A readvanceable mortgage is a type of mortgage that allows the borrower to add a line of credit to the loan which allows the borrower to re-borrow any part of the principal paid down. Essentially it is a mortgage packaged together with a home equity line of credit or HELOC. As the borrower repays their mortgage, the amount of credit available to them increases with each principle payment so the net debt remains the same. In a traditional mortgage, as a borrower makes regular mortgage payments a portion of the principal loan is repaid which decreases the loan amount and net debt of the borrower (the other portion of the monthly payment pays the interest.) With a traditional mortgage if you need access to cash through the equity in your home you would have to do a refinance.
Mortgage loans are typically at a lower interest rate than a line of credit balance so this can be risky if the borrower is not disciplined with how they use the re-borrowed funds as they will want to mitigate the impact of the higher interest rates on the line of credit portion.
A readvanceable mortgage may be used to make mortgage interest tax-deductible in Canada, via the so-called Smith Maneuver.
Under Canadian law, interest payments on reborrowed funds under a readvanceable mortgage can be tax-deductible so long as the reborrowed funds are used for investment purposes. This is a crucial mechanism of a Canadian tax strategy known as the Smith Maneuver, which exists to make home mortgage interest payments tax-deductible in Canada.
While the borrower is usually free to spend their line of credit as they choose, the Smith Maneuver strategy tends to be the recommended rationale for taking out a readvanceable mortgage in the first place. By reinvesting the line of credit funds and taking advantage of Canadian tax-deductions on the interest, a savvy borrower can profit from those investments, while simultaneously deducting interest when filing taxes, increasing the potential tax refund for that year. That refund can then be used to pay down the loan principal, which can accelerate the overall time to repay the mortgage.
Example of a Readvanceable Mortgage
If the borrower had a Readvanceable mortgage for $300,000 with an interest rate of 4% and an amortization period of 25 years, the monthly mortgage payments would be approximately $1,578. In about year 13 the amount of the monthly payment that would go to principle would be approximately $1,000 so the borrower may re-borrow $1,000 per month or $12,000 per year in funds available under their line of credit. The homeowner can reinvest that $12,000 and that interest is tax-deductible at the end of the year if the funds are used for investment purposes through the Smith Maneuver. Funds from the tax return can then be used against the loan principle, reducing the overall principle at a greater rate.
Questions? Contact me at mia@mortgagesbymia.ca or 306-291-3817