How the Smith Manoeuvre works, month by month

Described as a loop it sounds abstract. Described as a month it is four transactions, only two of which you have to do anything about. This page walks that month, then the ones after it, and says which parts the lender performs and which are yours.

The one moving part

A readvanceable mortgage is a Canadian product that combines a mortgage with a credit line whose limit re-advances as mortgage principal is repaid. Every principal payment frees the same amount of borrowing room, which is the mechanism the Smith Manoeuvre re-borrows and invests. Common examples are RBC Homeline, Scotia STEP and Manulife One.

Everything else in the strategy follows from that single product feature. Without a limit that re-advances there is no new borrowing room each month, and without new borrowing room each month there is no conversion to run.

The month you start

Four things happen, in this order:

The mortgage payment leaves your chequing account. It splits into an interest portion and a principal portion, as every mortgage payment does. Only the principal portion matters here.
The credit line’s limit rises by the principal portion. The lender does this automatically on a readvanceable product — the sub-account limit tracks the mortgage balance down as it is repaid. Nobody calls anybody.
You draw the newly available room and move it to a non-registered investment account. This is the step that is yours, and it is the step that has to be recorded: the date, the amount, and what the money then bought.
You buy an income-producing investment with it. The use of the borrowed money is what supports the interest claim, so the purchase and the draw belong to each other and should be dated close together.

Note what has not happened. Your total debt is unchanged: the mortgage went down by the principal portion and the credit line went up by the same amount. What changed is the character of that slice of debt and the paperwork now attached to it.

Every month after that

The same four steps, with two additions that compound.

The first is the credit line’s own interest. It accrues on a rising balance and is payable monthly. Pay it from your chequing account, never by letting it capitalise onto the line — a balance that grows by its own interest is a balance whose principal no longer matches the sum of the investment draws, and reconstructing which is which years later is the problem the record-keeping page is about.

The second is the refund. Interest paid on the line is claimed as a carrying charge on your return, so a return that would otherwise have balanced now produces a refund roughly equal to that interest multiplied by your marginal rate.

Where the refund goes

Against the mortgage principal, as a lump-sum prepayment.

That is the whole of the accelerator, and it is worth being precise about why it works. A prepayment reduces the mortgage by its full amount immediately, which frees the same amount of credit-line room immediately, which is drawn and invested in turn. So the refund does not merely shorten the amortisation — it advances the conversion by a year’s worth of interest, every year, and the effect grows as the deductible balance grows.

Two constraints on it. Prepayment privileges are capped by the mortgage contract, usually at some percentage of the original principal per year, and a refund is not certain: it depends on the rest of your return. Both are reasons the projection is a projection. Run it against your own numbers rather than against the defaults, and read the assumption set printed under the result.

How does the Smith Maneuver work if my mortgage is not readvanceable?

It does not, without a refinance. The strategy needs a credit limit that grows by the exact amount of principal you repay each month; an ordinary home-equity line has a fixed limit that does not re-advance. Converting to a readvanceable product usually means breaking or renewing the mortgage.

What this page leaves out

Deliberately, two things. It does not tell you whether the arrangement is a good idea — that turns on leverage you can carry through a drawdown, and on what the strategy costs when it goes wrong. And it does not tell you what your own interest claim looks like, which depends on facts about your return that no page can see. The mechanics above are the same for everyone; the strategy in full puts them next to the conditions and the arithmetic.