RRSP, RESP, TSFA or Mortgage prepayment? Which has the best returns?

February 22, 2012 — Steve Garganis

HOW TO GET THE MOST OUT OF YOUR MONEY

Trying to decide what’s the best move can be difficult…. and I must admit, this is not an easy subject to tackle.   There are so many opinions…. But it’s important enough that I’m going to put my 2 cents in.  My final recommendations are listed at the bottom if you want to fast forward…

First, let’s come to an understanding that we are all different and have different needs…. you must ask for professional opinions and make up your own mind. Having said that, I think that for me, this is actually a very easy decision.

RESP   If you have kids, put money into an Registered Education Savings Plan…  the govt gives you 20% on a max contribution of $2500/yr per child.. that’s $500 of free money… Just be careful to not invest in any risky funds or stocks… you’re making 20% return already… don’t get greedy.

TFSA  If you have some extra cash, then yes, put those funds into a Tax Free Savings Account.  You can contribute $5,000 per year and any unused contribution limit carries forward each year… and the good news is that whatever investments are allowed for RRSPs are also allowed for TFSA.  Funds can go in and come out and grow tax free.  But I wouldn’t be putting too much in here while you still have a mortgage… Pay your mortgage off first.

RRSP  An old favorite for many.  Millions of Canadians have contributed to RRSPs in an attempt to be masters of their future and retirement.   Mutual Funds have become a favorite investment within RRSPs.  But now let me ask you… how has your RRSP performed for you?  For most of us, that answer comes with some profanities…%@!)*&%!!!   or something like that.

RRSP contributions are tax-deductible… and higher income earners will benefit greater…your funds can grow, tax-free… but you must pay taxes when you withdraw the funds.   At age 71, you have 3 options…-transfer to a Registered Retirement Income Fund, -buy a life annuity (better when interest rates are high), -or take the cash (bad choice as you will have to include those funds as income in one tax year which will result in large tax bill.)

RRSPs are a way to grow your investments, tax-free, and defer paying the tax… but you will have to pay the tax… make no mistake about that…

MORTGAGE PREPAYMENT   Probably the least exciting but the best choice for many.. just pay down your mortgage… your mortgage is not tax-deductible, unless you have a mortgage on an investment or rental property.    Get rid of that mortgage faster..make prepayments…  even little prepayments done regularly will make a difference…. On a $300,000 mortgage, a $3,000 annual prepayment will shorten your amortization from 25 years to 20 years, 10 months.   Based on today’s 3.29% mortgage rate, that’s a savings of over $28,000.   Hey, a $28k return on a $45k investment isn’t bad.

ONE MORE OPTION…INVEST IN REAL ESTATE  Sure, we’ve all seen property values go up over the last few years… actually, they’ve gone up over the last 12 years.. this is a long bull market for real estate… and there will probably be a correction.  But if you buy a rental property, you should plan to hold it for the long-term… 7 years or more… that’s usually enough time for any price correction to reverse itself.  Rental properties are popular today because mortgage rates are low and vacancy rates are even lower.

Another way to invest in real estate is through private mortgages.   Private mortgage rates run from 10% to 15%.   It takes a little more knowledge and experience to understand this investment, but it could be worthwhile.. Just be careful to get as much information as possible before making any 2nd mortgage investment decision.   These are RRSP eligible too. This subject will have to be covered in greater detail as there is a lot more to it.

FINAL DECISIONS.   For me, RRSPs just haven’t performed well…  And maybe I haven’t invested wisely…. One thing is certain, my Investment Advisors and Fund Managers all won… they take their cut off the top…   Not all Investment Advisors are alike, but I seemed to have hooked up with those that talked a better game than they could deliver.    Here’s a question… were you ever put into a Deferred Sales Charge (DSC) mutual fund?  You know, the funds where you can’t exit the fund family for 5 or 6 years without paying a hefty penalty?   I know several friends and clients that got pushed into those funds…. not one  of them is happy… I am staying away from these funds…

In case you can’t tell, I’ve lost my faith in mutual funds and decided to manage my own money.. and guess what?  I’ve done better than any advisor I know… I’m sure there are good advisors out there…but I’ve just decided that no one will care more about my money and future than me…

It’s time to take charge of our money….   so here are my suggestions…

  1. Put money into an RESP… if you have kids, this is a no brainer…  make sure to park that money in a safe, low risk investment… remember, you already made 20% with the govt’s contribution….let’s not get greedy.
  2. Pay off your mortgage.   Make lump sum prepayments… anything.. something is better than nothing… and try to increase your regular payments… this will accelerate the retirement of your mortgage.
  3. If you have to invest in stocks or funds then put this into a TFSA…
  4. Invest in real estate… it’s not exciting.. it’s not sexy… but history tells us it goes up over the long run…
  5. RRSPs… putting them last on my list… I’m just not a fan of them… if you have other cash, why not invest it elsewhere…  but if you have to put money in RRSPs, play it safe..  this is your future, your retirement… don’t gamble with it.
  6. Seek professional advice…. if you’re not sure what to do, get some advice… if you don’t have anyone to turn to, feel free to contact me… if I can’t answer your questions, I’ll direct you to someone who can.

 

Posted in Money saving tips, Mortgage Tips, Real Estate news. Tags: , , , , , . 2 Comments »

Consolidate your debts and save money with today’s record low rates.

December 29, 2011 — Steve Garganis

It’s December 2011, fixed mortgage rates are at historical lows…a 5 year fixed rate can be had for 3.39% and in some cases, even 3.29%.   Does it make sense to refinance your mortgage and consolidate that car loan, student loan, credit card, line of credit or other debt?   The answer is an overwhelming YES!

Compounding interest rates are a killer.  If you have $20,000 or more in non-mortgaged debt, then you should consider consolidation.   Especially with today’s record low interest rates.

Here’s an example of one situation:

 Rate  Balance  Payment
 Mortgage 3.99% $300,000 $1,349
 Car loan 6.00% $24,000 $563
 Credit Cards 18% $10,000 $300
 Line of credit 7% $10,000 $300
mortgage penalty $2,993 $0
 Totals $346,993 $2,512

And here’s what the new situation could look like after consolidating their debts:

 Rate  Balance  Payment
 Mortgage 3.39% $346,993 $1,533
 Car loan $0 $0
 Credit Cards $0 $0
 Line of credit $0 $0
mortgage penalty $0 $0
 Totals 3.39 $346,993 $1,533

So in this example, we are reducing the monthly payment by $979.00.     Let’s take some of that money and put it towards your new mortgage… if you took $500/mth and put this towards your mortgage for 5 years, you would reduce your amortization to 10 years and 7 months.   Clearly, this is worth breaking the mortgage and paying the penalty.

(keep in mind, the penalty could be higher if the lender uses an Interest Rate Differential to calculate the penalty… Always speak with your Mortgage Broker to ensure the penalty is accurate).

 

 

Posted in Case study, Consumer Debt, Money saving tips, Mortgage Tips. Tags: , , . Leave a Comment »

BMO announces lower rate IF you take a shorter amortization!

December 23, 2011 — Steve Garganis

Have you heard the big news?   BMO lowers rate their best discounted 5 year fixed rate to 3.49%  to encourage Canadians to take an amortization 25 years or less.  They claim they want to encourage Canadians to pay their debt off faster…..  Sounds nice and in keeping with the Christmas spirit, doesn’t it?

Ok, before we get all warm-hearted and teary eyed, let’s take a closer look at what this really is.    First, this IS NOT the best discounted fixed rate in the market.   A good Mortgage Broker can get you 3.39% out there with no restrictions on amortization (even lower with some No Frills mortgage products).   We all want to pay our mortgage off faster, but choosing a shorter amortization only limits your future options…   My recommendation to almost all my clients is to take the longest amortization possible……

It’s not that I want you to have a mortgage forever, it’s about having options….  I always take a ‘what if’ approach….   Follow me for a minute…

Let’s say you had a $300,000 mortgage and you took this BMO 3.49% rate,  your payments on a 25 year amortization with be $1496.23/mth.   But if you took a truly discounted mortgage at 3.39% with a 35 year amortization, your minimum payment would be $1216.75/mth.   You could always INCREASE your payment to accelerate your amortization to 25 years or shorter.

Now, let’s say you lost your job, had some unexpected expense come up, or a financial emergency or just needed to lower your payments.   If you chose 25 year amort, then you are stuck with that payment.. if you chose 35 year, then you can always go back to that lower payment…    That’s the flexibility that we want.  It’s not about taking longer to pay, it’s about having the option to reduce your payment if needed.

LET’S NOT FORGET THE BANKS HISTORY WHEN IT COMES TO RATES

In keeping with the Christmas theme, Mr. Potter would be approve the Banks latest strategy.   In case you didn’t know, the 5 year Canada Bond is in record low territory…. hovering at around  1.31%… the 5 year fixed rates are priced from the bonds… the spread is normally around 1.25% to 1.40%… and yet today, the spread is 2.18%…. WOW!  and why?  TO MAXIMIZE PROFITS.   This is has nothing to do with wanting to helps Canadians. 5 year fixed rates should be under 3.00% but they aren’t, because the Banks want to maximize profits.

VARIABLE RATE PRICING IS AT 1990′s LEVEL

Variable rate pricing went from Prime less 0.90%, 3 years ago, to Prime plus 1.00% in during the October 2008 US mortgage crisis, to Prime less 0.75% just six months ago…. to Prime plus 0.20% today.    That’s right, Prime PLUS 0.20%.  Haven’t seen this pricing since the ’90s.  There are no fundamental reasons for this… it’s simply profit taking by the banks.. they are forcing us to take a 5 year fixed rate.   Sure, today’s 5 year fixed rates are at historical lows, so there is very little attention being given… but when rates go up, and they will in a few years, we will start to ask for more competitive products and better options other than a 5 year fixed rate….  (Can you see Mr. Potter’s grin getting larger?).

My advice… think about who your banker works for….and who your Mortgage Broker works for….

Posted in Interest rates, Money saving tips, Mortgage News, Mortgage Rates, Mortgage Tips. Tags: , , , , , . 2 Comments »

Death, taxes and interest payments. Part 2 of 2.

October 26, 2011 — Steve Garganis

Part 2 of 2….  In Part 1, we examined rental properties and how they can be a great way to reduce your taxes, build net worth and create an income stream.     Part 2 looks at Interest payments.    Interest payments are big part of our personal expenses.   Here are  few suggestions on how to reduce your interest costs.

INTEREST PAYMENT REDUCTION TIPS

It is estimated there is over $1.5trillion worth of personal debt outstanding in Canada.   $1trillion of this is mortgage debt and $500billion is credit card and other debts.   Interest rates can vary from 2.60% for a Variable rate mortgage to 20% for a credit card.   Banks make an obscene amount of profit from these interest rates.   Let’s reduce the amount we contribute to their coffers…

-consolidate your debts…. there is no reason to carry credit card balances if you qualify or have access to a line of credit… Interest rates for unsecured lines of credit are around Prime plus 3%… that’s 6% today.  ($20,000 in credit cards could cost you around $4,000 in interest annually… a line of credit cost around $1,200 per year… a savings of $2,800 per year).

-consolidate your personal loans and unsecured lines of credit into a new mortgage or secured line of credit if you have the equity in your home.  Residential mortgage rates charge the lowest rate of interest…  Variable rate mortgages are around 2.60%. ($40,000 of loans and unsecured lines of credit could cost $$2,400 annually… a mortgage could cost you $1,040… a savings of $1,360 per year).

-increase your mortgage payments and pay your mortgage off sooner… making an extra month’s worth of payments annually, will help you pay the mortgage off in 20 years vs 25 years.  Hey, rates have been extremely low for almost 4 years now… take advantage… pay that mortgage down.

-choose the right mortgage product.   Fixed rate or Variable rate?    Short term or Long term?  The answer depends on personal circumstances, your needs, goals and the mortgage market.   All too often, the first question borrowers ask is, “what is the interest rate?”.  Good question, but they should probably be asking “which product will cost me the least amount of money to own my home?”  This isn’t a one time question and answer.   A mortgage needs to be evaluated regularly, just like an investment.  There are times where it makes sense to exit one mortgage product, mid-term, pay a penalty, and get into a lower cost product.   A mortgage requires planning and on-going review.  The strategy should always be to eliminate this large debt as soon as possible.

- speaking of penalties,  “what are the biggest costs associated with a mortgage?”.   The answers are penalties, interest and being in the wrong mortgage product.   A mortgage penalty can range from 3 months interest to 6, 9, 12 or ever 15 months worth of interest (yes, there have been several penalties charged to borrowers in the 10 to 15 month range by Canadian Banks).  That’s why being in the wrong mortgage product can be costly.

- beware of ‘No-Frills’ mortgages.   This is the latest thing to hit the mortgage industry.   These products carry limited repayment options, carry higher than normal penalties to exit and some don’t allow you the exit unless you sell your home.   You better know the penalties and limitations associated with that low-interest mortgage before signing into a contract…

- stay away from the water-cooler talk.   It’s great to talk with friends and co-workers about mortgage rates and compare.  This usually generates good questions.  But don’t make any decisions before speaking with a professional.   Your brother’s in-law’s cousin’s friend’s mother that works at the grocery store may have got a great mortgage rate or they locked into a great fixed rate when rates were going up…. but what are the details of that mortgage and the circumstances around that person’s decision?  What are the terms that went with that mortgage?     Don’t rely on water-cooler talk….  Speak with a professional that can review YOUR needs and give PERSONALIZED on-going advice for the next 15 to 17 years that it normally takes us to repay the mortgage.  You’ll have a better chance of doing the right thing with your mortgage.

-who said to lock into a 5 year fixed rate?  A lot of us were contacted by our bankers and told to lock into a 5 year fixed rate over the past few years…. clearly, that was not the best choice as Variable rates outperformed Fixed rates by as much as 3%….. Remember, the Banks would love to have all their clients in a 5 year fixed rate mortgage.   This is their most profitable product.  But this isn’t always the best choice for you.  There is very little data to suggest that 5 year fixed has been the best mortgage term to choose.    But perhaps we are in one of those rate times where 5 year fixed does make sense.  Get a professional opinion and then decide…

-turn your bad debt into good debt.   A couple were considering buying a new home and keeping their existing home.  The existing home had little to no mortgage debt.  The couple were going to finance the new purchase with a mortgage on that new house and rent the existing house.  This is not a good strategy.  A better option would be to refinance their current home, while they are still occupying it… thus reducing the amount of the mortgage they require on the new house.   Then, once they buy a new home and rent the current home, they could deduct the interest cost against rental income…. minimizing their taxes.

The bottom line is that there are some things you can do to minimize taxes and interest costs…. and maybe by taking some action, we can also live a little longer by taking some stress out of our lives.

Posted in Case study, Consumer Debt, Money saving tips, Mortgage Tips. Tags: , , , , , . Leave a Comment »

Death, taxes and interest payments! Part 1 of 2.

October 25, 2011 — Steve Garganis

Death and taxes… .. the only two things that are certain in life….you’ve heard this one before.   I think there is a third thing that can be just as stressful… ‘interest payments’…. (before this article becomes too depressing, I’m going to share some things that will help to reduce our interest costs and minimize our taxes).

Paying interest on your credit cards, loans, lines of credit or mortgage is something all of us will experience at some point in our lives or, for many of us, for most of our lives…   ‘Paying interest and taxes can be the death of us’.   That’s because taxes and interest payments account for as much as 67% of our gross incomes.  That’s right, 67%!!

Tax Freedom Day (the day in which Canada, as a whole, has earned enough income to pay all their taxes for the year) this yeas was June 6th.   Any income earned up to this point was paid over to the govt.  Any income after this date is paid to yourself.    It’s hard to know exactly how much tax you really pay given there are several hidden taxes such as alcohol, amusement, gasoline tax, property taxes, HST, etc.    That’s about 42% of your gross annual income going towards taxes.

Now let’s add in how much we pay towards carrying out debts.   There are different stats out there but from my experience, I would say that 25% of gross income goes towards paying all debts...

Add the two together and you get 67%.   67% of your gross income goes towards taxes and interest…  Okay, that’s the bad news.. and now for some positive news…. Here come the tax and interest tips….and maybe this will extend your life by making things a little less stressful.

TAX TIPS

Foreward   - I’m going to skip the usually RRSP recommendations…. anyone invested in the stock market over the past 10 years will know that there has been virtually 0% return during this time..  There may be a place for RRSPs but I’m just not a big fan of them…  Remember, RRSPs are not tax exempt like a Tax Free Savings Account.   Tax is still payable when you withdraw the investment.   ..The theory is that your investment can grow within the RRSP, tax-free, and then you can withdraw your investment at a later date and pay taxes only on the amounts you withdraw….

-In general, to reduce the amount of tax you pay, you must take advantage of tax-incentive programs or participate in tax-deductible investments..  One of the proven winners over the long and short term has been real estate.   We all know someone that made money by buying investing in property…

REAL ESTATE RENTALS

-buying a rental property will allow you several different deductions and opportunities to build capital and a future income stream….

-rental property purchases will allow you to write off expenses associated with purchasing the property… such as legal fees, any arrangement fees, account set up fees, bank fees, maintenance and repair of the property, etc.

-interest payments and on-going maintenance costs can be deducted from rental income, resulting in reduced rental income or a possible rental income loss that can be written off again your personal income.

-the property can appreciate in value, tax-free…. You ONLY pay tax if and when you sell for a profit.   (Historically, property values increase every 7 years… we are in an unusual period of history at the moment.  There are no guarantees the property will be worth more tomorrow..but I like a proven winner.).  If you plan to buy an investment property, then plan to hold for 7 years.

-when you sell the property, you will have to pay capital gains tax on the net profit (purchase price less expenses such as real estate fees, lawyer fees, moving costs, etc).    At the highest marginal tax rate, you would have to pay around 21.50% of your net sale profit towards tax….  Here’s a link to the formula…  That tax rate is in line with the RRSP withdrawal tax rates…

-let’s not forget that your mortgage on the rental property is being paid down for you by the rental income.… each and every year.   If you buy, rent and hold, then you will have a mortgage-free property in 20 or 25 years.. maybe sooner if you factor in the normal rent increases every year…  Rental income is usually indexed with the cost of living….    This part of the investment is rarely considered or talked about.

Watch for Part 2 for our advice on how to minimize taxes and reduce your interest costs.

Posted in Case study, Money saving tips, Mortgage Tips, Real Estate Trends. Tags: , , , , . 2 Comments »
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