More From Mortgages

by Jeff Hui

My clients often tell me that one of their most

important financial goals is to pay off their

mortgage rapidly. But is there another strategy

that will lead to greater financial independence?

Let's assume that Brother A and Brother B each buy

a home worth $400,000 and make a $100,000 down

payment. They each take a mortgage at 5 per cent and are

both in a 40 per cent tax bracket.

Brother A pays down his mortgage so that at the end of 25

years, he is mortgage free. Brother B takes a re-advanceable

mortgage, which has two parts: your regular mortgage plus an

investment credit line for 75 per cent of your home value less

your current mortgage balance. Rather than keeping equity in

his home, he borrows money against his house for investment

purposes.

Canada Revenue Agency "will allow you to deduct the

interest you pay on money you borrow for investment

purposes, as long as you use it to try to earn investment

income." The interest that Brother B pays on his investment

loan is tax deductible, so he gets 2 per cent back as a tax

refund (40 per cent tax bracket times 5 per cent mortgage

rate equals 2 per cent). His after-tax cost of borrowing is

only 3 per cent (5 per cent mortgage cost less 2 per cent tax

refund equals 3 per cent).

"Tax-deductible mortgage interest can be your best friend

in helping you achieve your financial goals, and when combined

with compounding interest, the benefits of these very

powerful tools are even more significant," says Fraser Smith,

a leading financial planner who developed The Smith

Manoeuvre, a revolutionary and simple strategy that enables

ordinary Canadian homeowners to make their mortgages

tax deductible.

Its premise is to free up the money that would otherwise

be trapped in the home and use it to create an investment

account. Smith explains: "As long as the investment account

earns a rate of return greater than the after-tax cost of

borrowing, it will always be higher than the outstanding

mortgage balance, thereby enabling you to achieve the

ultimate goal of greater financial independence."

Financial institutions and businesses have used always

debt to achieve greater growth and returns, even if they

have plenty of assets in place to cover their liabilities. If

a bank borrows money at 3 per cent and lends it out at 5 per

cent, it will make a huge profit, especially when lending

large sums. Similarly, individual homeowners can use

this concept of arbitrage on a smaller scale to build their

financial strength.

It's important to note that if Brother B used the money to

buy a depreciating asset such as a new car, yacht, or vacation,

then it would be more financially prudent for him not to

borrow the money at all. However, if he has financial discipline

and is able to put the money in an investment vehicle that

generates a rate of return that is greater than the net cost of

borrowing, then this would be a formula for success.

One major concept is that the rate of return on home

equity is zero. Regardless of whether you put down

$100,000 or $400,000, a $400,000 home that appreciates at

10 per cent will make you $40,000. Home equity only grows as a result of mortgage balance reduction and home value

appreciation.

Let's see what happens to Brothers A and B after 25

years. Brother A will own his home and will have no debt

and no other assets. Since he will have minimal income in

his retirement years, he may need a reverse mortgage and

will likely end up with no home equity.

Assuming a 10 per cent annual return on his investment

portfolio (which is the 55 year average of the TSE), the

results from the Smithman Calculator show that Brother B

will have $814,919 in his investment portfolio and the

$300,000 mortgage that he started with, so he will have a

higher net worth of $514,919. Additionally, he will have a

$10,000 tax deduction, which gives him a $4,000 tax refund

every year for the rest of his life!

Is this strategy appropriate for everyone? The answer

depends on the individual. For those who have a difficult

time managing their money or who can't sleep at night

if they have money in an investment product, they are

better paying off their mortgage. Savvy consumers who

are financially disciplined would do well to implement

The Smith Manoeuvre.

It's important to seek the advice of both a skilled

investment planner and a mortgage advisor to ensure success

with this strategy. If you are one such consumer, it's likely

that you're already doing well in your finances, but if you

could do better, shouldn't you?

To find out more about The Smith Manoeuvre, visit

www.smithman.net. Smith's book and calculator show

you how to improve results if you have existing assets or a

savings plan available.

To enter a draw to win one of 10 free copies of The Smith

Manoeuvre by financial planning expert Fraser Smith or to

discuss this strategy further, please contact mortgage

consultant Jeff Hui at jeff@mercurymortgages.com or at

905-273-4234.