Readvanceable Mortgage

AAA

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.

INVESTOPEDIA EXPLAINS '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.

VIDEO

RELATED TERMS
  1. The Smith Maneuver

    A strategy that makes interest on a residential mortgage tax-deductible ...
  2. Mortgage Interest Deduction

    A common itemized deduction that allows homeowners to deduct ...
  3. Future Advance

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

    An arrangement between a financial institution, usually a bank, ...
  5. Reverse Mortgage

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

    A line of credit extended to a homeowner that uses the borrower's ...
Related Articles
  1. Calculating The Mortgage Interest Tax ...
    Home & Auto

    Calculating The Mortgage Interest Tax ...

  2. How Line of Credit Works
    Credit & Loans

    How Line of Credit Works

  3. The Smith Maneuver: A Canadian Mortgage ...
    Personal Finance

    The Smith Maneuver: A Canadian Mortgage ...

  4. Tax Deductions On Mortgage Interest
    Taxes

    Tax Deductions On Mortgage Interest

comments powered by Disqus
Hot Definitions
  1. Effective Annual Interest Rate

    An investment's annual rate of interest when compounding occurs more often than once a year. Calculated as the following: ...
  2. Debit Spread

    Two options with different market prices that an investor trades on the same underlying security. The higher priced option ...
  3. Odious Debt

    Money borrowed by one country from another country and then misappropriated by national rulers. A nation's debt becomes odious ...
  4. Takeover

    A corporate action where an acquiring company makes a bid for an acquiree. If the target company is publicly traded, the ...
  5. Harvest Strategy

    A strategy in which investment in a particular line of business is reduced or eliminated because the revenue brought in by ...
  6. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
Trading Center