The Smith Maneouver, review by DW

June 30, 2007 by Dan White.

RE: Smith Manoeuvre: How to make your mortgage tax deductable.

While the Smith Manoeuvre works and is very appealing to financial planners because they can get clients to invest the money borrowed against home equity, the program is fundamentally foolish. A prime rule of investing is to not invest borrowed money in risk investments.

People earn money as good business people; they lose money as bad investors. If the true statistics of the investment market were ever known, there would be a lot less investors in things like mutual funds. There is a very real risk that the investor will end up with a tax deductible mortgage payment on money that has been lost. The multitude of transaction fees… (yes I know they are tax deductible) also reduce the return on your money. While I agree that it is a great idea to use the equity in your home to build wealth there is a less time onerous way to do this. It is not as sexy sounding as the Smith Manoeuvre, but is easier and makes more sense.

Simply take out a business loan using the equity in your home as security to get the loan. The debt is registered on title. It is called a mortgage. The mortgage payments are then tax deductable and you have the use of the tax free loaned money to make money in bonified business activities.

Keep a separate account where you track your borrowed money. Open up a bank account to be used solely for accruing tax free money that will be used to reduce your mortgage once a year. Whenever you receive tax free money, such as tax refunds, business refunds, gifts or loans, divert that money into the mortgage fund to be used in reducing your mortgage principal.

Establish a line of credit. Use your line of credit to pay deductable business expenses such as interest so that you free up money to pay down your mortgage…Remember you can use borrowed money and debt money to pay off a mortgage. The real objective here is to restructure things so that 100% of your mortgage interest is tax deductable. You end up with a line of credit and debt that you owe money where the interest is tax deductable and a fund you use in business equal to your equity in your home.

When you consider putting your equity money into an investment, you should be aware that money is often lost in investments; you need to be very informed about statistics before putting your money in someone else’s hands. The odds are not good that you will make money.

Money is made in business. Either you are a worker which to the surprise of many is really a form of business or you are a recognized business. The best investment is always in you; your business or your wage earning power. If you are a wage earner, invest in your education and training that will allow you to earn a greater income for the rest of your life. If you are in business, you should figure out how to make minimal risk investments in your own business. You will earn much greater returns than any passive investment where the odds are working against you.

Having said the negative things above regarding passive investments, I do believe in low risk passive investments for the purpose of preserving wealth. What you need to think about is. If you are paying 6% interest on your money but earning only 5% and paying all kinds of fees to your broker, you are being tax wise and dollar foolish.

The first intelligent step for all investors and all those who consider the Smith Manoeuvre, is “Have I calculated all the numbers and what other right answers are there?”. If you are thinking of turning your home equity into an investment portfolio, I strongly advise you to go for financial advice from someone who has no vested interest in your investments.

Invest wisely.

 Dan White

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