Why Some Very Successful People Still have to Pay Higher Rates

In the mortgage and other credit industries, I often find that clients who are very successful still have to pay high rates. Some of my clients don’t understand why and for this reason I think it’s worthwhile to teach you about how lenders evaluate risk and expect to be compensated for it, with higher rates. I’ll break down a few different archetypes of clients that need to pay higher rates.

The Classic Poor Credit

The classic poor credit client is someone who has not paid their bills in a timely manner, declared bankruptcy, or has been denied credit more than once due to high obligations as compared to their available credit. Institutional lenders need to charge these clients a higher rate to ensure that they are compensated for the additional risk presented by a client who has a history of not paying in a timely, comprehensive manner. The threshold for many lenders is about 640. If you are below the line, you have to pay a higher rate, and are often not offered options with your mortgage unless you pay an even higher rate.

The Self-Employed Tax Evader

A lot of successful self employed individuals including lawyers, consultants, dentists, accountants, and construction contractors, have to pay higher rates on their credit. Why? — They don’t like to pay taxes. Who does? As a self employed individual with stellar credit, many people try to expense everything they possibly (and legally) can in order to claim that they have the lowest possible taxable income. Some of the things you can write off include meals (with clients*) gas, rent for a home or office, supplies, gifts for clients and more. Some lawyers make less than $40,000 per year on paper. It is because people show such little income that when they want to buy that $800,000 home in Toronto, their bank refuses to give them financing at a low rate. Banks are handcuffed by their strict borrower profiles, which is why many of these clients head to mortgage brokers to sort out their home financing.

The Newly Employed or Promoted Homebuyer

This poor fellow is simply guilty of not making enough money for a long enough time. I have a friend who quit his high paying IT job to work as a consultant. He is making more money than he was in the past BUT, since he is now self-employed (and expensing a lot) it looks like he doesn’t make the big bucks anymore. If you just got a raise, or work in an industry where your 2nd and 3rd years are going to bring you significantly more income, you may find yourself not being able to borrow enough money to buy your home. When your employment is in flux, you’ll have to pay a higher rate to justify a lender taking a risk on you. What if you lost your new job at your higher rate of pay? How would you make your loan payments?

These are just some examples of clients who need credit and mortgage advice. I hope you learned something here, and am always available for further explanation in the comments.

Stay tuned for more finance.

Beginner’s Luck: An Overview of Canada’s First Time Home Buyer’s Plan

In 1992 the federal government introduced a plan to allow more Canadians to become homeowners. Since then over 2.6 million people have taken advantage of the tax breaks and incentives that the government offers to those purchasing a qualifying home. In order to benefit from this initiative, it is critical to understand what benefits are available and how you can qualify for them.

There are three government programs that benefit first time home buyers (FTHBs) and they have different criteria and nominal values.

The three programs are:

  1. Land transfer tax rebate – a pro-rated rebate of up to $4000 ($8,000 in Toronto) based on home price)
  2. FTHB RRSP plan – allows up to $35K withdrawal from each person’s RRSP for down payment
  3. FTHB tax credit – a credit of $750 (all parties combined) from income taxes

These three benefits are a great way to let the government reward you for helping drive Canada’s housing market and the overall economy. The land transfer rebate and tax credit are obvious opt-ins for most folks but the RRSP Plan benefit really depends on your tax bracket at contribution time versus your bracket at withdrawal time. Taking advantage of the RRSP withdrawal will allow you to reduce your (current) tax liability by a larger amount as your annual income increases. Actually I used to believe this benefit was greater than it actually is. The real benefit of the RRSP FTHB benefit is the tax not paid on the withdrawal for the term of the loan and the resulting savings on money that does not have to be borrowed under the mortgage. For example, a $35,000 withdrawal with a 30% tax rate yields a benefit of $10,500 of tax that is not required to be paid and can therefore reduce the mortgage amount. If the mortgage rate is 2.5%, then the actual benefit of the withdrawal is $262.50 for the first year. This benefit reduces over time as the loan must be repaid over 15 years.

Who is a first time homebuyer?

The CRA does not use identical criteria to determine eligibility for each benefit listed above. The criteria which are common however, are quite simple. Below is a short list of the basic criteria, with links to the CRA website for more comprehensive definitions befitting more complex situations.

FTHB Eligibility:

  1. You must purchase a qualifying home (most homes qualify, more on this here) and intend to occupy it as your principal residence within 1 year of your purchase date. You may also buy the home for a relative with a disability and not occupy it yourself.
  2. For Land transfer rebate – You may not have owned an interest in a home anywhere in the world previously
  3. For Tax credit and RRSP – You may not have lived in a home owned by you or your spouse in the previous 4 year period as defined here

Other useful rules criteria:

  1. RRSPs must be in your account for 91 days before you withdraw them for your deposit. The funds must also be paid back to your RRSP over the next 15 years.
  2. You must build or buy a qualifying home before October 1st of the year after you withdraw the RRSP funds
  3. The government wants you to claim these benefits all in the same tax year.
  4. You can own a rental property and still be considered a FTHB for the Tax credit and RRSP

This is all well and dandy but…

How does one actually receive these benefits?

All of these benefits can be claimed at the time you would have incurred the tax liability.

  1. Land transfer tax rebate – Apply either electronically or by paper form to the Land Registry Office. The lawyer who closes your purchase and/or mortgage will usually do this for you.
  2. FTHB RRSP plan – Fill out and submit a T1036 to the institution where you withdraw your RRSPs
  3. FTHB tax credit – Claim this credit on line 369 of your yearly income tax return

Some interesting facts that might surprise you:

  • One could qualify as a FTHB under the RRSP Plan more than 3 times with enough persistence.
  • Your spouse could have owned a home that they are selling this month, and as long as you have not lived in it, you are entitled to receive some FTHB benefits.
  • You don’t have to spend the RRSP funds on your down payment if you’ve got $25,000 cash already going into the home. You could spend it on closing costs, renovations, furniture, or whatever you like because your cash is replaced by the withdrawn funds.

I am always available to discuss the contents of this article by phone or email at 416-371-2077 or david@mortgageoutlet.ca. I also maintain a blog at www.weteachfinance.com for all your financial and borrowing needs.

Edit: After posting this article I was asked to weigh in on Four essential questions for the FTHB by the editors at Typical Geek, an honour I gladly accepted.

Useful Resources:

Income Tax Calculator:

http://www.ey.com/CA/en/Services/Tax/Tax-Calculators-2015-Personal-Tax

CRA – Home Buyer’s (RRSP) Plan:

http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/rrsp-reer/hbp-rap/menu-eng.html

CRA – Home Buyer’s Tax Credit:

http://www.cra-arc.gc.ca/hbtc/

Ministry of Finance – Land Transfer Tax Credit:

http://www.fin.gov.on.ca/en/refund/newhome/

 

Bank Hack 3% interest 1% loan

 

Bank Hack: Earn 1% on as much as you can borrow unsecured from Scotiabank

I am always looking to make a quick easy buck. There are plenty of opportunities to do so if you know the promotions in the personal finance marketplace. I wrote an article last week about credit score improvement and this week I have found a Bank Hack that could earn you some pocket change, and improve your credit with 2-4 hours of work.

The borrowing play:

Scotiabank has a promotion whereby you can borrow on their Value Visa for 0.99% for the first 6 months.  There are many terms and conditions, which are mostly standard, the card has a fee of $30/year unless it is part of a Scotia Total Equity Plan (STEP) mortgage. The maximum credit limit for each card is $75,000 but you can have more than one if you qualify. For this hack you’ll want to get approved for as much as possible.

The investing play:

Equitable bank is a bank licensed mortgage lender looking to grow in the residential and commercial mortgage business. They are starving for your deposits, and have offered what is the best bank account I have ever heard of. The offering consists of a 3% interest rate bank account with zero fees for most things, 5 free interac e-transfers per month and more. As part of this Bank Hack they will give you $25 for opening your account by using the referral code mentioned in the next step.

The set up:

  • Open a High interest savings account at Equitable bank (eqbank.ca/savings), and use a referral code to receive $25 (no money to me, only account holder L) Referral Code: 968833
  • Have a seat with a Scotiabank advisor and tell them about your intentions to get a Value Visa at as high a limit as you qualify for.
  • Use a Cash Advance to make out a cheque from yourself to yourself for deposit into the EQ Bank Savings account (through their app)
  • Set the EQ Bank account to make a monthly recurring payment to your Scotiabank Value Visa for your minimum payment
  • Create a set of payments (max $5,000 each) to close out your position at the end of the promotional period on the Visa.

OR

5)  Move your Value Visa balance to another card with a promotional rate and repeat.

The expected return:

With a $20,000 Value Visa limit, you can earn $195 for less than 4 hours work.

If you can get a Value Visa with a $50,000 limit, you stand to earn $495 over 6 months after bonuses and fees.

If you have a STEP mortgage with a $150,000 line of credit, you stand to earn $1,525 over that same period.

It’s not exactly a free lunch but it’s well worth the work and as risky as having money in a bank account.

You’re welcome!

Broker Beats Bank

I’ve wanted for a while to publish a chart highlighting the rate differences between Canada’s different mortgage lenders to show the vast spread between their pricing at any given time. I found this a difficult task because most lenders don’t advertise their prices openly or accurately. Lost somewhere in the posted rates, discounted promotions, and bait and switch quoting of insured mortgage pricing, lay the truth: If you’re not looking at more than one lender, you’re probably getting ripped off.

To mitigate a lack of quality and reliable data, I was forced to collect what data was available to my brokerage over time to deliver a meaningful comparison between the lending institutions. Fast forward 2 years and we are finally here. To construct a fair comparison and in the interest of simplicity I used the pricing of 5 year fixed rate uninsured residential mortgages with “full” privileges. Many mortgage rates are quoted as insured, or with prohibitions on activities such as the ability to break the mortgage. Below is a table that shows the rates that were available to mortgage brokers between January 2014 and the end of October 2015. The ‘Savings’ column hammers out a salient point: There is almost always a better place to go than your bank when it comes to rates.

5 Year Fixed Rates for Uninsured Residential Mortgages

In case you’re a graphical person, the blue line below represents the savings of the best rate over the best bank, and the group of trend lines above indicates the pricing of a few banks and the best rate which had a downward trend from January 2014 to October 2015.

As of today, November 14, 2015 our best rate is 0.25% cheaper than the best bank rate. This will save you $250 per $100,000 of your mortgage per year. For a $350,000 mortgage that is savings of $875 every year. Why would you pay more?

As always, call me any time to find the best products and rates for your financing.

David Steinfeld, Mortgage Agent 416-371-2077

Why You Need A HELOC ?

  • Cash to use for investments or purchases , Convenient way to withdraw large amounts of money
  • And at one of the lowest rates available Interest is tax deductible
  • Pay off and re-borrow
  • A charge on your home which helps prevent mortgage fraud
  • You need to be financially prudent and disciplined
  • http://www.thestar.com/news/gta/2014/04/05/golnaz_vakili_lawyer_in_hiding_accused_of_stealing_millions_swears_shes_innocent.html

House Free and Clear? –Here’s Why You Need a Line of Credit

A home Equity Line of Credit (HELOC) is a useful tool to any homeowner, yet I still meet with clients who are skeptical about using one. This has prompted me to write a concise post listing what I believe to be the advantages of a HELOC and the one reason you might not want one.  As always I’m looking to impart some of my financial knowledge I’ve gained advising clients over years and studying finance at one of Canada’s top business schools – The Schulich School of Business.

Reason #1: Liquidity

Having assets that are liquid enables you to take advantage of opportunities. An opportunity may present itself as a chance to buy an investment, a chance to pay off your credit card balance, or to buy a camping trailer at a great price. When you need a large sum of money to get a great deal, or invest to make more money, where will you get it? The short answer is that pulling the money out of your home is a great way to take advantage of opportunity.

Reason #2:  Low Cost of Borrowing

As I have mentioned in some of my other posts, borrowing money using real estate as security will help you get one of the lowest rates around. Currently, most financial institutions offer HELOCs at 3.5% (Prime + 0.5%).  Most reasonable investments should expect to return much more than 3.5% even in tough economic times like these. As an example, the S&P/TSX composite index closed July 23, 2014 at 15,394.38 which was up from 12,672.30 exactly one year before on July 24, 2014, a gain of 21.4%. More than 20%!!! This is not your typical return, but we had a good year in Canadian markets. How much profit would you have made if you borrowed money on your home to invest in the market? I don’t want to upset my readers, so take a breath before you continue. If you borrowed $100,000 against your home, you’d have earned $21,400 less the interest charges of $3,500 and assumed taxes of$6,265 at 35% for a total gain of $11,635. If you’re one of the lucky few who own a million dollar home free and clear, you’d have earned $69,810 on borrowed funds of $600,000. Why do you think you can or should afford to have your money tied up in your house?

Reason #3: A Charge on Your Home Helps Prevent Title Fraud

Fraud is always prevalent where it can be profitable, and fraudsters are always discovering new ways to rip off everyone from the big banks to Johnny Homeowner. An example of a very profitable form of fraud is Title Fraud. Title fraud usually occurs when an individual steals a person’s identity and takes a mortgage in their name against a home that is rightfully owned by the victim. The fraudster then takes the funds advanced as part of the loan and disappears, leaving the homeowner to pay the bill. Title fraud can be prevented by having a charge on your home which prevents someone else from borrowing against the home. The result – opening a HELOC can be an easy way to add one more layer of fraud protection to your home and life.

Why you might not want a HELOC

After listing numerous advantages, I will also give you the #1 reason not to take out a Home Equity Line of Credit: your own discipline. A HELOC has the potential to be a very large loan and needs to be managed very carefully. Some individuals who have issues budgeting may run up the line of credit too high and have trouble paying it off. Given the fact that they are usually issued with variable interest rates, your payments can increase drastically if the prime rate goes up. The way to mitigate this risk is to be financially responsible, and plan when to use the funds and for what. A line of credit is a great way to shift your high interest credit card debt to a lower rate, but shouldn’t be used as an excuse to run up an unmanageable amount of debt.

Parting Words:

If you can operate on a budget, with discipline and understanding of your financial situation, a HELOC is a great tool for building your wealth. Feel free to leave questions in the comments section below.

More finance to come!

The Time Value of Money

I sometimes think that one of the most important lessons a young person can learn is that $1 today is worth more than $1 tomorrow. It is amazing to observe that many young adults don’t learn this, one of the most critical principles of finance, until they reach university. My goal with this post is to make it easy to understand why money today, this month, or this year is worth more than money in the future.

Why is money today worth more than money tomorrow?

Simply put, because money can earn interest (and have less purchasing power due to inflation).  If I receive $100 today and can earn 5% interest annually, my money is worth $105 is one year. $105 a year from now is worth exactly the same as $100 right now for me as an investor. That being said $100 today is worth more than $104.99 in a year from now.

Why is this important? 

Making personal financial decisions is something that we have to do every day. If we know that it is better to pay in the future (because money is worth less at that time) then we would surely take advantage of times where people let us pay later rather than now. My favorite example of this is a car loan. Many car dealerships will offer you 0% or a very low interest rate to incentivize you to buy a vehicle from them. If you had $10,000 to pay for the car outright, is it still better to finance it? Yes! Simple math can show you that if you have no borrowing cost, but can earn interest that your $10,000 car could cost you much less!

You could pay $10,000 today for that vehicle, or you could pay $275 a month (for example) for 3 years and pay off the car. If you take time to pay off the car, your cash that would have been used to pay the whole balance can be in an investment earning you 5%. After one year, you will have paid $3,300, and used the remaining $6,700 to earn you $340 in interest, making the care effectively cheaper.

This principle is one of the fundamentals of financial theory and will affect the way that we calculate the value of things today versus in the future. There is a formula which can be used to describe the relationship between dollars today and dollars tomorrow. It is shown below.

PV = Present Value (value today)

FV = Future Value (value after one period)

r = The discount rate for the period (interest rate with or without inflation included)

 

Why Use A Mortgage Broker

I passed my mortgage agent’s license in December of last year and have been talking with my friends and family about what I do and it surprised me to learn that not a lot of people actually know what a mortgage broker does or why they should use one. If there is one thing you can take from this post it is this. If you are seeking out real-estate backed credit (e.g. mortgage for any reason) you MUST talk to a mortgage broker. But why?

  • We ask the right questions

Arranging mortgages all day can be a tough job, but it hardens us mortgage agents into financial fighters, credit combatants, money mercenaries, you get the point. We have extensive knowledge of the many different mortgage solutions that exist for folks in all types of situations, and can provide well informed guidance toward the products which best suit your unique needs.

  • We shop around

When you are looking to buy something that costs more than $1,000, do you go to one store, hear their pitch and then buy whatever product they offer you? Wouldn’t it be smart to consider looking at other stores? A mortgage broker is like a personal shopping assistant who can bring you the best from over 45 mortgage lenders. This is the best way to get to know what products are offered across the industry. You could call all the lenders in Canada or the GTA, it wouldn’t be THAT hard, but you could also let a broker point you in the right direction.

  • We negotiate on your behalf

Not surprisingly, many clients I have dealt with have issues negotiating with the bank or asking for a better rate. As brokers we demand a better rate. The banks and lenders know us, and know we are fully informed negotiators who know what price it will take to get our clients’ business. This negotiating power and experience combined with our volume as partners of the lenders make us the most suitable champion of your interests.

  • We provide service for life

Many lenders will let your mortgage roll over every term and automatically renew you until you re-actively check into your options. Good brokers have a duty to follow up with you every few months to ensure your product is still working for you, and to investigate whether you might benefits from a change in your mortgage. We follow you every step of the way until you are mortgage-free.

Essentially, a mortgage broker is an expert shopper who is paid by the lender to provide you with a mortgage. You have absolutely nothing to lose, and everything to gain by dealing with a mortgage broker. Now that we have cleared that up, happy home buying!

Full disclosure: I am a net-present-value ninja and mortgage agent at Northwood Mortgage. Call me anytime at 416-371-2077.

The Relationship of Risk and Return Part 2

Last week I posed a question to you at the end of my post asking:

Would you exercise the option of betting $1000 on a game in which you had a 51% chance of receiving $2000 back (+$1000) and a 49% chance of getting $0 back (-$1000). I would allow you to repeat the bet as many times as you could pay for it. Would you make the bet? Why or why not? Would your answer change if the bet was $100, $1?

One respondent’s first answer to this question was that he would not take the bet. He told me that even though there was a 51% chance of winning $1,000, there was also a significant chance, 49%, of losing your $1,000. When I explained to him that you could repeat the bet as many times as you like, he was still weary of losing $1,000 every time, and going broke. Truth be told this is a possibility but the more times you can repeat the bet, the more likely you are to reach the expected average of 51% success. This example brings to light a very important fact – risk can be mathematically calculated, and if you can find something that returns more money than the risk level would usually return, you will be a winner more often than not, and what else can we hope for?

When there is a 49% chance of losing your money, the odds of losing 10 times in a row are less than 0.09% which is just less than 1 in 1000. The expected value of your bet given these chances is expressed as $2,000*51% + $0*49% = $1,020. To make this bet costs you $1,000, and your expected value according to some solid math is $1,020. Every time you make this bet, you are theoretically buying something worth $1,020, for only $1,000.

In essence, after you made this bet 100 times, you should have made $2000. Now, not all of us have a cash reserve large enough to support making this bet with enough repetition to reap serious rewards, which is why I suggested using $100 or $10 instead. If you have $20,000 and can make a $100 bet 200 times before going broke, the odds are heavily in your favour to earn on average $2 every time you make a bet.

Buying something for less than its market value

Robert Kiyosaki, author of Rich Dad Poor Dad showed us that your profit is actually gained when you buy something that is undervalued.

Every time you have the opportunity to buy something that is worth $1,020, for a cost of $1,000, after all things are considered you will be ahead $20.

The Relationship Between Risk and Return

At different points in your life you have a different appetite for risk. Personally, as a late twenty-something I feel like I am a little less risky than my early 20’s (down about $23K in stock market trading) but I still have a hunger to grow aggressively because I am simply not comfortable living the middle class lifestyle. I want big things in my life, not just to have big things, but to do big things.

It’s easier to do big things with money, but how can you get it. With some discipline and a comfort with risk it’s not impossible to build a fortune earlier in your life. I know a successful entrepreneur by the name of Dan Demsky who told me that one of his best motivators is necessity. Dan faced a looming tax bill in his early years as an entrepreneur and frankly told his team “we need to sell X dollars to survive” and they did. I believe that to be successful, you need to create a sense of necessity through goals, and you need to take calculated risks.

This perspective helps me lead into a discussion of risk and expected return. There is a simple principle in finance which states that there is a relationship between risk and return which is; the more return you expect to get, the higher the amount of risk you need to bear. Let’s dive a little deeper into a technical explanation.

The Risk Free Rate

There is a return in the market which you can expect to earn without taking any risk. This is called the risk free rate. An investment that is risk free is one that is considered to have no risk of default or loss and a prime example of this kind of investment is a Government bond (in Canada). Speaking truthfully, the government can default on a bond but it is highly improbable, so in the finance industry we often use this as a risk free rate. If you take no risk you should be able to earn this return on your money which right now is about 1% per year in Canada.

Your Reward for Bearing Risk

After you’ve decided that you’d like to earn a little more than the inflation rate, you may ask yourself “how am I rewarded for bearing risk?” There is also a standard unit of risk called ‘beta’ that earns you a “market risk premium” which is a return. In simple terms when beta is 1 you are taking the average amount of risk for the entire stock market.

 

Your expected return can be expressed as:

The risk free rate + the level of risk of beta (1 is average) * the market risk premium  = Expected return

 ⇓                                                     ⇓                                                                  ⇓

Return without risk    +     How risky your investment is      *       The reward you get for average risk

 

What does this mean to me?

This relationship can show you that you are in fact rewarded for bearing risk. When you plan for your future you need to consider if you can tolerate the possibility of loss for the mathematically greater likelihood of making more money in the long run. If I gave you the option of betting $1000 on a game in which you had a 51% chance of receiving $2000 back (+$1000) and a 49% chance of getting $0 back (-$1000). I would allow you to repeat the bet as many times as you could pay for it. Would you make the bet? Why or why not? Would your answer change if the bet was $100? Stay tuned for my next post to explain which decision I would make and why.

How to Improve Your Credit Score in Canada

There are a few simple reasons why you might have a bad credit score. You haven’t paid in full or on time, or you have borrowed lots of money without having a lot of assets or income to use as security.

Once your credit is in the danger zone (less than 550 Beacon), there are a few things you can do to improve it effectively. In the mortgage industry we say “Two trades for two years” helps build you back up. Below are some examples of trade lines of credit

Types of Credit Which are Good Building Blocks for Credit

Getting a Secured Credit Card

The best way to improve your credit score is to have credit and deal with it properly, i.e. PAY YOUR LOANS! A secured credit card is a credit instrument whereby you put down a deposit and borrow against it using your credit card. This is a sure way to show future creditors that you have the intent and capacity to pay your debt.

Taking out an RRSP Loan

An RRSP loan is borrowed from the bank and used to make a deposit into your RRSP account which is later invested for tax-sheltered profits. The loan is one of the easier types of credit to qualify for, and can also help you establish a positive credit history.

Using a Car or Furniture Loan

A car or furniture loan will be a monthly payable which as mentioned before helps your credit score. Car and furniture sellers are also motivated to grant you financing to buy their products, so it is a relatively easy way to get diverse credit.

You Also Need to:

Pay all Your Loans Credit Instruments in a Timely Manner

If you can qualify for 2 of these credit facilities and pay your bills on time, you should be in a much better credit situation in as little as 1-2 years. This will ensure that you don’t have to pay those high rates forever!

Avoid Having too Many Credit Checks

Be careful with which types of credit you apply for and often consider going through a broker who can share your credit information without having other parties inquire about you separately. The less people who check into your credit, the better.

Avoid Borrowing more than 75% of your credit limit for each credit facility

Utilization of credit is a heavily weighted factor used to determine your score. If you borrow a high % of your limit, you are penalized and your score may go down.

 

It’s tough but doable!

If you follow the steps I mentioned above you should be well on your way toward being able to borrow the money you need once more.