The following is a guideline to creating a tax deductible mortgage in Canada by Jason Friesen of the Calum Ross mortgage team. Calum Ross is among the top CMP brokers in Canada and counts many investors as clients. If you fancy yourself an investor, or simply want to maximise your wealth, read on.
Since 2003, when Canada Customs & Revenue Agency set out its “cash damming“ guidelines, there has been an approved strategy to help Canadians pay down their mortgages considerably faster while at the same time saving money for their retirement. The strategy was originally known as the Smith Manoeuvre which was established in the 80`s and since then, there have been many enhancements to this strategy. It basically converts your mortgage interest into tax deductible interest over time. Why haven`t you heard about it? The primary reason is that bank`s do not want you out of debt and are definitely not promoting it, as they use you to grow their shareholder value. Instead, you should be using the banks to grow your personal net worth. This strategy can save hundreds of thousands of dollars over the life of a mortgage by paying down your debt much quicker and is worth exploring.
You can engage in this type of strategy when you reach 80% loan-to-value in your home. By acquiring a mortgage that has a Home Equity Line of Credit attached to it (HELOC). In this strategy, you can use the equity in your home to pay your mortgage off quicker. Here is how it works. Let`s say you have a home worth $350,000, you are now at $270,000 on your mortgage, your payments are $1175 per month and you are in a variable rate mortgage at 2.3%. When you make your payments, $508 goes to the bank in interest and $667 goes to pay down your mortgage. If you take the regular mortgage route, then this will take 25 years to pay off your mortgage. If you choose the other route, then each month you borrow back the $667 and invest the funds in a qualified investment to earn you income. The interest on the borrowed funds is tax deductible. Each month the income from the invested funds goes first to pay the interest on the borrowed funds and second to making an extra mortgage payment and thus paying your mortgage down quicker. This monthly cycling takes time to build but the benefits grow exponentially over time. At the end of the year when you receive your tax refund, you make an extra mortgage payment.
Assuming you are making a 6.5% return on your investment, you will save 5 years off of your mortgage or $70,500 in future mortgage payments. If you want to speed up this process, you can start with more leverage and increase your saving up to 14 years of mortgage payments or $197,400 in savings.
With any strategy there are risks and it is important to get the right professional advice before engaging in a strategy like this. The first risk is in structuring this properly to satisfy CCRA. Many of those people who like to “do it yourself“ make mistakes and this can put your tax deductions at risk. The second risk is how you invest the funds. Most mutual funds and investment products are not appropriate for this type of strategy as they take big swings with the market cycles and they generally have lower performance due to structure and high fees. For a tax deductible mortgage to work, an investor needs to have an investment that pays consistent cash flow and the risk should be managed.
If you are a mortgage rate shopper and believe the best way to save on a mortgage is to negotiate a better rate, you may want to consider your mortgage strategy first. It can save you a lot of interest and have your house paid of years faster than you would expect, without any additional money out of pocket every month.