Thursday, 31 March 2016

Ah Spring! Wanna buy a new home?

Yes it’s that time of year when for-sale and open house signs are sprouting like spring flowers on lawns and buildings and the dream of buying a home is in full bloom.  Buying a home is one of the biggest commitments, financial, emotional and other a person makes during their lifetime and can take many forms… it can be a house, townhouse, condo … or even a houseboat.   

The following are some thoughts, both financial and non-financial, from much reading, comments from family, friends, readers and personal experiences (I’m on house number two and have been a home owner for about 25 years).  This is a long one so feel free to get a drink and snack before diving in.  To get you started, here a couple of general references:

Know your Needs vs. Wants but be flexible.  Make a list of the “must have” items versus “nice to have” items but be prepared to be flexible.  For our first house, we had decided a certain area in Toronto as a “must have”.  The houses in this area were mostly in the 80-100 year old range and the ones we could afford were the un-renovated ones.  Remember in horror movies, the scary furnace in the basement?  We found out where they film those scenes.  “Non-scary” furnace was moved to the top of our “must have” list.

Know your Credit report and Credit score. Any idea what yours is?  It’s a good idea to find out.  There are companies tracking how well you use credit products such as loans, credit cards, lines of credit and payment of bills.  All the details of your use of these products is your Credit Report and the number assigned to how well you use them (ranging from 300 to 900) is your Credit Score.  The higher the score the better for getting a good mortgage.  You are going to be asking a financial institution to loan you a large amount of money so it’s worth looking to make sure your report is accurate.  Mistakes on it can cost you.  The main companies in Canada are Equifax and TransUnion.  The Credit Report is free.  There is a small fee if you want the Credit Score.

Don’t let others make you house poor.  Be careful on what mortgage lenders say you can afford.  Their calculators use income, other debt, and some expenses to come up with their numbers but are missing a lot of other expenses and “having fun once in a while” costs.  You house won’t feel so great if you can never afford to even go out for dinner.  Sorry but I’m going to use the “B” word now.  The only way you’ll really know the number you are comfortable with affording is to do a full budget. 

Lenders aren’t the only ones to watch out for.  Your real estate agent may encourage you to buy a bit more house than you want.  When we were shopping for our second house, our agent encouraged us to bid on a house out of our range saying we could negotiate the seller down.  When they didn’t come down into our range, we backed out.  Our agent couldn’t understand why we didn’t just “go for it” because it was only a bit more than our number. 

Where to save your down payment?  The best way is to use your Tax Free Savings Account (TFSA).  The current maximum lifetime limit is up to $46,500 for 2016, if you were 18 in 2009.  Assuming you’ll need the down payment money fairly soon, you’ll be using fixed income investments (e.g. GICs, money market funds, savings accounts) to keep it safe and all the interest income will be tax free.  

Another option for first time buyers is the Home Buyers' Plan (HBP) that lets you take up to $25,000 per person from your registered retirement savings plans (RRSPs).  The catch is you have to put the money back in your RRSP and can take up to 15 years to do it or it will be taxed as income.  This one is trickier to see if it’s right for you. Can I afford the yearly repayments? Will I lose money on the investments in my RRSP if I sell them now?  How much will this set me back on my retirement savings goals? Depending on your answer to these questions, it might be better to save any money you need on top of the TFSA amount in a non-tax sheltered investment.  I’m going to leave out the “rich relative leaving you an inheritance” as an option.

Understand your closing costs.  Make sure to take into account all the costs besides the mortgage itself when purchasing a home.  If you start with the Home Purchase Cost Estimate from Canada Mortgage and Housing Corporation and compare some of the other ones I found such as CIBC’s or Integrated Mortgage Planners you should get a pretty complete list.  I like CMHC’s “other costs” section as a reminder about things you may not think about like curtains if the previous owner takes them or having a little money budgeted for surprise small renovations/purchases you only find out about when you move in (e.g. guess what?... the washer just stopped working or needing a new light fixture for the dining room after taking a practice swing with your golf clubs).  Don’t ask me why the last one happened.  I must have been delirious with joy at buying my first home...I didn't like the light anyway. 

It’s easy to miss something.  With our first home, we thought everything was covered but found we were $1000’s under for the Statement of Adjustments portion since the previous owner had already prepaid all the property taxes and now we owed them.  Nothing like a last minute search for some money you weren’t planning on to get your heart pumping.  And remember don’t get the mortgage life insurance (See “Life Insurance? A little vanilla please!”)

If you are a first time buyer or buying a new-built home, look to see if there are any special credits/refunds for you such as Land Transfer Refund for Ontario First-time Home buyers or the GST/HST New Housing Rebate.

House Inspections…. don’t go without.  With all the costs of buying a home, a home inspection might be something you feel you can skip.  Unless it is a new construction, don’t do it.  It’s a visual inspection systems in your home looking for ones that are deficient, unsafe or nearing end of life with you receiving a written report.  While it is not a guarantee, it does give you a good indication of what is wrong and could go wrong but it doesn't cover everything.  A friend of mine purchased in January and had a full inspection but there was no way to inspect the pool and sprinkler system.  They tried to cover this by speaking with the company who serviced the pool and all seemed fine, but come Spring had to spend on a new salt converter, fix a broken water line to the heater, install a new liner...all unforeseen. Also the underground sprinkler system needed repairs.  

The Ontario Association of Home Inspectors have a good list of what their members cover with their inspections. You could use is to quiz your inspector.

Contractors like the number $1000.   It seems that for all but the simplest work you want done on your home, contractors quotes will be in the 1000’s.  Getting their quotes is a lot like the feeling you get when you take your car in for service and dreading the call back because you know it will be big.  Follow the standard advice of getting multiple quotes and compare apples to apples.  Listen to the explanation from the contractor on the work needing to be done and why they would do it in a certain way.  If the explanation doesn’t make sense to you, think twice.  I had to have the mortar patched for my 80 year old first house and had one contractor recommend grinding out all the mortar and replacing it all for the whole house!  Talk about overkill.  I politely turned him down.  

If you are having any messy changes done, try to do it before you move in and leave extra time as a buffer because it always takes longer than contractors say.  If this isn't your first house, account for this time as well with your bridge financing.     

Type of mortgage? Mortgages come in all shapes and sizes.  Conventional, High Ratio, Fixed rate, Variable rate etc.  There are even mortgages that look like a line of credit.  I’ll just give a few thoughts only since it would take multiple postings to fully cover this area.  A bit of terminology first.   The total length of time to pay off your mortgage is the Amortization Period.  This is the scary commitment number that could be as long as 25 years.  The amortization period is broken up into a number of smaller agreements.  The length of time of these agreements is call the Term.  At the end of the term, a person must pay off the mortgage or reach a new agreement on the next term (renew the mortgage). 

An example: Someone takes out a $250,000 mortgage with a 4% interest rate, a 25 year amortization period and a 5 year term.   The payments are based on the 4% rate and apply only for 5 years.  After the 5 years, they need to pay off or renew the mortgage with a new term.
What type of mortgage should you get?  Here you have to do some research on the types and know yourself.  Do you like the comfort of having the same payment amount for the entire term or can you handle the payments changing as interest rates change?

So you start shopping for a mortgage and want to get some pre-approvals to help decide how much house you can afford (Note some pre-approval limitations).  Should you use a mortgage broker or go to your primary financial institution?  I’d say both.   I’ve read about concerns and limitations of using brokers (5things your mortgage broker isn’t telling you, Mortgage Broker or Big Bank- Who to Choose?) but don’t consider them significant.  If I can offload to someone else getting me get quotes from multiple institutions sounds good to me.  Go to the institutions you already do business with and ask them as well.  They will want to make you happy so you bring more of your business to them.  Mortgages are negotiable so don’t accept the posted rates.  Ask for better.  Interest rates are low right now so there won’t be a lot of room to negotiate but worth a try.  Make sure you understand the conditions and features of the mortgage with each quote.  The cheapest rate might not be the best for you.

Pay off your mortgage sooner.  I know what you’re thinking… wait a minute!  I just scraped together the down payment and I have enough to pay for my living expenses but not extra to put against the mortgage… but it is something to be thinking about.   Doing biweekly payments is something you can do right from the beginning.  If you divide a monthly payment in half and pay that every 2 weeks, you end up paying the equivalent of 13 month of payments per year.  

Some mortgages offer a once a year opportunity to increase the payment amount and/or make a lump sum payment up to a certain percentage penalty free.  Every time you get a raise, consider using some of it to increase your payment amount or if you get a bonus or RRSP refund, use a portion as a lump sum payment.  I’m seen lump sum payment minimums as low as $100 so it won’t hurt that much but could cuts months and years off the life of your mortgage if you do a little each year.  

See Three ways to pay off your mortgage faster for elaboration.  I’m not going to try and analyze the “payoff mortgage or contribute to RRSP first” question.  There are lots of articles discussing this.  I like making the RRSP contribution and taking the refund and putting it against the mortgage.  Gives me the feeling I can have my cake and eat it too.

House as an investment?   Someone told me recently they were thinking of buying a home instead of renting (and investing the excess compared to buying a home) since they felt it would provide a better return than the stock market.  I can understand the feeling with the current stock market but I’ve never thought of my house as an investment but as a lifestyle choice.  It’s definitely cool to own your castle and there’s the “I have my own home so I must really be an adult now” feeling.  I’m not trying to convince anyone not to buy a home.. I love mine but do it for the right reasons.  

When you look at the numbers it just doesn’t work out as an investment.  Over the long term, on average, stocks have a bigger gain than real estate and the home expenses can be unpredictable and potentially quite large.  Freeing up your money from “home” investment is also tricky.  You still need to live somewhere and to make money it has to be somewhere cheaper than where you currently live.  Making it harder to part with is probably the only advantage.   When housing prices go down, people don’t panic and sell their house to cut their losses like they do with stocks.  Real estate or stocks – which will make you richer? expands on this discussion nicely.  Buy your home for the enjoyment factor and if you make some money in the end consider it a nice surprise but don’t count on it.

One last closing thought.  There is no rush to buy a home.  If you’re not ready for whatever reason (e.g. not enough saved for a down payment, haven’t found the right place) you’re not ready.  Don’t let headlines (e.g. mortgage rates are rising, housing prices are rising), agents (e.g. you can’t pass this up), the thrill of open houses, bidding wars or peer/family pressure convince you otherwise.  You want to be able to love where you live.  This is a big decision and you’ll likely be on the hook for 20+ years so make sure it’s right for you.

Happy hunting! 

James Whelan

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Tuesday, 23 February 2016

RRSP for my teenage son!

I was doing my yearly check of the RRSP (Registered Retirement Savings Plan) limits for my wife and I to see if we could or wanted to make any last minute February contributions on top of our monthly ones when I realized my teenage son had some RRSP contribution room this year.
Last year, he had a part time job working at a grocery store so I did his first tax return for him and he ended up with some contribution room.  He's not 18 so can't use a TFSA(Tax-Free Savings Account) yet so I thought why not make an RRSP contribution this year.  The thought of having some tax deferred saving starting when he’s in your teens so there’d be 40+ years of growth and compounding is very appealing.   My approach with my kids and money is very much in line with an article I read lately by Tim Cestnick called Three things every teen should understand about money.

So I talked over the idea with my son.  This is how it went:

Me: I think you should put some money in an RRSP.  You have $Y of contribution room from your job at the grocery store last year.
Son: Isn't that for people that want to retire?

Me: You're right RRSP stands for Registered Retirement Savings Plan and the original purpose was for people save for retirement tax free and pay less taxes later when their income was lower.   But now a lot of people use it for other things as well like a down payment for a house or for education.
Son: Why would your income be lower later?

Me: When people retire they don’t have pay from their job so their income is normally lower and they pay less taxes.
Son: Makes sense. Their tax rate is lower.
Son: Why can’t I just keep money in my saving account?  I’m getting some good interest there.  (He has one of these high interest savings accounts to save for university where he’s getting about 1.3-1.5%)

Me: You can but the bank will send you a special statement for all your interest called a T5 and you’ll have to pay tax on it.
Son: Huh. (with a tone implying this was news he may have to pay tax on interest)

Aside: We did have a separate talk about if you have a smaller income you will pay very little or no tax (i.e. $11,474 of taxable in 2016 without paying federal tax and varying amounts between $7,708 to $18,451 for provincial or territorial tax depending where you live.  See 2016 Personal Tax Credits - Base Amounts for exact amounts).

Me: I'll check out your options and then we can do it.
Son:  That's an awesome idea Dad! (The actual answer was more like "okay" but his tone definitely said awesome.  He's a teenager after all)

He didn’t take much convincing but I wasn’t surprised.  He’s always liked to save money.  When he was small, my wife and I would find him in his room with his piggy bank poured out on the floor counting and stacking his allowance.  Always made me think of Scrooge McDuck hanging out in his vault with his money.

So I’ve started the hunt for a good place to open an RRSP for someone only starting with 100’s of dollars.  

I’ll probably also include looking at a TSFA as well since he is only a couple of months from his 18th birthday.

I’ll do a future post letting you know how we made out.  It will be an interesting hunt because many mutual funds have $500 minimum initial investments, many RRSP Savings accounts interest rates are very low, the same for GICs if you can find one to buy with less than $1000 and then there are the various RRSP administration fees many financial institutions charge.

For those of you already with some ideas, please pass them along.  I’ve already found some to consider but don’t want to spoil the sequel to this adventure prior to a future post.

James Whelan

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Wednesday, 20 January 2016

Life Insurance? Give me some toppings!!

Back to our discussion on life insurance.  

We covered the basics in Wanna bet... on my life! and then the vanilla of the life insurance world, Term insurance, in Life Insurance? A little vanilla please!  

Now the toppings!!.

Permanent Life insurance, like the title implies, doesn't just cover a specific period of time but is there “permanently” or for your entire life.   Similar to term insurance, the insurance company calculates the average premium you need to pay across the entire term, in this case your estimated lifespan.   

Compared to term life insurance, the premiums will most likely be more expensive in the early years of the policy and less expensive later.  This is because if I bought a term policy in the early years, I would most likely be healthier and less likely to die so the cost is less.  Similarly, a term policy in later years would be more expensive since I would likely be less healthy and more likely to die. Permanent life smooths out your costs similar to when you choose an equal billing option for a utility bill to keep the payments the same.

This type of insurance usually has a built-in savings account funded by part of your premiums known as the Cash Value.   You can get this cash back if you cancel your policy or sometimes you can borrow from it directly or use it as collateral on a loan.

Permanent Life Insurance comes in two common variations – whole life and universal life.

Whole life insurance is the “chocolate topping” compared to Term life keeping your premiums the same for the life of the policy and amount paid out is guaranteed  

Universal life insurance adds the “cherry” with the ability to change the premium amount plus having an investment account.  You are able to choose how the premiums are invested, normally from a select group of investments.  The amount paid out and cash value is dependent on how well the investments do.

So when would you choose one type versus the other?  Whole life is good if you want to have certainty on what you are paying and how much your beneficiaries are going to get.   Universal life gives you growth potential and another place for investments to grow tax-free similar to an RRSP but without any maximums plus you can leave the investments in the policy for your beneficiaries or use them for income during retirement.

Now that we are talking about Permanent Life, I want to revisit the question about insurance for children.  I had several readers respond to this when it was discussed related to Term insurance.  Thank you.   I’m not a big supporter of term life insurance for children though no doubt, parents experiencing this type of loss would benefit from having the financial means to take the time to deal with the emotional pain and suffering.  Insurance is always a very personal decision. 

When it comes to Permanent Life insurance there are stronger arguments to consider it.  An individual policy for a child could be used as savings so when they become an adult, they could cancel the policy for the cash value or continue paying the premiums to keep the coverage.  A child rider (add-on) could be added to the parent’s policy and later converted into the child’s own policy when they are an adult without going through the medical tests and questionnaires to see if they are eligible for coverage.  If your child is unlucky with illness, or just makes bad health choices later in life having these options would be really valuable.

Bettina Schnarr of  HollisWealth has "come to see the value, not only in the coverage it (the rider) provides on the child today, but mainly because it can be converted (at least 5 times the initial amount), usually by the child's 25th birthday, to permanent life insurance, without proof of insurability.  These days, it's becoming harder and harder to qualify for life insurance without being rated and insurance companies also look for any hereditary conditions in the immediate family.  …they are now asking about grandparents, not only parents and siblings as before… a whole life policy for $30,000 for a 10 year old male would be at least $200/year.  However, a $30,000 child rider is around $150 and is guaranteed convertible at 5 times that amount.  The real bonus is that these child riders cover all of your kids for the same price!  So it is a lot cheaper per child the more children you have".  [Disclosure: I don’t have any investments with Bettina]. 

So aside from covering parents, if they ever suffer this type of loss, this is an investment in your child’s future.  Go with the individual policy if you want to give them the options to continue with the insurance or cash out when they are an adult or go with the rider if you worry about their health and ability to get insurance later and/or you have lots of children.

So we’ve talked about Term and Permanent Life Insurance but how do we put it all together?   The best way to think about it is in layers with one long layer covering the long term or “Permanent” needs and another shorter layer for the more temporary or “Term” needs.  Normally, you would go through a financial needs analysis with an insurance agent to determine what you need covered.

Let’s use my own situation as a very simple example.  My wife and I both are currently working with our children both in high school.  Soon they will be going to university and sometime after that we’ll be retiring.  Examples of temporary needs for us would be our mortgage, paying for our children’s education and replacing the income of a parent who dies prior to retirement.  Permanent needs would be funeral expenses, taxes and any decreases in income.  We have covered this with a combination of individual Term life policies from our employers plus purchase of additional term policies and a joint Permanent Life policy.

This concludes my series on life insurance.  If you want to do some further insurance reading, take a look at the links below.

For my next posting, I’m thinking about advice on buying a house.  If any of you have an advice to share or ideas for other topics, please drop me an email or twitter message.
James Whelan

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