Ed Rempel has put together an article for us indicating his favorite Smith Manoeuvre Mortgage(s). This is part 3 of a 3 part series. In case you missed the other articles, here is part 1 and part 2. This final article of the series will help you decide whether or not to cancel your existing fixed mortgage to start the Smith Manoeuvre.
What should you do if you want to implement the SM, but your mortgage is not due now?
If you are just buying your home or your mortgage is due now, you can just go get the best SM mortgage and start. But what if it is not due? Some mortgage brokers would encourage you to always pay the penalty to refinance, citing the huge tax benefits you will get. However, you will get these benefits anyway if you wait, and you could pay significant penalties to get out of your existing mortgage. This may or may not really benefit you. It is worth doing the math.
Fortunately there are a few options:
- You might be able to convert your mortgage to an SM mortgage at your current institution without penalty. Some will and some won’t.
- You might benefit from paying the penalty to refinance your mortgage and roll in other debt. There is a benefit to starting the SM sooner and you could save on refinancing other debt, all of which may or may not justify paying a penalty. It is worth it to do the math.
- You could get a 2nd SM mortgage and simulate the SM as best you can until your mortgage is due.
Some general guidelines:
- Today, with interest rates having risen in the last several years, if your existing mortgage interest rate is much below today’s rates, getting a 2nd readvanceable mortgage is most likely the best choice. Why? Because creatively setting up a 2nd readvanceable mortgage can usually mean you can get most of the SM benefit now anyway, so why pay the penalty and higher interest rate?
- If you have more than 2 years left in your mortgage term and the rate is lower than today’s rates, it is better to pay the penalty and move even to a higher rate if you would otherwise not do the SM at all. However, getting a 2nd readvanceable and doing the best SM you can is usually the best option.
- If you have more than 2 years left in your mortgage term and the rate is NOT lower than today’s rates, in most cases it is better to pay the penalty and start the SM in full now.
The best SM mortgage, if you are stuck in a non-SM mortgage, depends on:
- Where is your existing mortgage (if it is not due) and when does it come due?
- How does your rate on your existing mortgage compare with today’s rates?
- How much is the penalty to get out of your existing mortgage?
- What is your marginal tax rate? (We can tell you if you tell us what your taxable income and your spouse’s taxable income are.)
- Do you have other debts at rates higher than your mortgage? What are they, how much do you owe, at what interest rates and how much are you paying on these debts now?
For example, the Parkers have a $400,000 home with a $200,000 mortgage at 5.2% for 4 more years and paying $500 bi-weekly. They owe $10,000 on a Visa at 19% and $10,000 on a credit line at prime +2% on which they are paying $600/month ($277 bi-weekly). They are in a 40% tax bracket. They can get a new readvanceable variable mortgage at prime -.6%.
Their existing bank will not convert their mortgage to readvanceable for no charge. Therefore, they have 2 options:
A. Pay the penalty to convert their mortgage to a readvanceable mortgage. They can roll in their $20,000 of other debt and then increase their mortgage payment by the amount they have been paying on this other debt, which would increase it to $777 bi-weekly. This could allow them to invest a lump sum of $100,000 plus $103 bi-weekly with the Smith Manoeuvre.
B. Keep their mortgage and add a 2nd readvanceable mortgage for $120,000. They will not be able to access their principal from their 1st mortgage payments, but they can still roll in the $20,000 of other debt and make it a fixed portion or their new readvanceable mortgage and pay the same $277 bi-weekly they pay on this amount now. With this option, they can still invest a lump sum of $97,500 with the Smith Manoeuvre (no bi-weekly amount).
The Parkers would pay a penalty of $2,600 plus $3,600 in the difference in mortgage interest rates for 4 years. The projected benefit including the tax refunds of investing $100,000 instead of $97,500, plus $103 bi-weekly with an 8% return would be $1,514 over 4 years. In total, they are $4,686 better off getting the 2nd readvanceable mortgage and doing as much SM as possible until their mortgage comes due.
Note that they would also save $6,400 over the 4 years by refinancing all their other debt into their mortgage, but they can do that either way – with a new 1st mortgage or by getting a 2nd readvanceable mortgage. Therefore, replacing the mortgage is better than not doing the SM at all, but getting the 2nd readvanceable is far better than either of the other options.
Some financial advisors or mortgage brokers would recommend breaking the mortgage anyway, saying that the tax refund of $2,500 each year is much more than the penalty. However, this is over simplistic and ignores all the other factors, such as the interest that is paid (in order to get the refund), a reasonable expected return on the investment & the tax-efficiency of the investment, and the interest rate difference between the old and new mortgage rates.
On the other hand, if the Parkers existing mortgage has a rate of 5.9% instead of 5.2%, then they will benefit by $564 taking into account all factors by breaking their mortgage now and paying the penalty. In that case, they should replace their mortgage now.
If you are not sure what to do with your existing non-SM mortgage, you can contact us with answers to the 10 questions in Part 2 about your situation and the 5 questions above about your existing mortgage, and we will do the math for you to figure out your best strategy. We call it the “Ed’s Mortgage Breaking Calculation”. It is actually a very complicated calculation.
If you would like us to do this calculation for you and you are a Million Dollar Journey reader serious about implementing the SM (either with us or by yourself), you can call or email us or FT leaving your name, email address and day phone number, and ask for “Ed’s Mortgage Breaking Calculation”. One of our financial advisors, Harvinder Arneja, will phone you (so leave your daytime phone #) within a week to tell you which of the 3 options is best for you, which SM mortgage is best for you and why, and then refer you to our contact to get that mortgage.
Again, another generous offer from Ed Rempel for MDJ readers. So if you're thinking about starting the Smith Manoeuvre, but you're currently stuck in a fixed mortgage, call Ed Rempel to calculate if the penalties are worth it or not.