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

  1. Even 65%… How could taking out 80% of a home “value” be legal? Aren’t millions of Canadians going to take advantage of that? When prices fall??? What happens???

  2. Dropping to 65% across-the-board was misguided. OSFI seems to think that banks either (a) cannot tell when someone is prone to default, or (b) will overleverage themselves despite being highly qualified. Neither are true in an overall sense.

  3. When prices fall??? What happens???
    I love reading “when” prices fall. I sure wish I had me a crystal ball as well.
    “How could taking out 80% of a home “value” be legal?”
    If you are seriously asking this question… Ask yourself how it can be “legal” to a buy a house with only 5% down and borrow 95% of the homes “value”
    For a property investor like myself, being able to borrow up to 80% on my investment properties allows me to make legitimate investments in other business interests or other real estate. Not everyone borrows to pay for vacations.
    This 65% rule is misguided at best. Just like 25 year amortizations, the government can’t lump all homeowners in the same bucket when making these misguided rule changes.
    Luckily all my investment properties have about 40% equity at current and my banks have not indicated that my LOCs will be affected, nor will I not be allowed to renew with 30 year amorts.
    I do fear they will apply blanket rules soon, like they did with the 35 year amort.

  4. Hi Rob,
    Interesting article. We’re still finding out exactly how each lender is implementing this, but with some lenders this is a non-event.
    They still lend 80% of the value of your home with a HELOC, but the mortgage portion must be at least 15%. That is no problem for most people wanting to do the Smith Manoeuvre.
    This will mean we do everything exactly the same until the mortgage is nearly paid off (down to 15% LTV). Then it will take a little creativity, but there are a few options.
    Your Latin quote is right on, Sandy – we will find a way or make a way.

  5. This new 65% limit will disadvantage Canadian investors for no good reason. This is probably the most thoughtless mortgage regulation I’ve seen so far. The “risk” argument is so overblown it’s just ridiculous. Regulators seem to understand nothing about mortgage lending. People with high Beacons and 20% equity simply do not default in large numbers, regardless of how bad prices fall.

  6. In retrospect, I believe that the new mortgage and HELOC regulations will be viewed as too harsh and too sudden.
    Housing was already cooling off at a reasonable pace beforehand. Minister Flaherty is especially culpable for piling on excessively, unnecessarily and too soon after OSFI starting turning the screws.
    At this juncture, I fear that a policy-led recession is a real possibility.

  7. “At this juncture, I fear that a policy-led recession is a real possibility”
    Amen to that. As has been said before though, this has just as much to do with loosening the credit to quickly as it has with tightening to quickly.

  8. What steps must you take to write off the interest you pay on a mortgage, assuming you’re borrowing to purchase income-producing investments? Do you simply claim the interest expense shown on your bank statements?
    If so, is it really that different from writing off the interest on a line of credit?

  9. They couldn’t loosen slowly because the q/q accumulation rate of total insurance-in-force would have breached the limit by mid-late 2013. F wasn’t not going to increase the debt limit and risk Canada’s credit rating just to keep the house of cards from falling.
    It’s game over. Deal with it. You want to borrow and lend money? Go get it in the open market and pay what the market prices you at. Keep the taxpayers out it.

  10. I am 45 years old with a plan to retire at 55. My home is valued at $295K with $30K remaining on my current mortgage. I am hitting the debt hard and plan to eliminate my mortgage within 18 months.
    I have made maximum RRSP contribution each year since age 19 and will have a union pension at 55.
    Is the Smith Manoeuvre something that is suitable for me.

  11. If you have enough retirement income already and can handle 20 years of risk, I’d say go for it. Lock in for 10 years at 3.69% and buy a safe dividend fund yielding 5%.

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