Monday, May 14, 2007

The Smith Manoeuvre

I have requested Smith’s book from the library for further research into this concept. Although I own my home mortgage free I’m curious to see what I might have done.

If I understand it correctly…the basic premise is that the house title in one’s name gives one the power to make a big loan. Rather than just pay down the mortgage, the Smith Manoeuvre goes one step further.

As the principle is paid off each month, use this increment in growing home equity as collateral for a second loan and use the loan for investment. The mortgage payment and original loan amount remains the same and your equity in the home continues to grow as under the normal approach.

The interest on the "new loan" amount is then income tax deductible. I guess, in general terms…if one makes 10% on investment, pays 7 % on the "new loan" and has a marginal tax rate of 50%, then the after tax cost of the new loan is 3.5 %. The net increase in net worth is 10-3.5 = 6.5 %.

One of the main benefits is that rather than waiting 25 years, while paying off the mortgage, then start investing, one starts investing much earlier in life. This time factor is one of the biggest obstacles to becoming financially independent.

2 comments:

Middle Class Millionaire said...

Other than allowing people to start investing early I think the major benefit of this strategy (if done correctly) is that you're basically allowing the interest on your mortgage to be tax deductible. This is one strategy that I'm also going to be researching further.

Cheers,
MCM

FinancialJungle.com said...

Since your house is paid for, Smith Manoeuvre is probably not going to save you taxes. If interest, I've written an article on the Smith Manoeuvre.