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Did OSFI Kill the Smith Manoeuvre?

Smith-ManoeuvreTens of thousands of Canadians employ leveraged investing strategies like the Smith Manoeuvre. They rely on these techniques to magnify their investment gains and to pay down their mortgage faster.

For those not familiar with it, the Smith Manoeuvre entails:

  • re-borrowing your regular mortgage principal payments
  • investing that money in the market
  • writing off the investment loan interest, and
  • using the resulting tax refunds to prepay your mortgage.

You need a readvanceable mortgage (a.k.a. HELOC) and at least 20% equity to employ the strategy.

The Smith Manoeuvre hit a roadbump this past June when Canada’s banking regulator, OSFI, officially announced lower HELOC borrowing limits.

As of October 31, 2012, investors with bank-issued HELOCs will be able to borrow only 65% of their home value via a revolving credit line, as opposed to 80% before the changes. Most banks have already implemented this new guideline, impacting the Smith Manoeuvre in the process.

Fortunately, leveraged investing is far from dead.

“The Smith Manoeuvre is still a huge potential benefit to Canadians,” says Rob Smith, son of author Fraser Smith, founder of the Smith Manoeuvre.

loan-to-value-CHIP“The limit drop is occurring only on the non-amortizing facility,” he notes. That means lenders will still offer 80% loan-to-value (LTV) financing—giving leveraged investors the option of a 65% credit line plus a 15% mortgage portion.

To the extent that lenders “allow readvancing on the 65% portion, but not on the 15% portion,” then the effect (of OSFI’s changes) “relates mostly to the lower amount of principal that can be readvanced,” says financial planner Ed Rempel.

“This effect could be minimized by amortizing the mortgage portion as long as possible (e.g., for 30-35 years), while paying down the readvanceable portion more quickly.”

While it’s not typical, “the fact that 15% of a readvanceable mortgage is now amortizing does not mean that 15% isn’t useful for investment purposes.”

“Qualified candidates can still use a regular mortgage for investment borrowing,” he says. Albeit, borrowing from an amortizing mortgage and deducting the interest requires additional tax/accounting considerations.

Related Factoids:

  • Most existing HELOC holders are not affected by OSFI’s new 65% LTV HELOC limit unless they make changes to their HELOC. Any such changes would likely lower their credit line LTV to 65% maximum.
  • “There will be a regulatory gap between OSFI-regulated banks and provincially-regulated lenders,” says Sandy Aitken, president of Tax Deductible Mortgage Plan (TDMP). “Therefore, it’s possible that some non-OSFI-regulated lenders (like credit unions) might exploit the opportunity to provide highly qualified HELOC borrowers with an 80% LTV credit line after the banks abandon this market segment.”

Strategies like the Smith Manoeuvre entail risk and are not suitable for all. Consult a licensed financial and tax adviser before initiating any such strategy.

Rob McLister, CMT