My wife and I have been using our convertible mortgage as an investment tool for a few years now. Turns out, this strategy has a name: the Smith Maneuver. It was coined by financial advisor Fraser Smith, who wrote a book on it in the early 2000s. Can’t believe I didn’t know that until recently! That said though, I do know about the strategy. Here’s an overview of the Smith Maneuver, a strategy that can help you accelerate achievement of your financial goals.
How it Works
The Smith Maneuver requires something called a hybrid, or readvanceable, mortgage. It’s the kind that, as you pay it down, the principle becomes available to borrow in the form of a Home Equity Line of Credit.
The idea of the Smith Maneuver is that, as you pay down your mortgage, you take your freed up principle and invest it in dividend-paying stocks or ETFs (I use the Hamilton Enhanced Canadian Bank ETF, ticker symbol HCAL), specifically in a non-registered account (more on that in a moment). The dividends should be large enough that they more than offset the monthly interest you pay for re-borrowing the money.
Benefits of the Smith Maneuver
Done properly, there are a TON of benefits to this investing technique. For one, interest you pay on a loan that you’re using to invest in a non-registered account is tax-deductible in Canada. That may not sound like a big deal for my American readers, whose mortgage interest is often tax-deductible by default, but in Canada, it’s huge. As you pay off your mortgage and re-invest into the market, you’re basically slowly converting your entire mortgage from non-tax-deductible to fully tax-deductible.
Second, you can benefit from capital growth in addition to being cash-flow positive. While your dividends keep paying off your interest, the principal keeps growing over time – just another way this thing makes you money.
Third, you can accelerate how quickly you pay down your mortgage. Just take any leftover dividend income, plus any tax refunds you end up with, and apply it all to the principal.
Lastly, when your mortgage is fully paid off, and all you’re left with is your Home Equity Line of Credit… just sit back and let the dividends roll in as bonus income! Many folks who use this strategy actually choose never to pay off their debt, because they make more money with borrowing than if they were to pay off their loan.
Risks of the Smith Maneuver
I want to be clear: this strategy is definitely not without risks.
First off, it’s not for the short term. If you don’t have a time horizon of at least 5-10 years, you shouldn’t be taking this approach. It comes with a ton of volatility risk, and you don’t want to be caught with your pants down, should you need the money.
Second, this is a relatively advanced investing technique. It’s not for beginners, nor is it for the faint of heart.
Third, if house prices dip (kinda of like they are right now), you could find yourself underwater on your house – that is, owing more than your house is worth. This can be dangerous because, while banks rarely do it, they have the ability to demand you to pay off your HELOC, in full, at any time. If they make this demand while markets are down, you could lose a lot of money.
Fourth, it requires a great deal of financial discipline – if you’re the type that often dips your hand into the cookie jar, the Smith Maneuver is not for you.
Lastly, you can’t use your HELOC for anything except investing. This is to keep your paper trail clean in case you get audited. It requires diligence and tracking, which can be annoying, even for someone who likes personal finance like me.
Wrapping it Up
Ultimately, I am a big believer in the Smith Maneuver. My wife and I have been able to generate hundreds of thousands of dollars by employing the technique at a good time (the crash that happened at the start of the pandemic). We took a huge risk I doing so, but it paid off, and literally shaved years off our working careers. Hard for me not to buy into the strategy given the experience we’ve had. But try it at your own risk, for it isn’t for the faint of heart!
