negotiate coverage of an appraisal fee.

Be aware though, mortgage salespersons are generally paid more when selling you longer term fixed-rate loans compared to variable-rate loans. You want variable, you want prepayment privileges, and you want no account fees.

Comments & Questions

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2 Replies to “The Smith Manoeuvre: Step 1”

  1. Considering starting the Smith Maneuver but have a question about the HELOC. It makes sense that having an account with two distinct portions would be ideal but is it possible to do with a single account? We’re very lucky to have special rates through our employer so we’re limited to a HELOC that currently has an amount owing, an amount available, and a monthly interest charge. Do you have any advice that would help make this work?

    1. Mr. Rich Moose says:

      The very, very important thing is being able to clearly separate the investment loan portion from the personal loan portion (usually a home loan) and properly account for that. The interest expenses on the investment loan must be clearly separated and draw a straight line to your investment account to purchase assets that generate some income.
      Usually you can separate these portions within the HELOC account by locking in part of the loan (the current amount owing) through a short-term fixed or variable rate mortgage. That’s how I had my account set up when I was a homeowner.
      You could try mix it in a single floating account, but be precise. The accounting can get messy fast with monthly interest expense adjustments and the borrow-backs. It’s even more work once dividends are flowing in one portion and being pulled out the other on a monthly, quarterly, or annual basis.
      If it doesn’t make sense to lock-in the personal portion to separate the account, make sure you use a spreadsheet to track the money movements and save every bank statement. This way, if the CRA comes knocking, you can demonstrate a clear paper trail that all money in (dividends) paid off the personal portion and all money out came from the deductible investment portion.
      The SM is not real advantageous if your interest expense tax deductions are not allowed.

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