But what if there was a way to make your mortgage work harder for you while you’re paying it down? That’s the idea behind the Smith Manoeuvre, a strategy that helps homeowners use their home equity to potentially build investments and improve tax efficiency at the same time.
Looking at debt differently
For many people, debt is something to avoid at all costs. And when it comes to high-interest consumer debt, that’s generally good advice. But not all debt is created equal.
Some debt is used to buy things that lose value over time, like vehicles, vacations, or consumer purchases. Other debt can be used to acquire assets that have the potential to generate income and grow in value.
The Smith Manoeuvre is built on this distinction. Rather than viewing a mortgage as nothing more than an expense, the strategy focuses on gradually converting traditional mortgage debt into investment debt that may qualify for tax deductions under CRA rules.
How the Smith Manoeuvre works
Despite sounding complicated, the concept is surprisingly straightforward. The Canada Revenue Agency (CRA) generally allows taxpayers to deduct interest on borrowed money when the borrowed funds are used for the purpose of earning taxable income. Under the Smith Manoeuvre, the mortgage is paid off from cash available, then re-borrowed to replace that cash and invested in a diversified portfolio that meets the income earning requirements.
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For example, Mary has a $250,000 mortgage and a $250,000 non-registered investment portfolio. She sells her investments to pay off her mortgage then immediately reborrows the $250,000 to invest in a non-registered investment portfolio. Mary is in the same position she started in, with a $250,000 mortgage and a $250,000 investment portfolio—but now, the paper trail shows she borrowed money to invest instead of borrowing money to buy a home, and the interest expense becomes tax deductible.
To maintain deductibility, investors must:
- Use the borrowed funds directly for eligible income-producing investments
- Keep clear records showing how the funds were used
- Avoid mixing personal and investment borrowing
The average Canadian may not have $250,000 in investments to do what Mary did, but the Smith Manoeuvre works for those who want to start doing this on a much smaller scale and on a monthly basis.
As you make your regular mortgage payments, a portion of each payment reduces the principal balance of your mortgage. With the right type of mortgage structure, known as a re-advanceable mortgage, that newly created equity becomes available through a home equity line of credit (HELOC).
Instead of letting that borrowing room sit unused, the funds can be borrowed and invested in qualifying investments that have the potential to generate income. The interest charged on the HELOC becomes tax deductible, since it was money borrowed for the purpose of investing.
Over time, the total amount of money borrowed remains the same (as your mortgage balance is reduced, your HELOC balance increases by the same amount), but now you can start claiming interest deductions to reduce your tax bill and start building an investment portfolio to increase your wealth.
Why this strategy is popular
The Smith Manoeuvre’s biggest attraction isn’t simply the tax deduction, it’s the possibility of accomplishing multiple financial goals at once: building wealth by growing your investment portfolio while also benefitting from growth in equity value of your home over time.
Many homeowners spend 20 or 25 years aggressively paying down their mortgage, only to discover they’re approaching retirement with significant home equity but relatively little invested capital. They’re often described as house-rich but cash-poor.
The Smith Manoeuvre attempts to address that challenge by helping homeowners build investments while they are still working and earning income, rather than waiting until the mortgage is completely paid off before beginning to invest seriously.
The goal isn’t necessarily to become wealthy overnight, but to build net worth more efficiently over time.
The power of starting earlier
One of the most compelling arguments for the strategy is the impact of time. Every year that investments are allowed to compound can make a significant difference over the long term.
