Readvanceable Mortgage


DEFINITION of 'Readvanceable Mortgage'

A mortgage feature that allows the borrower to re-borrow the principal amount of the original mortgage that has been paid down. A readvanceable mortgage consists of a mortgage and a Line of Credit (LoC) packaged together. With every monthly mortgage payment made by the borrower, the mortgage principal is reduced by a certain amount; the funds available to the borrower under the LoC go up by the same amount and are generally re-borrowed automatically. While the borrower’s net debt remains the same, the interest payments on the LoC are tax-deductible in Canada if the borrowed amount is used for investment purposes. The readvanceable mortgage forms part of a tax strategy called the “Smith Maneuver” that is designed to make interest payments on Canadian home mortgages tax-deductible.


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BREAKING DOWN 'Readvanceable Mortgage'

For example, assume a homeowner takes out a readvanceable mortgage for $250,000, with an amortization period of 25 years and a mortgage interest rate of 5%. The monthly mortgage payments are approximately $1,460, of which part constitutes mortgage principal repayment and the balance mortgage interest. If the first mortgage payment of $1,460 comprises $460 in principal repayment and $1,000 in interest, then the amount that can be re-borrowed by the homeowner under the LoC is $460. At the end of the first year, if the mortgage principal that has been repaid totals $6,000, the amount available to the homeowner under the LoC is $6,000.

The rationale for taking out a readvanceable mortgage is that the funds available in the LoC should be deployed immediately in investments. This would make interest payments on the LoC tax-deductible, unlike interest payments on mortgages that are not tax-deductible in Canada. This tax-deductibility of LoC interest may result in a tax refund when filing a Canadian tax return. This refund can be used to pay down the mortgage principal, thus accelerating its repayment.

A readvanceable mortgage has some drawbacks. First, the homeowner’s net debt remains the same after many years, rather than being paid down as it would be with a conventional mortgage. Second, use of this strategy requires investment acumen and strict fiscal discipline. The homeowner has to invest the re-borrowed amounts judiciously and not fritter it away on frivolous purchases. Third, the LoC interest rate is typically significantly higher than the interest rate on the mortgage component.

  1. The Smith Maneuver

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  2. Mortgage Interest Deduction

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  3. Future Advance

    A clause in a mortgage which enables the lender to advance funds ...
  4. Home Equity Line Of Credit - HELOC

    A line of credit extended to a homeowner that uses the borrower's ...
  5. Reverse Mortgage

    A type of mortgage in which a homeowner can borrow money against ...
  6. Line Of Credit - LOC

    An arrangement between a financial institution, usually a bank, ...
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