Mortgages are more often sold than bought. Evidence of this truth is best illustrated by the number of Canadians choosing to buy into the TD Collateral Mortgage structure.
Now, TD isn’t the only bank offering Collateral Mortgages, they just seem to be the most aggressive in their sales approach with clients.
If you have a TD or Scotia bank STEP mortgage, you likely have a collateral mortgage and you might want to know what that means. Likely the bank told you about all of the advantages of such a structure, but they may not have emphasized the drawbacks.
First, let me distinguish between a Collateral Mortgage and the traditional Regular Mortgage. I asked Bob Woods, of Assured Mortgage Services (www.assuredmortgage.ca/bob) to clarify the differences.
He said, “A collateral mortgage is a loan attached to a promissory note, and backed up by the collateral security of a mortgage on a property. These are not new in Canada and historically have been used in the granting of secured lines of credit. They work well by allowing the balance of the loan to float up or down depending on the customer’s needs.”
So I asked Bob what are the downsides of such an approach for a conventional mortgage. Here is the list that he gave me:
Collateral mortgages appear on your personal credit bureau, while Regular Mortgage Charges generally do not. Even when Regular mortgage charges do show up, they do not affect the credit rating. Bob has seen individuals with Credit Scores in the low 700’s drop to less than 630 after the promissory note loan/collateral mortgage showed up on the credit bureau. The reason for this is that 30% of Equifax’s Beacon Score is attributable to balance limit rations. A $300K limit and a $300K balance can do some serious damage to a person’s credit score.
A collateral mortgage is often registered for the total value of the property. TD is known to be offering up to 125% loan to value. This offers the customer the “convenience” of applying for additional credit when the value in their property appreciates, without additional legal or registration fees. Personally, I don’t see this as an advantage at all, since it facilitates taking on more debt rather than paying it down.
It gives the bank more power as it relates to other unsecured debt (credit cards, lines of credit etc.) that you may have with the lender. A Collateral Mortgage allows the lender to seize equity (mortgage payment) and or re-direct that payment to cover other debts that you have with that lender. So in essence, you are securing all of your loans with your collateral mortgage.
A collateral mortgage cannot be transferred under a “no fee” offer by a competitor bank at maturity. To transfer the mortgage would require new legal fees, re-registration of the mortgage etc. This is a disincentive to transfer your mortgage in order to get a better rate from a competitor.
Finally, if your collateral mortgage goes into default, even briefly, the bank can revert to the registered face rate. Check your paperwork; this is likely to be Prime plus 10%.
I have no problem with banks changing their product structure or creating different borrowing options. What I do object to is the lack of transparency in explaining the pros and cons to the ultimate consumer.
A few Money Insights readers that read the most recent blog regarding searching for unclaimed bank balances asked if there was a similar search service for missing life insurance policies.
There is. It is free, and is offered by the OmbudServices for Life and Health Insurance (OLHI). But before the OmbudServices dedicate time and resources searching for a policy, they expect you to have done a little sleuthing first. At the very least, there are two minimum requirements:
1. There is a reasonable basis for the search. Due to the size and scope of each search, there must be basic evidence to support the premise that some un-located coverage does exist.
2. Specific, factual data about the deceased is available
OLHI expects that you will have already conducted a thorough search through the deceased’s papers, files, and safety deposit boxes. In spite of the lack of policy documents, you must have reason to believe that a policy exists. For example, policy renewal statements, bank statements showing pre-authorized premium payments, and written correspondence with an insurance company would likely justify an inquiry.
OLHI will not do a search within the first three months following the date of death or later than two years after the date of death.
The search will not turn up policies purchased outside of Canada or group insurance policies. For possible group insurance, an executor should contact the deceased’s employer and professional associations to determine if any group life insurance existed. Credit card issuers and banks should be contacted to confirm if any creditor insurance had been purchased.
At the end of 2009, there were over one million unclaimed bank account balances worth $395 million dollars in Canada.
An "unclaimed balance" is a Canadian-dollar deposit or negotiable instrument, issued or held by a federally regulated bank or trust company. It can be in the form of a deposit account, bank draft, certified cheque, deposit receipt, money order, GIC, term deposit, credit card balance, or traveller's cheque.
When there has been no owner activity in relation to the balance for a period of 10 years, and the owner cannot be contacted by the institution holding it, the balance is turned over to the Bank of Canada, which acts as custodian on behalf of the owner.
The Bank of Canada will now hold unclaimed balances for thirty years, once they have been inactive for ten years at the financial institutions. Therefore, balances will now be held a total of forty years prior to being prescribed.
It is not unusual for older Canadians to have a myriad of bank accounts as a means of maximizing CDIC insurance, which until 2005, was $60,000 per bank account and GIC. (The coverage is now $100,000) Such accounts can get lost in the shuffle, particularly if the customer has moved residences multiple times. If you become a financial power of attorney or estate executor, it makes sense to inquire with the Bank of Canada regarding potential unclaimed balances.
You can search for an unclaimed balance by completing the online form at http://bit.ly/zytV8 or by calling the Bank of Canada at 1-888-891-6398.
If you have been a member of a pension plan for a number of years, the benefits you have accumulated in the plan could be an important (possibly your primary) source of income in retirement.
When you leave your employment, voluntarily or not, you may have to decide what to do with this benefit. The options can be varied and in some cases, confusing. Once you have made your choice, there is no turning back. That is why it is essential that your decision is a fully informed one.
This is how the process typically works:
At the point of termination the company will provide a written outline of your company pension plan options. Watch for a deadline being stipulated for your response. Without a response within the required timeframe you may end up with a default option that is either not your preference or not to your best advantage. Typical options include:
Leave your funds in the pension plan
1. Hassle free - One of the advantages of this choice is that all investment decisions are made for you in exchange for a lifetime income. Before selecting this option, you want to be comfortable that the pension plan is solvent and the company is in good financial shape. Even then, the health of the pension plan, and company, is subject to change/deterioration over the length of your retirement. This used to be of little concern to pensioners until the recent financial crisis highlighted underfunded pension plans. Pensioners of some of Canada's premier employers (i.e. Nortel) will be experiencing significant pension income reductions as a result of underfunded pension plans.
2. Choose an appropriate spousal benefit - If you are married, you can elect that your spouse receives the same income, or a somewhat reduced income for their life in the event of your death. Making this election requires a trade off for lower income during you life. Given the uncertainties of life, we generally recommend electing a 50% spousal benefit at minimum. Anything less generous that will typically require the spouse to acknowledge the choice in writing.
3. Medical Benefits - Another benefit of the pension option may be medical benefits that may accompany the pension. Depending on the extent of the benefits, this could be a very valuable part of the pension option.
Commuting to a Locked In Retirement Account (LIRA)
1. Contol - The greatest benefit of this option is control; control over how the pool of capital is invested, and control over access to the capital itself (liquidity).
2. Liquidity - Lump sum withdrawals in excess of the monthly pension are not permitted, but LIRAs allow them within certain limits. In addition, at the time of transfer from LIRA to a Locked in Retirement Income Fund, unlocking provisions can provide additional liquidity if taken advantage of. You may never need to take advantage of the additional access, but it is nice to know the option exists in an emergency.
3. Premature death - In the event of the premature death of the pensioner without a spouse, the remaining value of account is available to the estate or designated beneficiary. In the case of a pension, without a guarantee period, the remaining capital is absorbed by the pension plan to be used to pay pensioners who live longer than expected.
4. A risk - One of the risks of choosing the transfer to a LIRA is of making poor investment decisions that erode the value of the benefit prematurely. Obtaining experienced advice is, therefore, important.
The decision to commute or not to commute is a complex one as there are many variables to consider. Make sure that you get advice, and that the advice is impartial and considers a full range of variables and your unique circumstances.
Did you know that most insurance companies use the Internet as an underwriting tool?
A recent article written by Manulife Financial advises that for insurance companies, the internet is a valuable research tool. Depending on the face amount and purpose of the policy, an underwriter might do an initial search on the applicant, policy owner and beneficiary.
In the majority of cases, they get positive confirmation of application details and this can speed up the approval process.
Here are a couple of recent cases that highlight how searching the internet made a difference.
Female, 29, applying for $250,000 Term 10 life insurance
This applicant had just moved to Canada from the southern United States and had initiated the application. This was a red flag because insurance is usually purchased on the recommendation of an insurance advisor – individuals don’t usually seek it out. The curious underwriter Googled the applicant and the first hit was a “Wanted” poster from the state the applicant previously lived in; she was wanted for forgery and passing bad cheques. The underwriter sent a link to the advisor and the surprised advisor confirmed that it was his client. The insurer declined the application.
Male, 35, applying for $4 million Term 10 life insurance
This young entrepreneur had an incredible business history. Due to the amount of insurance being applied for, the underwriter conducted a search on his business and name. The information on the business helped the underwriter feel more comfortable about the suitability of the product, and about the risk, as very little financial information was available through the standard Inspection Report. (An inspection report is required in the case of large size policy applications, and they are completed by a third party who has no direct interest in the transaction. The purpose is to confirm details reported on the insurance application form.) Interestingly, the client’s You Tube video of his 35th birthday party was also available and showed the insured in an advanced stage of inebriation with a sign on his shirt that said “If found please return to…” This certainly made the underwriter stop and think about this risk! (But ultimately the policy was approved as applied for.)
So, it’s not just potential employers, first grade crushes and potential mother-in-laws Googling you. It’s might also be an insurance company. You heard it here.
Caring for an ill parent brings many challenges; emotional, logistical, physical and financial.
On the financial front, in spite of our government funded health care system, caring for an ill parent does result in costs that are not covered by provincial health care programs. Some of these costs include:
Lost wages for time taken to care for your parent
Private care from a registered nurse or personal support worker (PSW)
Medication not covered by provincial health care plans
Medical devices to facilitate quality of life
In this article I outline a range of sources of funds that can help fund some of the costs associated with caring for an ailing parent.
Private Insurance Plans
Your parent may be a member of a private insurance program that funds a portion of some of these expenses. This could be the health benefits that accompany pension plan benefits, or stand alone privately paid for coverage. I have seen children fund health care expenses all the while the parent had insurance coverage that would have paid for some or all of those costs.
Also inquire if your parent purchased Critical Illness, Disability or Long Term Care insurance. They may be eligible for benefits through these plans.
Attendant Care Credit
If your parent qualifies as disabled and requires the services of an attendant to enable them to function, they may be able to claim some or all of the costs of the attendant. The attendant must be at least 18 and not a spouse. The deduction cannot be claimed where the expenses were claimed for the Medical Expense Tax Credit (explained below).
Disability Tax Credit
This credit is available for disabled persons and is 15% of $7,239 or $1,086 for 2010. The credit can be transferred in certain cases.
Medical Expense Tax Credit
A credit for medical expenses not covered by other sources is available. The amount of the credit is for expenses in excess of the lesser of $2,024 or 3% of the person’s net income in 2010. The credit can be transferred in certain cases. Provincial credits are also available.
Infirm Dependent Credit
Where your parent is dependent on you due to physical or mental infirmity you may be able to claim this credit. The amount of the credit depends on your parent’s net income and is a maximum of $633.45 in 2010 (15% X $4,198). Provincial credits are also available.
Caregiver Tax Credit
This credit is available to taxpayers who are providing in-home care for a relative over the age of 65. The amount of the credit will be related to the dependent’s net income and is a maximum of $633.45 in 2010 (15% X $4,223). Provincial credits are also available.
If your parent has been a contributor to the CPP during their working lives and are less than age 65 they will probably be eligible for some CPP disability pension. To receive the pension they will need to meet the CPP definition of disability. The maximum current CPP disability pension is just over $1,100 per month and is considered taxable income. Your advisor can assist you in describing the specifics of the program and how an application can be made.
If your parent was a member of a private pension plan and has not yet started receiving benefits, most pension plans will provide an early pension if they meet the plan definition of disability. The pension sponsor should be approached to determine the specific benefits provided.
Caring for an ill parent is a big responsibility that can at times feel overwhelming. Hopefully this information will help you tap into additional financial resources that will relieve some of the financial burden you and/or your parent may be facing.
Fighting about money is one of the most common reasons for divorce in North America. Many couples face an overwhelming task when creating and managing the household income. These couples find themselves frustrated when it comes to combining their financial styles, and, as a result, both their net worth, and relationship suffers.
So how do you prevent money stress from eroding your relationship? Here are five common situations that we see in our Financial Planning practice, and some suggestions for overcoming the difficulties.
“We don’t discuss money, we fight about it”.
To prevent a money discussion from turning into an argument, make it a planned discussion. Most couples bring up the subject of money when they are unhappy about something and so the conversation turns into an “I’m right, you’re wrong” debate. For example, spouse buys an expensive item (flat screen tv, fancy new clothes etc.) while the other spouse feels the funds should be going towards the mortgage. What starts as a discussion turns into an argument about which use of funds is “better”. That’s a no win debate.
I recommend that couples meet regularly to discuss finances when they are calm, not at a time of crisis. A quarterly meeting on the weekend, or in the evening over a glass of wine works best. The fewer the distractions the better.
“We’ll never retire at the rate we’re going”
Uncertainty about the future can be very stressful for some people. To alleviate the anxiety, find out where you stand and assess your financial reality. Prepare a net worth statement and prepare a cash flow review. There are many retirement calculators on the internet that will give you some idea as to how close your retirement goal is. Email me at firstname.lastname@example.org for a monthly Budget Tracker that will help you calculate your current cost of living and start the dialogue.
“I’m a saver and he/she is a spender, that’s the problem”
The problem is actually thinking that you can turn a spender into a saver or vice versa. Compromise and moderated behavior is the key. Rather than labeling one another, consider this line of thinking, “We both spend but on different things. Let’s budget”
Create a spending plan together that addresses your individual and combined financial needs and goals. This will often mean having a joint account for “family” expenses and individual accounts for personal spending. The budget should be a reflection of both spouse’s current and future lifestyle needs.
“You worry too much!”
It can be frustrating when a spouse worries constantly about money. In my experience the worry comes from a lack of information about how money is being spent, or whether certain financial goals are being achieved. Even if the worry is unfounded, the solution is complete disclosure. Regular meetings to review the family finances will eliminate the mystery and set the stage for constructive, joint decision making and goal setting.
“We aren’t making any progress”
Hire an objective third party to help facilitate dialogue and develop a financial plan that respects both spouse’s concerns and goals. The Financial Planner should have experience working with couples that are having difficulty having constructive conversations about finances. The planning process and ongoing, regular meetings with the planner will help diffuse the inter-couple stress and keep them focused on working together constructively.
I took my daughter to Great Wolf Lodge recently, which is a family resort built around an indoor water park.
The park highlights are the water slides. They range from the kiddie slides to the high intensity Vortex.
Now, if you really must know, if I could get away with it, (and if I was under 48 inches tall), I would choose the kiddie slides every time. However, my 11-year old daughter is adventurous, but not so adventurous that she'd go on the slides alone so I made the sacrifice and joined her on the more “exciting” slides.
We inched our way towards the “Eagle”, which appeared to be the most tame option at 1,100 feet of twists and turns. During the approach I listened to the squeals of glee and the screams of fear. I watched each person shoot out the end of each slide, focusing on their facial expressions. “Were they upset? Were they laughing?” How would I feel when I got to the bottom?”
It got me thinking about investing. Anyone can go on a water slide and survive (even thrive) because at the scariest point of the slide you can't get off. There are no escape hatches, or ejector seats. All you can do is hold on tight, scream if that helps, and you get to the bottom safe and sound.
Investing can be as unnerving as a wild water slide for some people. The problem is an investor can bail out at any time. Research tells us that they do so frequently when it is scariest, which is usually the worst possible time.
So picture some water slides of varying intensities but you cannot see the end, and you cannot see how people are when they get to the end. Which slide would you choose and see the related investor risk tolerance.
Lazy River – not actually a slide, but a slow moving current where you can coast on an inner tube enjoying the ride while the sound of laughter and screaming surrounds you. Risk profile – Ultra Conservative. Forget investing, go for high yield savings accounts and cash equivalents.
Kiddie slide – a gentle, sloping ride ending in a light splash. Risk profile – Conservative, stick with GICs and quality bonds.
Eagle – a medium speed slide with a few twists and turns. Risk profile - Moderate, a preponderance of GICs and bonds with a sprinkling of quality equity investments.
Grizzly – a fully enclosed tube with higher speed twists and turns. Risk profile – Moderate/high, a balanced mix of fixed income and equity investments.
Niagara River Rapids – a roller coaster like ride with unexpected ups and heart pounding downs. Risk profile – High, primarily equity investments including smaller, non dividend yielding holdings.
Vortex – a dramatic drop down a dark tube into a huge wide basin where you are whipped around at a high rate of speed ending in a final dark, deep descent. Risk profile – Very high, speculative equities including the penny stock that the cab driver told you about yesterday.
It is a well known fact in the insurance industry that bank mortgage life insurance is underwritten at the time of claim.
It is not as well known by the borrowing public. In fact, the majority of mortgage customers are not familiar with the difference between underwriting at the time of claim vs. underwriting at the time of application. Do you know the difference and why it matters?
Simply put, when you buy bank mortgage insurance you only have to answer a couple of medical questions. Unless the size of the mortgage is very large (and hence you are buying a very large amount of life insurance) a nurse does not visit and take blood, urine, your blood pressure and weight.
The bank is not interested in any additional detail because they don't actually underwrite (rate the risk) the policy until there is a claim. At that point, they may actually decide that the insured is not eligible for coverage.
That's right, you don't know if you really are covered until you die and your next of kin files a claim.
If you think I'm joking, watch this episode of CBC Marketplace. It will be crystal clear.
Mortgage insurance has other drawbacks as well, but they pale in comparison to the possibility of your beneficiaries finding out that the insurance they believed would protect them will not pay out.
Usually, basic term life insurance is the better alternative. That being said, it's best to make a life insurance purchase decision in the context of your overall financial plan since everyone's circumstance is different and there is no one answer for all individuals. If you own mortgage life insurance, you can replace it with individual coverage. Just make sure that you get the individual coverage in place before you cancel the mortgage insurance.
For most Canadians, a mortgage is the largest debt they ever take on. Much time and attention is given to negotiating the lowest possible interest rate, but typically much less time is taken determining the optimal amortization period. This is even though the length of repayment (amortization) is directly correlated with the amount of interest paid and, therefore, the ultimate cost of your house purchase.
Here are the four most common approaches to choosing an amortization period along with potential drawbacks:
1. I select the maximum amortization in order to qualify for as large a mortgage as possible, so I can purchase my dream home.
This, of course, is one of the strategies that got many Americans into financial distress. The problem with this approach is that it leaves little room for financial hiccups such as, increasing interest rates, job loss, and unexpected expenses such as home repairs. When the “unexpected” happens, credit cards become the solution and a debt spiral begins.
2. The shortest amortization that I can afford. I can't stand being in debt.
There is nothing wrong with this in theory.....but it lacks practical considerations. This approach also leaves little room for the financial hiccups noted above. Asking the lender to extend the amortization while you look for a new job doesn't always go over well. You know how it goes, it's easy getting credit when you don't need it......
Any half decent mortgage provides the option to double up the payment, increase the payment by 10% and make principal repayments of 20% of the original mortgage every year. All of these options speed up repayment. An alternate to committing to a short amortization would be to moderate the amortization and accumulate the extra funds in a savings account. Every six to twelve months you can determine how much of the savings to apply to the mortgage. If your employer has just announced another round of layoffs, hold onto the cash.
3. I chose an equity line of credit so I can control the rate of repayment.
This is a popular approach these days. It is a lot like #1 but can be even worse since often equity lines of credit only require that the monthly interest charges are covered. This is called the “forever” amortization. A typical rationalization we hear is that it doesn't make sense to pay down the mortgage when interest rates are so low. The reality is that it's the best time to pay down the mortgage since the majority will go towards principal. When interest rates inevitably rise, the rate will apply to a smaller outstanding balance.
Equity lines of credit are best suited to the most financially disciplined of us. Those individuals benefit from the additional flexibility of an equity line of credit without the risk of still being indebted when reaching retirement age.
4. I chose what lender recommended.
This is hit and miss. The suitability of the recommendation depends on the experience, ethics and integrity of the lender. Even the best, most trustworthy lenders base their recommendation on fairly limited information about the client. Lenders typically gather asset/liability and income details in order to determine affordability and credit worthiness. They don't always know about the complete financial life of the client, which if they did, might lead them to an alternate recommendation.
So, how do you choose the mortgage that is right for you?
The options should be considered in light of your overall financial plan.
We give very specific recommendations to our clients regarding the maximum amount of debt they should consider as well as the optimal structure of the mortgage. The advice takes into consideration the client's entire financial reality, their many goals, and risks and opportunities they may not be aware of. Armed with the advice they can negotiate with their lender with much more confidence and power.
What's your amortization and is it optimal for you?