Understanding the Smith Manoeuvre
Before we delve into the Cash Flow Dam process or strategy, let’s grasp the basics of the Smith Manoeuvre.
The first thing to note is there is a lot of misinformation about the Smith Manoeuvre on the internet. The best place to get the information is from the actual source or a Smith Manoeuvre Certified Professional (SMCP).
In a nut shell, the Smith Manoeuvre is not a debt reduction strategy but a debt conversion strategy. It utilizes combination of a residential mortgage and a Home Equity Line of Credit (HELOC) which are usually set up at the same time, whereby the HELOC is used to borrow against the equity in your home for investment purposes. This combination is often referred to as a re-advanceable mortgage.
The borrowed funds are then invested in income-generating assets, such as rental properties, dividend-paying stocks, bonds, or other investments with an income component and even your operating company under the appropriate circumstances. By doing this, you aim to convert the interest on your non-deductible mortgage into tax-deductible debt. There are pros and cons when employing the Smith Manoeuvre because of the leverage usage. Here is a link to an article explaining how to manage the risks associated with the Smith Manoeuvre.
Smith Maneouvre Concept – Basic Representation
Progression of Smith Manoeuvre Key Metrics
The second note is that most Canadian institutional lenders offer some form of a re-advanceable mortgage, which is an integral component needed to properly and smoothly employ the Cash Flow Dam strategy.
Part of the re-advanceable mortgage includes a Home Equity Line of Credit (HELOC). However, not all these readvanceable mortgages are created equally or work the same way, so it is imperative to consult with a SMCP Mortgage broker to find out what would work best for your situation.
As a SMCP Real Estate Agent, I can connect you with a SMCP Mortgage broker that can help you with your needs. Here is a link from Keaton Kirkwood explaining how to optimize the Smith Manoeuvre.
Unveiling the Cash Flow Dam Process in the Smith Manoeuvre
The Smith Manoeuvre is a strategic financial technique employed by Canadian homeowners to transform their non-deductible mortgage interest into tax-deductible debt. It essentially allows you to turn your home into a tax-efficient investment. Within The Smith Manoeuvre strategy, there are several accelerators that can improve the performance of the strategy. One of the most powerful accelerators is is the Cash Flow Dam process, which plays a pivotal role in its success. With the help and guidance of my accountant back in the early 2000s, I employed the Smith Manoeuvre and more importantly the Cash Flow Dam accelerator to expedite the conversion of my non-deductible debt to tax deductible debt. Since then, I haven’t looked back. But it is not something that should be done without proper guidance and implementation from knowledgeable professionals to avoid costly mistakes.
The Role of Cash Flow Dam
The Cash Flow Dam is a concept introduced by Fraser Smith, the originator of the Smith Manoeuvre. It acts as a safeguard to ensure that you maintain control over your investments while optimizing your cash flow.
How Cash Flow Damning Works
1) Once you have your re-advanceable mortgage you will also have established a connected but separate HELOC account/component. When implementing the Smith Manoeuvre, it’s essential to set up a dedicated HELOC account. This HELOC account serves as the gateway for your investments.
2) Direct All Investment Income: As you invest borrowed funds, any income generated, such as dividends, interest, or rental income must be directed into residential mortgage and then you will be able to borrow the funds from the HELOC account to reinvest or pay any of the rental property operating or financing expenses. This is where the Cash Flow Dam process comes into play.
3) Debt Reduction and Tax Deductions: By using your investment income to pay down the residential mortgage, you reduce your non-deductible mortgage debt. Simultaneously, the interest you pay on the HELOC becomes tax-deductible, providing tax benefits.
Cash Flow Dam – Simple – Flow Chart
Advantages of the Cash Flow Dam Process
Rather than diving deep into all the details of the Cash Flow Dam Accelerator, I am going to keep it at a high-level so that you get the general gist of it. To completely understand how it could work for you, I would recommend scheduling a call or zoom meeting with me or another SMCP professional.
Although the Smith Manoeuvre and the super powerful Cash Flow Dam Accelerator can make an incredible difference to your debt conversion, they must be taken seriously and employed properly.
Again there are risks and not all lenders provide immediate access to the HELOC funds or don’t permit full access to all the funds because of loan to value (LTV) restrictions. In the mortgage terms, the institutional lenders will generally stipulate limits as to the percentage amount of mortgage prepayments on a monthly and or annual basis.
The Cash Flow Dam Process Offers Several Key Advantages Within the Smith Manoeuvre
1) Optimized Cash Flow
By routing investment income into your HELOC through the principal residence mortgage thereby potentially freeing the equivalent amount in your HELOC account, you can rapidly pay down the borrowed funds for your investment or mortgages related to your rental properties. This not only reduces your non-deductible mortgage, but when there is excess room in your HELOC it also frees up cash flow for further investments.
2) Tax Efficiency
One of the primary advantages of the Smith Manoeuvre, including the Cash Flow Dam process, is the tax efficiency it provides. As you pay down your non-deductible mortgage using the borrowed funds from the HELOC, the interest you pay on the HELOC becomes tax-deductible. This can result in significant tax savings, especially for high-income individuals, as it reduces the overall tax liability. If there is an actual tax refund involved, this too can be put towards your non-deductible portion of your principal residence mortgage.
3) Control and Accountability
The Cash Flow Dam process ensures that the income generated from your investments is directed into debt reduction. This strategy helps maintain control over your financial plan and ensures that the investment income is used for wealth-building purposes rather than being spent elsewhere.
4) Accelerated Wealth Building
By employing the Smith Manoeuvre with the Cash Flow Dam process, you create a powerful wealth-building mechanism over time. As you pay down your non-deductible mortgage while simultaneously accumulating investments, you can build wealth at an accelerated pace. This process can lead to long-term financial security and increased net worth.
5) Bonus Tip
It has nothing to do with the Smith Manoeuvre, but it can be powerful when used properly and addressing the associated added leverage risk.
If you have rental properties that are being or will be used in your Cash Flow Dam, consider taking re-advanceable mortgages on your investment properties, because then you can borrow from that HELOC as down payments for further investment.
Recent Changes to Re-advanceable Mortgages
The office of the Superintendent of Finance Institution (OSFI) recently announced changes that involve reducing the outstanding LTV on the HELOC component to 65% down from the maximum of 80%. Here is the OSFI Announcement Link. Here are two Mortgage brokers links explaining in greater detail of the potential effect from changes: Kirkwood & Brennan Mortgage Group or Canadian Mortgage Trends
Final Thoughts
The Cash Flow Dam process is a super-charger accelerator of the Smith Manoeuvre strategy, enabling homeowners to transform their mortgage into a tax-efficient investment strategy.
By utilizing this method, individuals can optimize their cash flow, reduce non-deductible debt, and potentially enhance their long-term financial well-being. However, it’s essential to understand that the Smith Manoeuvre is a complex and ideally a long term financial strategy, so it is not going to be a suitable strategy for every homeowner.
Seek the guidance of a Smith Manoeuvre Certified Professional, a qualified financial advisor or tax professional that completely understands the Smith Manoeuvre to ensure that it aligns with your financial goals, risk tolerance, and overall financial situation and is employed properly.
