Ed Rempel, a certified financial planner (CFP) and accountant, is a regular comment contributor to the “Smith Manoeuvre” articles on this blog. He has come up with a twist to the Smith Manoeuvre strategy that maximizes the tax and investment return on your leveraged portfolio.
He calls this strategy “The Rempel Maximum“. If this is the first time you are hearing about the Smith Manoeuvre, it is basically a financial strategy that converts your non-deductible mortgage into a tax deductible investment loan. You can read more about it my article “The Smith Manoeuvre: A Wealth Strategy“.
How exactly does “The Rempel Maximum” work?
- The “Rempel Maximum (RM)” is a variation of the Smith Manoeuvre (SM) that maximizes both your tax and potential portfolio return while using $0 of your own cash flow. When you use the SM, you will get a small increase in your HELOC balance as you pay down your mortgage which is then used to invest. With the RM, instead of using the small increase to invest, you use the increase to fund your investment loan/HELOC. This may result in obtaining an additional investment loan depending on the size of your principle payment. More on this below.
- This way, you get the tax deduction from the HELOC along with the tax deduction from the investment loan. Canadian tax rules state that you can deduct the interest from a loan that supports an investment loan.
- On top of that, you’ll have a large balance to work with initially to take advantage of compounding returns and time.
How is it implemented?
- You’re probably wondering how large of an investment loan can you obtain? According to Ed Rempel:
For example, if your mortgage payment pays $500/month of principal ($6,000/year), you divide the $6,000 by the interest rate (say 6%), which gives you $100,000. You increase the credit line limit on your readvanceable mortgage to 80% of your home value, which is often done for free at the major banks. Then you borrow and invest up to the credit line limit. If there is less than $100,000 available, then you finance the rest from an investment loan.
- Based on the above example, the banks will give you [principle payment/interest] as your maximum investment loan including your HELOC. Depending on how much equity you have in your home, you could end up with a fairly large investment loan.
What are the risks involved?
- This strategy uses the maximum leverage available to you based on your principle payments or how much your credit line is readvanced with every payment. Needless to say, the investor must be aggressive, comfortable with risk, and experienced with investing.
- As you probably already know, leverage amplifies your returns, good or bad.
What are the potential returns? How does it compare to the regular Smith Manoeuvre?
- Using the maximum available loan amount potentially means higher returns or bigger losses. If you are investing for the long term 25+ years, then your overall losses will most likely be minimized.
- Below is an example from Ed Rempel:
They have a home worth $400,000 and a mortgage of $200,000 at 5% and are paying $1,169/month (25-year amortization). They can reborrow at prime of 6%, the investments average 10% long term and they are in a 40% tax bracket. Each mortgage payment pays down $336 of principal x 12 months / 6% = $67,200. Since they have more than the $67,200 in available credit in their SM credit line, they can borrow this $67,200 to invest. The interest payment is $336/month which can be paid entirely from the SM credit line each month. Additional benefit of the Rempel Maximum over the SM: After 25 years: $410,000* Total benefit of the Rempel Maximum: After 25 years: $718,000
Who should use this?
There are 3 criteria that a person should consider before implementing this strategy:
- The investor must be experienced and comfortable with risk.
- The RM works best if your initial HELOC balance is small. ie. Someone who is just starting the Smith Manoeuvre with a little over 25% in equity.
- The investor must be in this for the long term, 20+ years.
The Rempel Maximum is a way to maximize the potential returns from implementing the Smith Manoeuvre through the additional tax deduction and increased leverage. This can be an extremely powerful and lucrative strategy if used properly over the long term.
If you are considering using this strategy twist to the Smith Manoeuvre, make sure that you are comfortable with the maximum leverage applied to your portfolio. Feel free to ask your questions in the comments section, Ed Rempel has agreed to help explain the details if requested.