I Love The Idea Of Making My Mortgage Tax-Deductible But Does It Work When Rates Are Rising?

An excellent question. Why? Because for over a decade now Canadians have been borrowing with very low rates. When we are borrowing to consume (think cars, boats, gas and clothes) we cannot deduct the interest which means we are incurring expensive debt – non-deductible debt – in order to buy ‘assets’ which depreciate in value and in most cases eventually leave no dollar value for us whatsoever. This is wealth destruction. However, when we Canadians borrow with the reasonable expectation of generating income – when we invest – we indeed can deduct the interest. This makes the debt considerably less expensive, plus, we are acquiring assets which increase in value over time. This is wealth creation.

Tax-deductible mortgages

We Canadians are in the unfortunate position that when we borrow to buy our home, the government considers this consumption because there is no reasonable expectation of generating income from the home in which we live. But that can be flipped using The Smith ManoeuvreTM. With this strategy we can reduce our tax bill via converting non-deductible debt to tax-deductible debt, and in the process, get rid of that mortgage debt much quicker than otherwise PLUS generate a valuable investment portfolio that otherwise wouldn’t exist – and it does not require any additional cash flow from our pockets on a monthly basis to accomplish all of this.

How Rates Fit In

That being said, even though we are acquiring GOOD debt as opposed to BAD debt, we are still subject to the vagaries of interest rate fluctuations when employing the strategy. And although this strategy has been around for almost 40 years, seeing how many Canadian homeowners began implementing The Smith ManoeuvreTM recently, they have been enjoying low rates which means they have the ability to invest relatively large amounts of ‘found money’ every month. But what happens when rates rise as we have been seeing recently? Won’t that negatively affect the results of the strategy?

The See-Saw Effect

The nice part about the strategy is that it works whether rates are up or down. When rates are low as we have recently seen for many years, the tax deductions the homeowner enjoys are relatively low but they have more to invest each month; when rates are high, while there is less to invest each month, the homeowner enjoys larger tax relief.

How About Some Numbers?

Using The Smithman CalculatorTM and certain assumptions, we can identify the relative increases and decreases. Let’s assume a homeowner is in the 40% marginal tax rate, has an $800,000 home and a 25-year amortized $500,000 mortgage balance and, for the first scenario with higher rates, a rate of 5% on the mortgage and a Home Equity Line of Credit (HELOC) rate of 5.2%. For the second scenario when rates are lower, we look at a mortgage rate of 3% and a HELOC rate of 3.2%.

The results of implementing The Smith ManoeuvreTMare as follows:

High-Rate Scenario:

$846 of new money to invest each month and total tax refunds over the original amortization of over $119,000

Low-Rate Scenario:

$1,124 of new money to invest each month and total tax refunds over the original amortization of over $76,000. 

The key takeaway here is that in the high-rate scenario, while less is available to invest each month, our tax savings are higher as compared to the low-rate scenario; in the low-rate scenario our tax savings are a bit lower but there is more to invest each month.

Bear in mind, though, that these results exclude any accelerators that any given homeowner may have available to them…the results only get better.

If you own a home in Canada and are concerned about how high your tax bill is and how little you are able to put away for your future, read up on The Smith ManoeuvreTM. It was developed in the mid-1980’s when interest rates were double digits and if it didn’t work then, you wouldn’t be reading this now. It could be worth hundreds of thousands of dollars to you and your family.

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