May 112020
 

Why inflation matters

U.S. government bonds in 1990 were paying investors 8% a year. That sounds amazing! Especially for a low risk investment. šŸ™‚ But not everyone was buying them. Why? Because investment returns don’t tell the whole story. The inflation rate that year was 5.4%. That means the real rate of return on those bonds was only 2.6%. Stashing $100 under a mattress would have lost $5.40 in value during 1990. As Ray Dalio says, “cash is trash.”

 

Obtaining a mortgage from an unconventional lender

Earlier this year I bought a rental property and took on a new mortgage at 2.44% fixed interest rate for 5 years. After asking around different banks I decided to use monoline lender MCAP. They deal with broker channels and often have lower rates than the big banks. šŸ™‚

negative interest rate mortgage

Since this is an investment property the interest on the mortgage is tax deductible. My marginal tax rate is about 30%. So my effective interest rate after tax adjustment is 1.71%. But this is the nominal rate. To get the full picture we have to subtract the inflation rate. Last year Canada’s official inflation rate was 2.25%. So my real mortgage rate equals the nominal rate (1.71%) minus the inflation rate (2.25%) which comes toĀ -0.54%.

So I’m effectively paying a negative interest rate. I’m earning 54 basis points to borrow money. Woot! šŸ˜€ Personal finance author Robert Kiyosaki says smart people use debt to get rich. He’s right. I’m growing my net worth by literally having this mortgage.

The historical average inflation rate in Canada has been about 2% annually. Let’s assume it will continue to average 2% for the foreseeable future.

This is bad for my mortgage lender. The asset they are holding (my mortgage) will slowly lose value over time. Fortunately for them the 2.44% interest rate they charge me is still higher than the expected inflation rate.

 

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Sep 162019
 

One advantage of owning real estate is being able to access the value of the underlying asset for financial gains. The more properties we own, the more equity we can use to buy additional properties. This is why it’s often easier for homeowners to grow their net worths, but harder for renters. One of the best reasons to refinance is to lower the interest rate on your existing mortgage. Historically, many lenders agree that refinancing is a good idea if you can reduce your interest rate by at least 1.00%.

As we know, a mortgage balance gets paid down slowly over time. In the beginning you might have a $300,000 mortgage. But maybe after the first 5 year term is over, your balance is only $250,000. When you go to renew your mortgage you’ll likely have a couple of options. One is to continue paying down the $250,000 balance. Assuming interest rates haven’t changed, your monthly mortgage payments would also be unchanged, because that’s how mortgages are designed. But the other option is to refinance at a higher balance so your total loan amount is increased. By refinancing, you can access up to 80% of your home’s value less any outstanding mortgages. So if the value of your property is now higher than when you bought it, you could potentially borrow more than your initial mortgage amount against your home. šŸ™‚ But your monthly payments would go up in this scenario because you have more debt.

In order to figure out when is a good time to use one method or the other, we need to consider the following factors.

  • How tight is your budget?Ā 
    If you are already struggling to make ends meet, then it’s usually not a good idea to refinance at a higher balance. Just keep to the lowest amount until your income and spending situation improves.
  • Are there any investment opportunities out there?
    If you expect a good return on a potential investment, then it may be worth it to borrow more money against your home. For example, the Canadian Apartment Properties REIT (CAR.UN) has performed somewhat predictably over the years. Its 1-Year, 3-Year, 5-Year, 10-Year, and even 15-Year returns have all averaged over 10% per year. If my mortgage rate is 3% then that’s a 7% gap minimum, before taxes. It’s reasonable to assume that a margin of safety of 7% is a low level of risk, considering the stability of Canadian real estate.
  • Do you have any other debts?
    Using home equity is a great way to pay out higher interest debt through a refinance. For example, let’s say you have outstanding car loans, student loans, and credit card balances that combine to equal $50,000. Chances are these are all charging a higher interest rate than your mortgage. So instead of refinancing at $250,000 you could simply grow your mortgage debt to $300,000. And use the extra $50,000 to pay off your other debts, saving interest expenses over time.

In terms of how to get more equity out of your home, you could either take on a home equity line of credit, or blend and extend your current mortgage with your lender. Please be aware there are costs associated with refinancing. If you want to refinance in the middle of your term to access equity or lower your interest rate your lender will charge you a penalty. For fixed mortgage rates this penalty is the greater of 3 months interest or the interest rate differential payment (IRD). For variable mortgage rates this is simply 3 months interest. There may also be lawyer fees involved with a refinance. You can also have multiple mortgages from different lenders at the same time, but a 2nd or 3rd mortgage will often come with a higher interest rate and may not be worth it. So it’s important to consider which type of refinance you need before renewing your mortgage. šŸ™‚

 

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Random Useless Fact:

Jul 042018
 

Five years ago I acquired a variable rate mortgage from CIBC. It was the cheapest rate I could find at the time. I was quite pleased with the rate but that mortgage term expired a couple of months ago. So I shopped around to see if I can find another good deal.

I expected my mortgage to become more expensive. Surely rates would have climbed over the last 5 years right?

But no. To my surprise I found a lender that offered me an interest rate that’s lower than my previous mortgage by 43 basis points. šŸ˜€ CIBC was not able to match this offer so I switched. The new financial institution I am with is not one of the big 5 banks in Canada. It is a lesser known company called National Bank.

I wasĀ paying 3.05% with CIBC. This was a variable rate 5 year mortgage at prime minus 0.40%. This was the best CIBC could do.
But my new mortgage with National Bank is only 2.62%. This is also a variable rate 5 year mortgage term. Except the rate is Prime minus 0.83%

A 0.43% difference in interest rates doesn’t sound like a lot. But my mortgage balance is around $193,000. So I will be saving roughly $4,000 over the next 5 years because I switched to a cheaper mortgage provider.

However there are costs associated with changing lenders. Appraisal costs $600, and legal documents from a notary public was $800 in my case. Luckily National Bank has a $750 rebate program for transferring over an existing mortgage. šŸ™‚

In the end the cost of changing banks was worth the extra savings in my case.

Even though most Canadians are choosing fixed rate mortgage I still believe that variable rate is the way to go if you want to save money.Ā The increase in fixed rate mortgages locked in by most home buyers this year is “seen as a response to rate hikes, and fear of higher rates in the future.” But critics have been calling for higher rates for over a decade. Yet rates haven’t actually gone up much. In fact, mortgage rates have dropped over the past 5 years as shown in my post today. That’s why we have to be informed of economic conditions so we can make our own financial decisions, instead of following others. šŸ™‚

I have been a homeowner for almost 10 years. During this time my mortgage interest rates fluctuated from 2.3% to 3.2%. It doesn’t look like rates will climb significantly any time soon. Until we see increasing mortgage rates, I would expect Canadian housing prices to climb even higher.

 

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Random Useless Fact:

30 years ago only 5% of the population admitted to being chronic procrastinators compared to 25% today. Some believe technological advances is the main cause of this change.

Sep 192016
 

The Effects of Debt onĀ Your Health

According to aĀ Globe and Mail article I recently read, people haveĀ gotten sick and depressed thinking about their debts. “Researchers and health professionals are making the case for treating personal debt as a public health problem.” Oh no. šŸ™ Dr. Donna Ferguson, a psychologist in Toronto says,Ā ā€œI think that itā€™s a major crisis. Itā€™s an issue that needs to be addressed.ā€

The averageĀ consumer debt in Canada is only about $21,000. Personally I don’t think that’s a whole lot.Ā Yet psychologists are calling this a “major crisis.”Ā šŸ˜ Ā People are blaming debt for making them feel physically ill. But I have much more debt than they ever will. So if having a healthy relationship with debt is their primary goal, then they should do something to keep their stress under control. šŸ™‚

LuckilyĀ I have a solution to help thoseĀ consumers. If we want them to get better we have to address the root of the issue. TheĀ problem is with individual psychology, not with debt. Instead of creating more health problems for borrowers and increase the burden on our public healthcare system, like what Dr. Ferguson suggests, let’s try to educate people about theĀ truth so we can prevent people from feeling ill in the first place.

So here’s my simple yet effective tipĀ to help anyone who may have debt anxiety:

If you don’t think you can handle the debt, then don’t borrow the money. šŸ˜€

Sometimes the negative consequences of debt are blown out of proportion. The ASA, a financial support organization, hasĀ even made a horror videoĀ to show theĀ trepidation and paranoia that comes with having student loan debt, which further supports the common narrative.

16-09-allow-debt-ruin-lives-meme

Some people have this irrational fear that if we have debt then somehow it will come to get us like the boogeyman. šŸ˜†Ā But the reality is nothing bad will happenĀ as long as we make the payments onĀ our debt.

Missing a Debt Payment is No Big Deal

The consequences for delinquent debt are very lenient towards borrowers. The bank can’tĀ just take our house away as soon as we stop making mortgage payments. In my neck of the woods for example, the bank has to first draft up a foreclosure petition if a mortgage payment is 3 months late. Then the court hearing will be a month later. And then the property goes into a redemption period for up to 6 more months. So we have plenty of time throughout this entire process to get our payments back on track. We can even sell our house if it’s worth more than the mortgage balance.

For other types of debt, if money becomes tight we can enter into consumer proposal or applyĀ for other debt relief options. We’re usually given at least 3 months to catch up on our payments before it goes to a collections agency. Despite the scary rumors, consumer debt cannot physically harm us.Ā We won’t be assaultedĀ or locked upĀ if we’re late on our credit card payments. Nobody will drag us to jail because we failed to make a car payment, lol. The worst they can do to us is take the car away and tarnish our credit score. But I think that’s only fair. Our vehicle is being repossessed only because we broke the debtor/creditor agreement first.

So there’s no reason to get all worried and stressed out over a reasonable amount of debt. šŸ™‚ We just have to be smart and not borrow too much.

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Random Useless Fact:

If the original Power Rangers series were made today in 2016, it would probably offend too many people and be banned from airing in most countries.

16-09-power-rangers-pose-faces

The yellow ranger was Asian. The red ranger was Native American. The pink ranger was portrayed as a ditsy white girl. The black ranger was black. And in later episodes they introduced the white power ranger who was the strongest.

Mar 242016
 

GradualĀ Change

According to the U.S. government, the country only grew 1% in Q4 of 2015. But that’s still better than Canada. Our GDP up here only increased 0.8%. Ā It doesn’t feel like the economy in either country is going to pick up any time soon. Personally I don’t mind slowing downĀ or even contraction. Slow economic times isĀ a natural part of the market cycle because it helps with the price discovery mechanismĀ and prevents bubbles from becoming too big. But of course politicians want to encourage more growth all the time which means investors have to be smarter and more cautious about where to deploy capital.

One concern that affects everyone in the world is an aging global population. Japan is leading the charge onĀ this one. Many Japanese couples grow fruit trees and live to a ripe old age. According to the World Bank, Japan has the oldest demographicĀ with 26% of its population being age 65 or older. We all know what happened in Japan for the last 20 years. It’s GDP is basically unchanged from 1995 to 2015. Same goes for Japan’s stock market. Any money thrown into the Nikkei 225 index 20 years ago would have produced virtually no gainsĀ as of now. The couch potato method of index investing doesn’t always work for everyone.

The percentage of Canadians who are 65 or older is about 17% today. In the U.S. it’s about 15% of the population. We are still a long way off from Japan’s 26%, but it’s worth noting that 17% of Japan’s population was 65 years or older in the late 1990s.

16-03-old-people-meme-technology

I would continue to invest in large, profitable companies. But high quality stocks have been bid up so much that there isn’t much room for them to goĀ higher in the short term based on fundamentals.Ā This is why I look at alternative places to invest as well.

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