Unlocking the Power of Readvanceable Mortgages: How They Work and Why They Matter

Julia Kagan is a seasoned financial journalist and former senior editor for personal finance at Investopedia.

Understanding Readvanceable Mortgages

A readvanceable mortgage is an innovative home financing option that merges a traditional mortgage with a home equity line of credit (HELOC). This unique structure allows borrowers to re-borrow any portion of the principal they have repaid, providing ongoing access to funds as they pay down their mortgage.

Key Highlights

• Combines a mortgage loan and a line of credit into one flexible financial product.
• Credit availability increases as the mortgage principal is repaid.
• Enables potential tax-deductible mortgage interest payments in Canada through the Smith Maneuver.

How Readvanceable Mortgages Function

Unlike traditional mortgages where principal payments reduce your debt, a readvanceable mortgage replenishes your line of credit by the amount you repay on the principal. This means while you lower your mortgage balance, your available credit grows, often at a higher interest rate. As a result, your overall net debt may remain unchanged, which can be less appealing to some investors.

In Canada, interest on reborrowed funds can be tax-deductible if those funds are invested, forming the basis of the Smith Maneuver—an effective tax strategy designed to convert non-deductible mortgage interest into deductible investment loan interest.

The Smith Maneuver Explained

Developed by financial planner Fraser Smith from Vancouver Island and popularized through his 2002 book, the Smith Maneuver is a debt conversion approach. It aims to accelerate mortgage repayment, generate tax refunds, and build wealth by reinvesting borrowed funds while leveraging tax-deductible interest.

Though borrowers have freedom in using their line of credit, the Smith Maneuver encourages reinvesting these funds to maximize tax benefits and grow investments. Tax refunds generated from deductible interest payments can be applied to reduce the mortgage principal faster, shortening the loan term.

However, because the principal is reborrowed, the homeowner’s net debt may not decrease as with standard mortgages. Success with this strategy requires financial discipline and savvy investment decisions to offset higher interest rates on the credit line.

Important Considerations

The Smith Maneuver isn’t suitable for everyone. It carries risks depending on your financial goals, investment expertise, risk tolerance, and economic conditions. Consulting a financial advisor before proceeding is highly recommended.

Example Scenario

Imagine a homeowner with a $250,000 readvanceable mortgage at 5% interest over 25 years, paying approximately $1,460 monthly. If $460 of that payment reduces principal, the borrower can re-access this $460 monthly through the line of credit. After one year, $5,520 becomes available to invest.

Even if the line of credit interest rises to 10%, the interest paid is tax-deductible. The resulting tax refund can then be applied to the mortgage principal, accelerating debt reduction.

Smith Maneuver and U.S. Tax Laws

The Smith Maneuver is tailored to Canadian tax regulations and does not apply in the U.S., where mortgage interest is already tax-deductible.

Readvanceable vs. All-in-One Mortgages

Both products blend mortgage and home equity access, but all-in-one mortgages integrate a bank account that offsets mortgage principal with any surplus funds, potentially reducing interest charges more directly.

Is the Smith Maneuver a Safe Strategy?

Because the strategy involves investing borrowed funds, it carries inherent risks including market fluctuations and potential declines in property value. Professional financial advice is crucial before adopting this approach.

Final Thoughts

Readvanceable mortgages offer flexible borrowing by allowing re-borrowing of paid principal through an integrated line of credit. In Canada, the Smith Maneuver leverages this feature to convert mortgage interest into tax-deductible investment loan interest, potentially speeding up mortgage payoff and building wealth. While promising, this strategy demands careful consideration of risk tolerance and financial planning.

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