New OSFI guidelines offer less than good news for mortgage brokers who deal in the Smith Manoeuvre.
The tighter guidelines for federally regulated lenders will likely impact borrowers seeking to use the complex tax-saving strategy relying on a re-advanceable mortgage to make mortgages tax-deductible.
“New rules cutting the LTV maximum from 80% to 65% will significantly reduce the benefits that borrowers expect to get through a Smith Manoeuvre,” said Brad Compton, a Toronto Invis agent.
For a Smith Manoeuvre to be really effective, borrowers must be able to draw upon as much of the value of their properties as possible, according to Compton, who spent more than a decade working as a financial analyst.
“People will still use the manoeuvre but they will not be able to get as much out of it under the new regulations,” he said.
The new rules from the Office of the Superintendent of Financial Institutions (OSFI) cut the maximum LTVs offered by banks on HELOCs from 80 per cent to 65 per cent
Last year, MortgageBrokerNews.ca reported that there was concern in the broker community that funding limits would hamper Smith Manoeuvre transactions.
The tax-saving scheme, developed more than a decade ago by financial planner Fraser Smith, relies on Revenue Canada rules allowing Canadians to deduct interest paid on loans for investment purposes.
In the case of the Smith Manoeuvre, that “loan for investment purposes” is a collateral mortgage, or HELOC, for the full value of the home. In exclusively using that line of credit for investments – preferably dividend yielding ones – the interest paid on the loan is made tax-deductible.
As the client continues to pay down the principal, that frees up more of the line of credit for additional investments. Eventually, according to Smith, not only does the homeowner end up having paid no interest on the mortgage, but has also developed a substantial investment portfolio in addition to paying off the mortgage. For the loan to be tax deductible, however, clients must restrict themselves to non-registered investments.
The system does come with a fair amount of risks, according to Compton. “As with any investment, the value of the investment instruments chosen for the Smith Manoeuvre can go up and down, putting your borrowed equity at risk.”
The Smith Manoeuvre is ideal for people seeking a long-term, buy-and-hold vehicle, which will hopefully average out over the long run, he said.
Compton said mortgage brokers will likely work to get their clients the maximum 65% through the Smith Manoeuvre and get the remaining 15% through a normal mortgage.