ARTICLE: You and Your Mortgage, Part 1

Good Evening, fellow consumers.

Our slightly late instalment for this evening comes as a response to the unexpected drop in Bank of Canada's key lending rate this past week. Another of the many questions we're frequently answering for our clients involve changes in lending rates, and what it means for their lives, going forward.

In the past eight months, there has been a sharp increase in mortgage refinances and early renewals. Why? Canadians are visiting their branches (and other banks), looking for a new lower-cost alternative for their home financing.

Have you reviewed your mortgage? Have you visited your branch to see what they're willing to do to save you money? To keep your business? What we're going to cover today are the basics of lending rates, and what they mean for you and your existing mortgage. In our three-part report on mortgages, we're going to explore Real Estate Lending and how to save you money.

Tonight, we're going to explore the basics: Mortgage Rates, and types of Residential Mortgages.

Rates and Terms

First, mortgage rates and mortgage terms. It's worth exploring what kind of rates are generally available on different kinds of financing options, as well as what influences changes in those rates, and what you can do to take advantage of those changes to your benefit. It's also worth looking at the role that your mortgage term can play in your financial planning, and how you can decide which is best for you.

The rates that are available at any bank depend on the kind of mortgage. That's right, there are different kinds. Fixed, Variable, Open, Closed, Convertible. It's sometimes difficult to keep them straight! So let's make our first step to explore what all of these mortgages are.

The "term" is the period of time for which that rate is guaranteed. For example, a 5 Year Fixed Rate mortgage is one where the rate is set and guaranteed ("fixed") for a period of five calendar years. It won't change, even if the rates available for fixed rate mortgages change during that time. You have a choice in your term. Major Financial Institutions will typically offer terms between 6 Months and 10 Years. (Usually 6 Months, 1, 2, 3, 4, 5, 7, 10 Years).

"Which term should I choose?"

The term that's the most beneficial for you depends on your personal situation, your willingness to risk your rate, as well as how long you plan to stay in the property. There's something else to keep in mind aside from these considerations: sometimes it's worth arbitrarily taking a common rate, like 4 or 5 Years, in order to obtain a low rate. Or, take a shorter term to try and take advantage of rate changes. Or again, take a longer term to try and hold onto a rate guarantee for as long as possible. There are many other factors that go into whether a particular term works better for you, so let's explore them:

• Short-Term Mortgages (6 Month, 1-3 Years)

These are best suited for a few different types of individuals:

Do you plan on selling the house in only a few years? These are perfect for those of you who definitely plan on staying in your property for a short period of time. Why? It means that if you want to pay out the mortgage (and in doing so, break the term early), your PrePayment Charge will be lower. (we'll explore this in detail later)

Are you open to the possibility (and pitfalls) of market volatility? Having a short-term mortgage does also mean that if there are rapid changes in the market and economy over a short amount of time, mortgage rates may fluctuate rapidly during that short period, meaning you may be able to save more money by essentially "holding out" for rates to go lower during a short amount of time. However, you may end up having a higher rate than you did originally as well.

• Common Mortgages (4 and 5-Years)

4 and 5 Year mortgages are the most common, and as such, having a rate locked for a common term such as 4 or 5 years also does a number of things for you:

You have rate security for a moderate amount of time, without being locked in for a long term such as 7 or 10 years. Having a long term mortgage means that you're committing yourself to a rate over a lengthy amount of time, during which you could see rate changes that you otherwise would have been able to take advantage of.

As mentioned already, since these terms are the most common, the best rates are usually available on 4 and 5 Year Mortgages. If you give even a casual glance at mortgage rates offered by financial institutions and other mortgage lenders, you will notice that they will primarily compete on their 4 and 5-Year Mortgages.

If your primary concerns are cost savings, consider taking a term that comes with a low rate.

• Long-Term Mortgage (7-10 Years)

The primary advantage to these considerably long terms is the fact that you're getting long-term rate security. For up to a decade, you can have your mortgage rate locked, and have long-term peace of mind.

However, these mortgage terms are comparatively rare to shorter terms. While you have considerable rate security, there are a few downsides as well. Primarily, financial institutions will not compete on these rates to a great degree simply because they aren't in high demand. Also, the rates are usually much higher than the shorter term and common mortgages.

Even in volatile times such as the present, when rates are changing often and projections put rates on an increase with expected inflation over the next 2 to 5 years, thus far in our experiences there has not been a trend away from the common mortgage terms, when many consumers are looking for more rate security than in the past.

If you're looking for long-term security, and plan on being in the property for a long time, this can be beneficial for you, but the rate security may be a trade-off against having the flexibility to take advantage of lower rates sooner.

These are the kinds of terms that are available. From short to long term, there are various advantages (and disadvantages) to each. The one that's best for you is the one that fits with your personal willingness for rate risk, as well as how long you plan on staying in the house.

"What rate is best for me?"

Next, we will explore what kinds of rates you can get over those terms. Mortgage "types" are categorized into the type of rate that you have- either fixed or variable. A fixed-rate mortgage gives you the rate security the we talked about above with regards to terms. A variable-rate mortgage fluctuates with your bank's Prime Rate, and while it offers no such security, the rate is often lower than a fixed rate.

• Fixed-Rate Mortgage

This is the most common kind of mortgage. A "fixed rate" means that your rate is guaranteed until the end of your mortgage's term (see our discussion of terms above if you're not clear), and won't change unless you break the mortgage entirely, or unless it comes up for renewal.

What's in it for you? A Fixed Rate Mortgage is ideal for those of us who prefer not to be open to market volatility. The fixed rates that are available are, in one way or another, influenced by changes in the market, and will change multiple times throughout the year. If you can imagine it, over five years, mortgage rates make change several dozen times.

A fixed rate mortgage is beneficial for someone who wants rate security and predictable payments. If your rate doesn't change, it means that the amount of interest you pay doesn't change, which means that your averaged monthly payments will be the same.

• Variable Rate Mortgages
  

Variable-Rate Mortgages are also very common. A "variable-rate" mortgage means that the rate will change over the length of the term. Why? Variable interest rate mortgages are based on a bank's Prime Rate, which is the lowest rate at which the bank lends to consumers.

With Prime Rates being the lowest in ten years, financial institutions are largely not giving discounts on these mortgages, whereas in the past discounts were available with negotiation. Variable Rate mortgages are generally working on "Prime Plus", meaning the interest rate is an institution's Prime plus a small fixed rate.

• For example, a Five Year Closed Variable Rate Mortgage may be at "Prime + 0.80%", meaning that it will always be 0.80% over whatever that institution's Prime Rate is.
  

We will get into Prime Rate in a moment. A Variable Rate mortgage has a number of advantages. First, it's generally always lower in face-value rate than what the posted Fixed Rate Mortgages are advertised at. If market conditions influence a change in Prime downwards, your interest cost and rate go down. Similarly, however, your rate can go up!

This last possibility is the largest disadvantage to Variable Rate mortgages. However, depending on whether you have an Open or Closed mortgage, you may have the opportunity to lock in your rate based on what Fixed mortgage rates are available.


Pre-Payment Policies


To continue on that thread, next we'll explore Closed and Open mortgages. This refers to the Pre-Payment Policy that's attached to your mortgage. What's a Pre-Payment Policy? It's exactly as it reads. It's the policy as written by your bank that controls how much you can put against your mortgage in lump sum payments (or pre-payments) per calendar year.

• Closed Mortgage
  

The majority of mortgages offered by Canadian financial institutions are Closed mortgages. Your Closed Pre-Payment Policy is expressed as a percentage of the original amount that the bank advanced for your mortgage, and is most often between 15% and 20%. For example:

Let's say you opened a closed mortgage in the amount of $300,000.00, and your pre-payment policy allows for 15% down payments. This means you can put up to $45,000.00 per calendar year against the principal amount of the mortgage, which is the amount that you owe.

There's a definite advantage to being able to make lump sum payments against your mortgage. It lowers the amount you owe immediately, as lump sum payments go directly against the principal, which is the amount you actually owe.

Doing such a payment doesn't pay your interest down for you, but because of the lump sum payment, your interest cost becomes lower. Why? You're paying off a smaller mortgage!

However, there is another side to a Closed Pre-Payment Policy. If you re-finance a Closed Mortgage, you're essentially paying the entire mortgage out in full so that it can be replaced by another one. Paying out a mortgage in full is obviously more than 15% or 20%! This is usually referred to as "breaking" your mortgage.

If you break this mortgage early, either by re-financing or paying it out, you incur a Pre-Payment Penalty. This is very important to research and keep in mind when deciding whether or not to refinance or to pay out your mortgage early (aside, of course, from selling the property).

"Is this right for me?"

The majority of Canadian mortgagors have Closed mortgages, and they are exceedingly common versus an Open mortgage. The primary reason for this is that Open mortgages, which we will explore next, do not have a lot of diverse rates available.

If your primary concern is to have a lower rate for a period of time, and you're not really planning on leaving the property, take a Closed Mortgage, since the rates are generally always better.

• Open Mortgage

An Open Mortgage is the exact opposite, and it's very simple to explain. You have a 100% Pre-Payment Policy, which means you can pay any amount against the mortgage at any time, without penalty. You could pay out the entire mortgage the day after advancing it, without paying any penalty.

Open Mortgages are best suited when you plan on keeping the property for a very short amount of time, or if you want to have constant flexibility to refinance. Having the flexibility to pay off your mortgage early via an Open Mortgage generally reflects a short-term need, rather than a long-term need for financing by consumers. As such, low rate security is usually not a primary concern. This is a very flexible option, however, the rates are almost always going to be higher, and you won't have as many terms available to you.

Let's be objective. Since these mortgages offer no guarantee to the bank that they will have sustained revenue for a fixed period of time, the available rates will be much higher than they would be for Closed Mortgages.

Always consult a mortgage specialist if you're concerned about whether an Open Mortgage would be right for you. As we've just explored, they are very different from other mortgages, and should only be used as a financing option when it will actually benefit you for a short amount of time.

That's all we have for our first instalment on Mortgages. Tonight we explored the differences and benefits between short and long terms, fixed and variable rates, as well as pre-payment policies. As always, we encourage responses, questions, concerns, and constructive opinions on our content.

In our next instalment, we'll be looking at Re-Financing. Watch for it!

ARTICLE: Tax-Free Savings Accounts (TFSA)

With our first informative post, we're going to cover the newest opportunity for the Canadian banking public to maximize their investments and save money on taxes. We're speaking of the Tax-Free Savings Account, a new type of Registered investment vehicle that was premiered this year as part of the federal budget.

The most common questions we tend to receive regarding the TFSA are usually, "How does it work?", and often in quick succession, "Is this right for me?". In today's post, we'll explore both of those questions, and help you make an informed decision as to whether this account is right for you.

Who Can Have One?

Any Canadian citizen over the age of 18 with a Social Insurance Number.

How Does It Work?

The Tax-Free Savings Account isn't exactly an account in the strictest sense of the word. What we mean by that is, it isn't just an account (like a regular Chequing or Savings account) that one would simply dump money into to gain interest.

In fact, what most Canadians don't know, is that you can have a Tax-Free investment in any vehicle you want to: a savings account, GICs, mutual funds, even stocks, through a brokerage account. One is able to invest any way they want to, in any kind of investment that fits their preferred method of savings and investing.

What's in it for you? Typically, you pay tax on your investment income and interest. Every year, each financial institution you hold a Non-Registered investment or savings account in will send you a T-slip for all of the interest earned on your investments in the previous tax year. With this account, you can deposit up to $5000.00 CAD per year into an investment or savings account registered as a Tax-Free Account.

• A Non-Registered Investment is (generally) anything that isn't part of your Retirement Savings Plan. You don't pay taxes immediately on RRSP investments, because RRSPs are tax-deferred, meaning you don't pay taxes on those investments until they're withdrawn, and in contributing to your RRSPs, you don't pay income taxes on that money you contributed out of your pocket.
  
• Your savings accounts, GICs, stock trading accounts, and mutual fund investments that aren't part of your RRSP are generally considered to be Non-Registered Investments.
  

This gets factored into your tax calculations, and affects the amount of your income tax return. Any investment income, interest, or capital gains you make within the TFSA are non-taxable. Essentially, the financial institution doesn't issue a T-slip for whatever gains you make inside the account.

Therefore, you pay less taxes on your investment income. Therefore, it saves you money.

Seems too good to be true, doesn't it?

It does, but there are limitations to the account in how it operates:

1) Contribution Limits

The primary limitation to the TFSA is the limited amount of money one can deposit into it. The Federal Government is setting an annual maximum contribution limit of $5000.00. Meaning, one can only deposit $5000.00 new dollars into the account or investment per calendar year.

Here's how it works:

• January 1st, 2009: The Annual Limit for 2009 is set at $5000.00
  
• January 2nd, 2009: I deposit $3000.00

In this example, after my initial deposit of $3000.00 new dollars, I have a further $2000.00 that I could potentially deposit into a TFSA.

$5000.00 2009 maximum
- $3000.00 contribution
= $2000.00 remaining

"Do I lose my contribution room if I don't deposit the $5000.00 maximum?"

No. It's carried forward to what you're allowed to contribute the following year. Let's go back to our example:

• January 1st, 2009: The Annual Limit for 2009 is set at $5000.00
• January 2nd, 2009: I deposit $3000.00

• January 1st, 2010: The Annual Limit for 2010 is increased by $5000.00. My remaining contribution from 2009 carries forward, meaning I can deposit up to $7000.00 in 2010.

$5000.00 2009 maximum
- $3000.00 contribution
= $2000.00 remaining

Then...

$5000.00 2010 maximum
+ $2000.00 2009 unused contribution room
= $7000.00 maximum contribution room

"Can I withdraw from the account or withdraw the investment?"

Yes. However, the limitations of your investments still apply. For example, if you're cashing a GIC, typically you pay a penalty to break it early, or in the case of a stock or a mutual fund, it needs to be sold at its current market price, which may be lower than what it was when you purchased it.

Also, and this is very important, any withdrawals you make from the TFSA affect your contribution room. What you withdraw you do get back in contribution room, but not until the following year. In our previous example, we showed how contributions work:

$5000.00 2009 maximum
- $3000.00 contribution
= $2000.00 2009 contribution room remaining

At this point, we have $3000.00 in our tax-free investment or account. Now let's make a withdrawal of $1000.00

$3000.00 balance in TFSA
- $1000.00 withdrawal
= $2000.00 balance in TFSA

Now, it looks like we should have an extra $1000.00 in contribution room, because there is now less money in the account. However, remember what we mentioned above: your annual contribution room is measured by deposits of new dollars. Meaning, in our example, we've already deposited $3000.00 for 2009, and therefore, can only contribute a further $2000.00 in 2009.

Now, let's see what things look like for 2010. First, let's go back to our example on how contributions affect our carry-forward room:

$5000.00 2010 maximum
+ $2000.00 2009 unused contribution room
+ $1000.00 2009 withdrawals
= $8000.00 maximum 2010 contribution room

You get your contribution room back after withdrawing from the account or investment, but you can't use it until the following year.

"Does my investment income or capital gains influence my contribution room?"

No. Only your original investments are measured into the contribution room. Your investment income and capital gains are not.


2) Is It Right For Me?

As impressive as the TFSA is as a tax-saving device, if you can believe it, it's not for everyone. The suitability of a particular investment vehicle depends on each and every person. It can be said generally that there are many trends and generalizations to how people invest, based on their investment experience, their time horizon (meaning, when in the future they plan to use the funds they're investing), and most importantly, where they are in their lives. All of these things influence how different investment vehicles have different suitabilities for each person.

First, let's look at how suitable it is depending on how long you want to invest those funds for:

Short Term Investing:

Short-term investing is generally understood as investing without definite time horizon, or investing specifically to have funds available after a fixed period of time that's one year or less. Short-term investors want a lot of liquidity in their investment- meaning they want it cashable and available in cash in very short order without penalty. If you want somewhere to temporarily park some funds for a specific purpose (say, a major purchase), the TFSA may not be right for you.

Why?

Think about the contribution room. In a very short amount of time, you'll deposit money into the account or investment, make some interest or gains (hopefully), and withdraw it. If this is all done in less than a year, you'll eat away at your contribution room quickly, and won't be able to replace the funds right away. Let's face it, an account or investment vehicle that you can't put money into is pretty much useless.

If your intention is to save or invest for a very short time, the TFSA is probably not right for you. Consider a regular Non-Registered savings account or investment.

Long-Term Investing:

Long-term investing is generally understood as being anything two years or more, where one doesn't necessarily want a lot of liquidity in what they've invested in. This is money they're parking into an investment or account either for no specific purpose in the short term, or for something specific in the future (a major purchase, perhaps).

This is where the account really begins to benefit its users. Long-term investors prefer to be able to continually put money aside and invest it for their desired purpose. While the limits on contribution room does make the TFSA a little inflexible, it does give a long-term investor the ability to top up that investment with each increase in the contribution room over many years.

When we look at how the TFSA operates, it's really the way contribution room is handled that decides who would benefit the most in terms of time horizon. Why would you put your money into something you could only use once per year (assuming you were to maximize your contributions)?

Next, let's look at the TFSA in terms of what you want to invest in:

Savings Accounts

Every financial institution offers savings accounts; accounts with no maximum contribution room, that offer a fluctuating rate of interest, often with a minimum balance needed to gain interest at all. Using your TFSA as a savings account benefits you if you want to deposit funds on an ongoing basis in instalments. (say, $50 or $100 every paycheque, for example). It gives you the flexibility to deposit as little or as much as you want to up to your maximum for that year, with no minimum deposit necessary.

If your intention is to have something you can occasionally toss funds into, on a regular or irregular basis, the TFSA as a Savings Account is right for you. First, it gives you that flexibility to put as much as you want into it upwards of your maximum contribution room in any amount you want to. It's very flexible, there's typically no minimum balance to gain interest, and major financial institutions have (thus far) priced the interest rates higher than other savings accounts.

However, you also need to keep your contribution room in mind. The other side of having this flexibility and liquidity is that you can also withdraw funds at any time. It was mentioned above that if you plan on using these funds on an occasional basis, i.e. only saving for a short term before using the funds, this will not benefit you.

• An ideal solution to this scenario is to use a regular Non-Registered savings account.
  

Any interest you make on the balance is not taxed.

GICs

GICs (or Guaranteed Investment Certificates) are offered by every financial institution for investors who want security in their investments, and want to make those investments in lump sums. Your original deposit (often referred to as the 'Principal Investment') is guaranteed, and you are also guaranteed an interest rate over a prescribed period of time (say, 2% for two years).

If your intention is to throw a lump sum of money into an investment and not have to worry about the market affecting that investment, a GIC is right for you. The important thing to keep in mind is that GICs do have minimum investment limits, typically of $500.00 to $5000.00 depending on the bank. If you are dropping a large sum of money into an account for a long period of time, and don't want to risk that money, a GIC is right for you.

Any interest you make is not taxed.


Mutual Funds & Stocks

Mutual Funds are, in a general sense, bank-controlled professionally-managed fund portfolios that invest in particular markets or sectors, and the those funds are made up of multiple major companies from those sectors. They can be purchased in units at a price per unit, and each unit will be made up of securities held in those companies. The big plus side is that since they're purchased in great volume by the bank for those funds, it's actually cheaper to purchase investments in particular sectors or companies through mutual funds, since the cost per unit is lower.

Mutual Funds are affected by the market, so there is the possibility that your original investment will be affected by fluctuations in the market. That being said, you also have a much greater potential for return on your investments if the market fluctuates in your favour.

Typically, you pay taxes on capital gains, which are the proceeds you gain from selling your funds or stocks at a profit over what you bought them at. This is where the TFSA really begins to shine.

Why?

The market is not predictable. The returns on your investments are also not predictable. With something like a GIC, you know exactly what you'll get out of it. With a fund or stock, you don't, but you generally hope and expect it to perform better than what it was when you bought it. Your stock or fund value could double overnight, and you'd pay for that gain. The TFSA means you don't have to.

Funds and stocks have the greatest opportunity to gain value, and as such, this is where your greatest potential tax savings are. If you're the kind of investor who prefers to put money into the open market, a TFSA Mutual Fund or Brokerage Account is right for you.

Any capital gains you make are not taxed. By the same token, you can't claim any capital losses.

Conclusions

Hopefully this was useful to some of you. The TFSA is nothing short of a convoluded investment and savings vehicle that may leave you second-guessing its usefulness. It is not right for everyone- no investment or savings vehicle is. However, with some of the examples we've just illustrated above, the account can be useful for you, depending on what kind of an investor you are.

Any questions or comments, please leave them below!

Introduction

Good morning, afternoon, and evening.

Welcome to the first post on what will be a comfortable, informative, and professional editorial on the Canadian financial system. It is written as a collaborative effort from financial advice specialists from major Canadian Financial Institutions. It is our collective intention to create a simplistic, easily digestible guide to banking, investing, borrowing, and financial planning for Canadian readers.

It's worth exploring where this idea was born, and why we felt it was necessary to create. As advisors in major financial institutions during these difficult times, we have generally noticed that Canadians are coming to terms with what can only be called a "past impassiveness" toward their own finances. Where they had previously ignored or had never inquired on how their portfolios worked, the public is taking notice, paying attention, and beginning to educate itself on their investments, their credit devices, even their daily banking accounts. They are taking charge in a general trend towards self-directed investing, and more personalized control over personal finances has begun to emerge in the Canadian market; a fast awakening sparked by the declaration of Recession.

It must be noted, however, that the federal declaration of Recession was not as much the cause of this rapid awakening, but moreso a solidification of economic and financial fears. In my own experience, this awakening slowly began over the summer and autumn of 2008, when the "Credit Crisis" in the United States began to manifest itself publicly, and major American financial institutions began to show weakness. The prospect of having one's own bank fall out from underneath them encouraged Canadians to re-familiarize themselves not only with the operation of the Canadian financial system, but the operation of their own financial products and services.

With an increased traffic flow to branch-level offices, we began to notice trends in questioning from our clients. "How does this work?" "How safe am I?" "How can I make this do better?" "How can I save?" "I heard that..."

All of these quotes, preceding questions about investments, daily banking, credit, and other technical concerns, were and still are very common. "How can I save money on my mortgage?" "How does this savings account work?" "How can I make my investments perform better?" "How safe is this investment?"

In your questions, this concept was born. Take our experience, our coaching, our advice, and deliver it to a mass audience. This is our primary mission statement. We will be objective, technical, simply-spoken, and encouraging. Will we give you financial advice? Generally, yes. We say "generally" because there is no catch-all maxim for investing, saving, and planning. The right financial plan is different for each person. However, what we will recommend are financial solutions for situations that are common across the Canadian public. We will not give you detailed financial advice, but rather will seek to educate you and encourage you to visit your bank with more information under your belt than you may have otherwise.

Those people in the offices at your local branch are there for a reason; they are paid to advise you in the best manner possible. They aren't paid on commission, they make no extra money from your investments or your mortgage. Use our experience and theirs to your benefit, and make the most out of your time with them.

We encourage comments, recommendations, and constructive criticisms. You expect us to be professional- we request the same.

Check back often! We're hoping for frequent updates as time allows. Here begins your financial education!

Read this blog and be informed. It is your right as borrowers, savers, spenders, and investors to know how to be financially secure, and duly educated.