In today’s episode, we chat with Megan from Victoria, BC. She and her husband use a strategy called the Smith Manoeuvre to help them reach FI.
Megan lives in Victoria, BC with her husband and four kids (aged 12, 8, 5, and 2). She homeschools her kids while managing three rental units and works one day a week at her government job.The first personal finance book Megan read was The Smith Manoeuvre: Is Your Mortgage Tax Deductible? by Fraser Smith. (She read it in high school.) It showed her how it was possible to get much further ahead by implementing the strategy.
As a teenager, she started putting money away to invest in real estate. After a few years of working hard and saving, she received a little bit of family help and was able to put a down payment on her first home. She slowly built up her equity until she had enough to implement the Smith Manoeuvre.
Smith Manoeuvre basics
For detailed information and to order the updated book, please visit the official website at https://smithman.net/
Converting your mortgage to a tax-deductible HELOC
- When you have a home with a mortgage, you can set up a home equity line of credit (HELOC) on that mortgage.
- When you make a mortgage payment, it’s split between paying the principal of the loan and the interest.
- Whatever you pay down on the principal portion of the mortgage becomes available to borrow from the HELOC.
- For example, if $200 of your mortgage payment goes towards the principal, then $200 will become available for you to borrow from the HELOC .
- You can take that $200 and purchase any investment: stocks, bonds, real estate, a business, etc. You can buy anything as long as it has the potential to create income.
Paying the interest
- Throughout the year, you pay interest on the HELOC.
- You can then do something called ‘capitalising the interest’ which means you use the HELOC to pay for its own interest.
- For example, let’s say you owe $30 in interest on the $200 you borrowed from the HELOC. Instead of taking out the full $200 to invest with, you only borrow $170—so you leave $30 to pay the interest.
- Basically, each month the HELOC pays for itself and doesn’t require any extra money out of your pocket.
- When you file your taxes, you’re able to write off all the HELOC interest that you paid for the year as a deduction.
- This lowers your taxable income, so you generally will get larger tax refunds. You’ll also receive increased government benefits such as the CCB, OAS, or GIS.
- Using the Smith Manoeuvre means you end up with more money in your pocket.
What happens at the end?
- Over time you:
- Pay more and more equity towards your house.
- Borrow more and more from the HELOC.
- Invest more.
- Deduct more and more interest from your taxes.
- Pay down your mortgage.
- You’ll eventually pay off the mortgage and have the entire mortgage amount, say $500,000, converted into borrowing room in the HELOC. At this point, you can:
- Pay the HELOC interest and let your investments continue to grow indefinitely, or
- Sell off your investments to pay off the HELOC, be done with the Smith Manoeuvre and still end up a lot further ahead than you were.
- The beneficiaries of your estate can also choose either option 1 or 2.
Smith Manoeuvre investments
- The majority of people use their HELOC to invest in the stock market.
- Again, you can buy anything as long as it has the potential to create income. Even a stock that doesn’t pay dividends qualifies—as long as there’s the potential that it could in the future. (Basically, as long as it’s not stated that the stock will never pay dividends, it’ll be okay.)
- If you’re earning an average 8% return on your stock market investments and paying 3% in HELOC interest, you’re banking the 5% difference each year throughout this 20-year (or longer) process.
- That 5%, after 20 years, ends up being a whole lot of money.
The Smith Manoeuvre seems complicated, but in practice it takes very little time to manage. (Megan estimates it takes her three hours per year.)
FI in Victoria
- Megan was born and raised in Victoria and her entire social network lives there.
- She loves the outdoorsy lifestyle and the climate in Victoria. (Sure it rains a lot, but you don’t have to shovel rain!)
- It’s big-city enough to have all the amenities, but not so big that they’re sitting in smog.
- Victoria is hard to cut costs in, but Megan and her husband do what they can to save (credit card rewards, shopping at discount grocers, etc.)
- She doesn’t have a ton of time to penny pinch, so she tries to focus on the big expenses to save a lot of money over the long run.
- Megan tries to connect with local FI-minded individuals to learn from them.
- Megan also discusses:
- Her family’s annual spending.
- How she manages their rental units.
- Her job and how she balances her one day of work with raising and homeschooling four kids.
- The Smith Manoeuvre: Is Your Mortgage Tax Deductible? by Fraser Smith
- Lifecycle Investing by Ian Ayres and Barry Nalebuff
- Smith Manoeuvre Calculator/Spreadsheet from Million Dollar Journey *
*This is an old calculator, updated version from the official Smith Manoeuver website coming fall 2019.
- Public Mobile (use referral code 88283Z for a $10 credit).
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