Masters degree not required. . . just a little common sense, a $5.00 calculator and a realistic plan is all you’ll need.
“There’s got to be a better way” resonates with many of us, when contemplating how frustrated we’ve become with our investment decisions. Too many Canadians are spending far too much on credit card debt, accept inflated mortgage rates from financial institutions they've been loyal to for years, and just don’t seem to have a realistic financial strategy in place.
With the myriad of savings, mortgage and investment options available today, rethinking your financial plan to make more efficient use of your money can be a daunting task. As a result sometimes the fear of making a costly mistake can lead to inaction, but inaction or procrastination will almost always cost you money in the end. So what is the correct course of action? The following column contains 8 valuable tips, which will provide a framework to help you earn more and save more of your hard earned money.
1. Pay yourself First - rule numero uno. From each pay cheque set aside 15 to 20 percent of you’re after tax income through an automatic deposit into a savings account or investment program. After a brief “adjustment period" you won't even miss it. It's important to make sure you have enough money on hand before you can entertain any investment strategy.
2. Pay down your consumer debt before investing - most investors would be ecstatic with an 18% + after tax return from their investment portfolio. Let me explain how paying off credit card debt actually translates into those kinds of returns. Let’s assume your carrying credit card balances of $3000.00 @ a simple annual interest rate of 18%. That’s $540.00 per year in interest charges…pay out the credit card debt and you're saving $540.00 a year. Can you see how that’s exactly the same as investing the $3000.00 into something that earns an 18% return after tax. In fact you would have to earn 36% return on your investments to emerge with the same $540.00 in your pocket if you were in say a 50% tax bracket. I suspect what you're saying right about now is that that’s all very interesting but where does one find the “extra money" to pay down those debts. Thank you for that excellent segway into my next tip, no# three.
The Straight Goods on Mortgages
3. Refinancing - the truth is even though it's likely your home may have greatly appreciated in value, it’s also very likely that you may be paying more than necessary on your mortgage. Refinancing commonly referred to as Debt Consolidation leverages the equity you may have already accumulated in your home to pay down high interest credit cards, credit lines and other debts. In 2002 and 2003, one in two Canadian mortgage holders refinanced their loans with over all savings of $7 billion in interest payments. A good rule of thumb to follow is - consider refinancing if your rate is 1.5% or more, higher than current rates. Always check your mortgage documents or with your mortgage holder to determine the penalty for discharging your existing mortgage.
It's always a good strategy to exercise your full pre-payment privileges before refinancing which will dramatically decrease any penalties involved. If your mortgage was previously insured by CMHC it may also be possible to refinance to a high ratio mortgage (anything less than 25% down) and pay the CMHC insurance “top up" fee only on the new money advanced after discharge.
To determine if refinancing is a realistic option for you calculate your total monthly debt payments; including personal loans, your existing mortgage payment, lines of credit, credit cards etc. and divide that number by your gross total monthly income. If your total is above 0.49 it’s likely refinancing could bring real value to your situation.
4. Ladder or Step - imagine registering a collateral charge against your property in consideration of its future value. Basically a “step" mortgage enables you to accomplish just that. With a step or ladder you can structure a mortgage combined with a credit line as well as overdraft protection etc. that will allow you to painlessly borrow money against the future value of your property as it appreciates.
Benefits of this plan include a hedge against risk, a lower rate if your current rate is higher than prime, as well as flexible payment terms - from making interest only payments to making any sizable payment or completely paying down the debt against the credit line without incurring expensive penalties. Best of all with a step mortgage you have the unique ability to painlessly increase your line in the future for educational purposes, renovations etc. based on the appreciated value of your home. It's best to trust an Accredited Mortgage Professional to structure this complex but infinitely more flexible mortgage plan.
5. Floating or Variable Rate Mortgage - York University Professor Moshe Arye Milevsky found in his study examining the last 50 years of mortgage rates that 88 percent of the time, home owners will find that the interest rate on their variable rate mortgage will be lower than the rate on a traditional five-year fixed rate mortgage. My advice is to definitely consider a variable rate but you must be able to tolerate the risk of your monthly payments possibly fluctuating. One way to offset this risk is to calculate payments based on a five year fixed rate against a mortgage calculated at a variable rate. You will likely not only save on interest charges but may pay off your mortgage considerably quicker.
Having the ability to lock into a “fully discounted" fixed term rate at some future date, without penalty is also an option worth exploring. Bi weekly-accelerated payments are highly recommended as well. It's basically nothing more than taking 1/2 of your monthly payment and remitting it to your financial institution every two weeks. It translates into making roughly one additional monthly payment every year but it really serves to substantially reduce your interest charges and amortization, which will allow you to own your home outright, sooner. Childs Education
6. Start early - Considering a price tag of about $50,000 for four years of post secondary education for a child born today based on current tuitions of $5,000 and education inflation of 5%, a Registered Education Savings Plan is simply a must. The earnings aren't taxable as they grow within the plan and the Canada Education Savings Grant is an added bonus. The CESG basically provides a guaranteed 20 percent return - where can you beat that? - You'll receive $400.00 from the government on the first $2,000 of contributions per child per year.
Registered Retirement Savings Plan
7. Save as much as possible - take full advantage of compounding while your account grows tax-deferred. Borrow if you must because in most cases deferring taxes and earning compound interest far outweigh the interest costs of borrowing to make an RRSP contribution. It’s also a prudent idea to apply your tax refund directly to the loan immediately reducing the payments. A “step" mortgage can also go a long way towards making this process more painless.
New home buyers - The Home Buyers’ Plan (HBP) allows you to withdraw up to $20,000 from RRSPs to buy or build a qualifying home for yourself (as a first-time home buyer) or for someone who is related to you and is disabled.
(http://www.cra-arc. gc. ca/tax/individuals/topics/rrsp/glossary-e.html#qualifying)You may still be considered a first-time homebuyer if you own a rental property or if you have not recently owned a home.
8. Spousal RRSP - is recommended. Split income in retirement and reduce your overall tax burden by contributing to a spousal RRSP now. You will significantly reduce your taxes by having the higher income earner make as much of the RRSP contributions as his or her room will allow, then use a spousal account so that each spouse continues to build the same RRSP savings.
The message here is that a sound knowledge of financial basics combined with some careful financial planning goes a long way towards helping you hang on to more of your hard earned money. It's always wise to consult with a mortgage professional as well as a competent financial planner to formulate a financial plan, review your budget and help match your savings and investments to your overall goals.
© 2004 Realtywide Corporation
Author: Dan Loney AMP CIMBL/ICCP
Dan Loney - AMP CIMBL /ICCPH is Chief Financial Officer of Realtywide Corporation and an Accredited Mortgage Professional with The Mortgage Alliance Company of Canada a $5 Billion mortgage originator. He is among the first to receive the AMP designation, recognizing that Mr. Loney has achieved the highest level of professionalism, ethics and education within the Canadian mortgage industry. Contact Dan Loney @ 1-877-366-3487 or visit www.REALTYWIDE.com