Step 5: Put All Extra Money to the Mortgage
In the last step we talked about opening the SM investment account. Normally when we have extra cash to invest, we simply make a transfer from our daily bank account to our investment account and buy ETFs.
We know investing beats quick mortgage pay-off. So, unless you foolishly bought way to much house and risk falling apart financially because of your debt, invest and build wealth!
The money movement as part of the Smith Manoeuvre is a little different. Instead of investing alongside our mortgage, we put all extra money to Portion 1 of the HELOC loan.
The Money Movement
To pay your normal monthly or bi-weekly mortgage payment, you transfer money from your regular chequing account to your Smith Manoeuvre chequing account. Then, the money from this chequing account is used to make your regular mortgage payments (Portion 1 of HELOC).
We take the extra step of transferring from your daily chequing account to your Smith Manoeuvre chequing account before making the mortgage payment for two reasons:
- Later in the process we will be adding dividends and other income to help pay down the mortgage balance faster; and
- It helps keep a clean paper trail of money going in and out of your Smith Manoeuvre related accounts for easy tracking later.
A regular mortgage payment consists of interest costs and principal repayment. The interest costs are lost forever to the bank, but the principal repayment portion reduces your outstanding mortgage amount. This principal repayment automatically increases the available credit in Portion 2 of the HELOC.
When making your mortgage payments, you should put any extra money towards your mortgage payment. With good prepayment terms you should be able to double up your regular payments without penalty!
Aggressive principal repayment under the Smith Manoeuvre strategy can drastically increase the pay-off time of your mortgage and exponentially reduce the mortgage interest expense as a percentage of each mortgage payment. As time goes on, a larger portion of each payment goes towards your principal, reducing more of the mortgage balance and freeing up larger amounts of money for you to borrow back in Portion 2 of the HELOC for investing.
As the not-deductible mortgage interest shrinks, your tax-deductible investment loan grows. The interest on your investment loan (Portion 2 of the HELOC) is completely tax deductible.
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