Canadians can save big with tax-deductible mortgage

How do you like the sound of a tax deductible mortgage? Wouldn’t that be great? You could save a potfull of money, and start socking away funds for your retirement a lot sooner. Yup, a tax deductible mortgage would be great.

What most Canadians don’t realize is that they can have a tax deductible mortgage under certain circumstances and it’s perfectly legal. In fact, some of the best financial advisors in the country have been building tax deductible mortgages for their clients for years, using a strategy that’s known as the Smith Manoeuvre (named for Fraser Smith of B.C.: the investment expert who developed the strategy).

The Smith Manoeuvre makes sense for Canadians who are torn between paying down mortgage debt and building up their retirement savings. For many average, cash strapped homeowners, it’s tough to decide whether to pay down debt or build up savings. If you wait until your mortgage is paid off (let’s say a 25 year amortization starting when you’re 25), then you’d be 50 when you were clear of your mortgage – leaving a very short period to save for retirement.

With the Smith Manoeuvre, you can start accelerating your retirement savings at the same time as you hammer down your mortgage debt. It’s a relatively simple strategy that trades bad debt for good debt: the kind that’s tax deductible. Think about how much loan interest you paid last year – on car loans or your mortgage. Now imagine that this interest was a tax deduction that triggered a refund from the taxman. Pretty appealing, isn’t it?

Here’s how it works. In Canada, the government determines tax deductibility based on what you borrowed the money for. Borrowing for a house, a car, a vacation? No tax deduction. Borrowing to invest? That interest is tax deductible: the government wants to encourage both savings and investment in the economy. The trick is to swap your non deductible debt for tax deductible debt.

Each month when you make your mortgage payment, a small amount of principal gets paid off (sometimes frightfully small, but that will change, too). With the Smith Manoeuvre, that amount of principal is immediately reinvested: triggering a tax refund. So as you pay down your mortgage, cheques begin to arrive from the taxman each year. This is where it gets fun: throw that refund cheque against your mortgage debt, and start accelerating your paydown. That means that future payments will be driving down the principal faster – triggering even fatter refund cheques for what is becoming a tax deductible debt. Your mortgage starts disappearing faster than you thought possible, and you’ve got a nice investment portfolio in its place.

How do you get started on a strategy like this? Find an independent mortgage broker with some expertise on the Smith Manoeuvre. The banks don’t have much to gain from the strategy, but there are established lenders with mortgage products that are beautifully designed to work with the Smith Manoeuvre. A good mortgage broker will help you find the right mortgage to fit your needs.

Wherever you’re at with your mortgage, the best time to start is as soon as possible. Every payment you make could be helping to build a tax refund, so the earlier you start, the faster you’ll pay down the mortgage. A good mortgage broker can help set you up with the right mortgage product to make this happen.