Housekeeping: TurboTax Canada giveaway is running this week. Don’t forget to enter.
Note: This is a guest post by Ross Taylor. His bio is at the end of the post.
Financial planners and mortgage professionals like to trumpet the Smith Manoeuvre, as coined by Fraser Smith in 2002. In a nutshell, this ‘program’ shows you how to free up equity in your home for investment purposes, and to do so in a tax efficient manner.
I hate to burst the bubble – as a matter of fact I am big fan of anyone who has the patience to write a book, but the notion of tax deductible investment loans has been around for decades.
I give full credit to Fraser Smith for popularizing an old concept, and even getting an entire industry and nation to name it after him.
When I started out as a fresh faced stock broker in the mid-eighties, this concept was already de rigeur. The guys at Investors Group, Financial Concept Group, Regal Capital Planners and the Principal Group were into leveraged investing in a big way. Fraser Smith himself was peddling the strategy as a financial planner in Vancouver at that time.
One person who embraced borrowing to invest was The Honourable Michael Lee-Chin, who was making his mark in the Hamilton office of Investors Group in the late seventies, before becoming regional manager of Regal Capital Planners in 1979.
Michael went on to huge success, becoming a self-made billionaire through a series of canny, gutsy business decisions in the eighties and nineties.
I recall irking one particular University of Waterloo professor client, who I had been courting for several months. One day he dumped me and said he was refinancing his home and pouring all the proceeds into mutual funds with Michael.
He said the capital gains potential and tax benefits were simply too good to pass up. I urged caution, suggesting this was a risky venture that could jeopardize his family’s future; after all, there was no guarantee the stock market would continue to go up and up. He wanted no part of my conservatism, and parted my company with a harrumph.
He had the last laugh as the stock market continued on a raging bull tear for years, and the strategy looked brilliant, and my fears for him groundless (this time).
Today the notion of leveraging your assets to invest is alive and well. True, there were hundreds of long faces in 2008 and 2009 when the markets for stocks and real estate took a bit of a beating, but that was in the past, and Fraser Smith’s ‘legacy’ continues to shine on.
Whatever you want to call it, please understand that borrowing against the equity in your home is a risky move – I said it twenty five years ago, and I still do – probably I will be right one day. What are some of the risks?
- The investments you make with the borrowed money could go down in value
- The cost of borrowing could increase if interest rates rise
- If real estate prices correct, you could end up penned into something uncomfortable – you really need to know your long term living arrangements
- Please be very prudent about investing in anything that has a sales commission attached either at the front end or the back end of your purchase
- Tax rules can change at any time in the future
If you would like to read others’ opinions on the Smith Manoeuvre, here are a few links:
Over the years, Ross Taylor has been a stockbroker, fee based financial planner, income tax specialist, mutual funds company executive, retail banking VP, tech company executive, and has raised capital for small to mid-size businesses. These days he is a licensed mortgage broker agent and registered credit counselor, and still provides advice on most personal finance matters. He writes a blog at www.askross.ca
The article is very one sided and does not discuss the advantages or the future use of these types of mortgages (rather gave a history lesson). I liked reading the article…however, felt that it left me hanging in the end. I will look to other resources to find more details and a more balanced solution as to how one can properly utilize as a personal finance strategy….
This is not intended to be a how to guide for tax deductible investing, it is more of a walk down memory lane. The fact is there are already several very good sources on the internet on this subject matter. Noted financial blog The Million Dollar Journey published a post by The Frugal Trader in 2009 that attracted more than three hundred comments on this subject.
Yes, today’s post tends towards the negative, but my commentary is more about the nomenclature than the actual strategy. I have personally borrowed to invest and continue to do so. I am quite comfortable with the risk/reward scenario.
My point is it’s not for everyone; it does not have to be as complex as others would have you believe, and you do not need to give it a name to make it tax deductible.
A very good commentary on the use of leveraging. I agree completely that there are a lot of risks and before i ever recommend this type of strategy to someone I make sure that I have addressed as many of the ‘what if’s’ as I can. So for people like bricksandmortar, the fact that you need to look more closely at this than the article speaks to the whole purpose of the article which is to get you to do exactly that.
Maybe a guest post on a rsp mortgage …they do work,but lots rules an fees
@jay_x2 Hi Jay, I’ve written a bunch of posts and columns on RRSP mortgages.
http://bondsareforlosers.com/holding-your-own-mortgage-inside-your-rrsp/
http://www.theglobeandmail.com/globe-investor/personal-finance/preet-banerjee/should-you-be-your-own-mortgage-lender/article1745125/
http://www.theglobeandmail.com/globe-investor/personal-finance/preet-banerjee/should-you-be-someone-elses-mortgage-lender/article1754671/
Curious what you all think, When’s the best time to renew a mortgage? 120days before end of term? My 120 days just started, June 22 is my term. Should I lock in now?
bikergofast preetbanerjee
Hi John, I guess it depends what you mean by “renew” your mortgage. A couple of months(give or take) before your renewal date, your current mortgage lender will send you a renewal notice, and provide you with renewal options and terms. The thinking is you would select one specific option and rate, and advise them accordingly. In this instance, your mortgage simply renews to the new terms you requested. No more paperwork is needed. Your actual lender can tell you whether or not you would benefit from a further decline in rates before the renewal date.
If you are asking how soon should you “shop around” to see what is available to you on the market, yes you could begin that process now. Some lenders will offer you a mortgage commitment now which will be good for 120 days. Other lenders would typically hold a rate for 90 days. And if rates go down by your renewal date, you would be given the lower rate. If they go up, you are protected by your original quote.
Some lenders in the mortgage broker channel have even better interest rates available if you can close within a short period of time – 30 to 45 days typically. Those rates would not be evident till 2 to 3 months from now. And they are typically available for new deals only, not for a deal the lender had already underwritten two months previously.
If though you wish to change the size of your mortgage or change the amortization period, that may require a brand new application with your existing mortgage lender. And it would certainly require a full new application with any other lender. And in both cases, you could begin that dialogue now.If this answer doesn’t address your question, please write back again, and I will reply right away.
Hi Ross, it’s the end of the first 5yr term, so I’m just learning the process of locking in a rate. I deal with CIBC. You say they should hold a rate for me if I reserve it now and if it drops in the next 120 days they give me the lower rate? Sounds good.
Now the question is fixed or variable. Anything is better than the 5.1% fixed I’m in now…variable looks good to me. Do you think the trend in the next 3-5yrs will be big rate increases?
Thanks!
Hi John, smart money prefers fixed rate mortgages these days. Some lenders are offering 3.29% for a five year fixed rate mortgage; whereas a five year variable rate mortgage (VRM) is usually anywhere between Prime less 0.1% to Prime plus 0.2% (which is 2.9% to 3.2%) Six months ago, VRM’s were more attractive as the difference between the best VRM and best five year fixed was quite large, but no more.I don’t have a clue where interest rates will be three to five years from now – and I doubt you should take anyone who says otherwise too seriously. What I do know is that 3.29% for five years (or even 3.99% for ten years) is a damn fine rate (look at the past fifty years in this table below from The Bank of Canada)
http://www.bankofcanada.ca/wp-content/uploads/2010/09/selected_historical_page57_58.pdf
i did not mean to imply CIBC would auto-drop your renewal rate – I think you should ask them what their policy is in that regard – each lender has their own way of doing things.
Thanks for the reply Ross, I went ahead and renewed my term, and I think there was a special early renewal offer: CIBC waived any fees for renewing ahead of term maturity (June 22), and gave me 2.8% on a VRM for 5yrs with option to lock in anytime I want. Sounds like I got a good deal, friends agreed with it too. Considering all the business I’ve given CIBC over the years it’s the least I’d expect! :)
Off to read your blog now…
This may not be the right forum for this question. But I was wondering, is there a way to self-direct an RESP into real-estate investment? I have built-up a small nest egg for the kids and would like to use it to purchase land (non-residential). It may sound silly, but my current portfolio has not been performing and the safest long-term investment I can think of is Real-Estate??