Mortgage Basics

When I first found myself looking for a mortgage, I was a bit confused by all the terms and procedures. I've tried to compile all that I could think of in this post.

Mortgage: This one is simple. It is essentially a loan that a lender gives you that allows you to buy the home. This of course only applies if you are like most of us and do not have all the funds to purchase your desired home outright in cash.

Mortgage rate: The lender will only front you the money for your home if there is something in it for them. So they charge you interest on the amount you borrow from them. The mortgage rate is the rate of interest per annum that you will have to pay for the borrowed funds.

Fixed rate: Most people go with a Fixed rate mortgage. This is the agreed upon rate of interest to be charged on the borrowed funds. This fixed rate does not change over the term of the mortgage. So your interest costs are predictable and the same can be said about your payments.

Variable rate: Variable rate mortgages have an interest rate that can change over the term of the mortgage. Mostly a variable rate will be lower than a fixed rate but that is not always true. A lot of people avoid variable rates because of the uncertainty. Currently interest rates are at historical lows and hence variable rate are low as well. But if the economy improved dramatically say in the next year and rates went up, your mortgage rate would also go up if you went with a Variable rate mortgage.

Open or Closed Mortgage: A open mortgage is one that allows you to pay off the balance of the borrowed funds at any time with no penalties. This provides flexibility in case you need to sell or move to a different lender. A closed mortgage assumes that you will stay with the current mortgage till the end of the term. If you try to leave before hand there will be some "early termination" penalties which typically tend to be around 3 months interest (but could be different). In my experience closed mortgages offer better rates than open and most people tend to opt for those.

Term: The Term of the mortgage is simply the duration of the contract with the lender. It should not be confused with Amortization which refers to the total time you expect to take to pay off the entire loan. The Term comes in various flavours - anywhere from 1 year to 10 year (some can be even longer) but the 3 and 5 year terms tend to be the most popular. At the end of the term, if there is still an outstanding balance on your loan / mortgage, you are free to pay it off without penalties or renew with the lender under new terms or move to a different lender.

Amortization: This is the total anticipated period of time that you expect to take to pay off the mortgage. In most cases it defaults to 25 years. And most people leave it at that. However it does impact your required payments - the longer your Amortization period, the lower your required payments.

Down-payment: The amount of saved funds you must bring to the table for the purchase of your home. Typically 5% is the minimum with some jurisdictions allowing 0% down mortgages as well. With lower down-payments you must also pay mortgage insurance (since the risk of you not being able to pay your mortgage is higher as you have not demonstrated sufficient savings ability) which normally applies if your down-payment is less than 25 20% of the cost of the home.

Appraisal: The lender at times will require that your home be appraised since they do not want to loan you more money than the house is worth. If you want to pay more than what the place is worth you have to do that with your own funds.

Pre-payment clauses: Most lenders will allow you some flexibility in making more payments than are required, thus allowing you to pay off your mortgage faster without penalties. Some will allow you to increase your regular payments by a certain percentage while others will allow you to make lump sum payments that do not exceed a certain percentage of the original mortgage amount in any given calendar year.

Payment schedules: Basic mortgage payment schedules require payments once a month. If you get paid twice a month you can split that monthly payment into 2 and pay it each time you get paid. Most lenders offer "accelerated" bi-weekly or weekly payments. For accelerated bi-weekly payments you are basically paying half the required monthly amount every 2 weeks. However since there are 52 weeks in a year, you are making 26 bi-weekly payments each year and thus making 2 extra payments (essentially 13 months worth of payments in 12 months). This only works if your budget allows it but it does allow you to pay off your mortgage a bit faster.

I can't think of anything else at the moment but if I am missing anything, please ask in the comments and I shall add it here.

Costco

I intentionally did not qualify the headline. This post is not just about whether I like Costco or hate it.

I have been a Costco member for a number of years now. My initial impressions were ...
1. Costco stuff is expensive
2. Their membership policy is stupid
3. I hate their receipt-checking at the exit
4. I hate buying in bulk
5. They have yummm soft serve ice cream

Over the years, most of these initial impressions have held.
1. Costco stuff is expensive: I do not mean that you pay for the same thing more at Costco than at other stores. What I mean is that because they only carry select brands and select models of products of those select brands, you end up paying more for the item. For example, at my local Costco, they have a Black and Decker Toaster Over for just under $70. When I wanted to buy a Toaster Oven, I could find ones in other stores for as low as $20 (on sale) . Granted that the ones at other stores aren't as big (capacity) or have as many features as the one at Costco but for someone who will mostly just use it to toast a couple of slices of bread, that $20 unit will be more than adequate. If you're looking for the cheapest product in the market, Costco is not the place for you. If on the other hand, you're looking for more value for your money ... that's a different story.

2. Their membership policy is stupid: I know from reading news items about Costco's financial results that most of their profits come from the membership fees. But I strongly believe that they would sell more merchandise and make more money if they did away with the fees. Or at the very least, let everyone visit the store so that they can at least observe the deals that the store is offering compared to other stores. I hate this Direct Buy-ish mentality.

3. I hate their receipt-checking at the exit: One of my greatest pet-peeves at Costco is the person (or persons) standing at the exit using their marker on your receipt. They add zero value to anyone. The format of the store does not allow you to walk out without having made your way through the cash. So it is highly unlikely that someone can steal anything from the store. And more importantly the person tagging your receipt is not in a position to do anything but do just that ... tag your receipt. Most people walk out with their carts loaded like the store won't open tomorrow. So even if the receipt checker wanted to be diligent and check every item in your cart, they couldn't. I would much rather have those people at the cash so that the lineups don't get too long.

4. I hate buying in bulk: Some items aren't too bad in terms of the size that one must buy. But others can last years. I moved last year and made the mistake of buying their packing tape ... it came in a pack of 8 ... i still have 6 1/2 left. Same goes for soap, dental floss, pens etc. I shall never buy buns or baguettes because they normally have a best before date of the next day and there's no way I wanna eat all that bread in such a short time.

5. They have yummm soft serve ice cream: At $2.09 (after taxes) that's a nice treat.

Over the years I have also figured out what works best for me in terms of saving (and spending) money at Costco.

1. Buy on sale: Most items periodically go on sale at Costco. And they aren't always listed on the coupons that are handed out at the door. When buying at those sale prices, you will rarely find better deals elsewhere. So stock up on things like Craisins, paper towels, bathroom tissue, diapers, wipes, furnace filters, batteries, Brita filters, salsa, cereal, juices, Gatorade etc.

2. Walk the isles: As I mentioned above, a lot of items that are on sale are not mentioned in the coupon handouts. So if you know that you're going to need batteries soon, its worthwhile to walk through that isle even if you only came to pick up milk.

3. Don't be shy about returns: I hate returning items and therefore I used to weigh my purchase carefully before actually buying the item. This does not work well at Costco since what you see in the store today, may not be there tomorrow. And as Costco staff have repeatedly suggested to me ... if you see something that interests you, pick it up. You can always return it if you change your mind. So that is exactly what I do now. With their liberal return policy, I can easily return the item at a later date. If the price drops (as it often does) you can always get cash back or return and repurchase the item if you haven't used it yet.

4. Check the silent markdowns: On clothing items specifically, when they have only a limited amount of stock remaining or only limited sizes, the price gets marked down without any indication that it is on sale. So you can find clothing that would normally be priced at $29.97 is now available for $7. I have a pair of Dockers shorts, Tommy Hilfiger dress pants, fleece pull over, shoes etc that all cost me less than $10 each. The least I paid was probably $3.97 for a nice sweater.

5. Gifts: When looking for presents for kids or house warming events, Costco is often a good place to shop. Most toy (sets) offer good value at decent prices. The only disadvantage is that there is no concept of gift receipts. I wish they had a way to fix that.

6. Get the risk free Executive membership: Their Executive membership is a no-brainer. Instead of the $55 regular membership you pay $100 but that extra $45 is risk free. If over the course if the year you do not make enough purchases to get it back through the 2% cash back rebate, just walk over to the returns / membership counter and they will refund you the difference.

7. Pharmacy: I like the Costco Pharmacy simply because it has the lowest dispensing fees I have seen. Shoppers Drug Mart and the kind charge close to $10 or more for that same service. At Costco it is in the $3 range. This saves everyone money because drug plan expenses are rising every year. Plus they take about 20 mins to do the prescription and that's about the time I need to make my walk through the store.

8. Enjoy the samples: I try to sample as much stuff as I can. But I will rarely buy the item then and there. When they offer the samples, the items are at regular prices. If you like it, wait a couple of weeks and it will go on sale ... unless of course you need it right away.

That said, I would love it if they changed their policies a bit ... especially get rid of the fees and the receipt-checker.

Do you have any special tips to share?

Should parents open their financial books for their children?

Money is a touchy subject in itself. To that pot you add the family dynamic and you have yourself one spicy drama. A lot of families don't really talk about money. Whether they have a little or a lot. And we always wonder what the best strategy is.

Kids often want to know everything - finances included. They want to know how much you make, how much you have and I guess how much they will have when you pass on. But should parents share all this information?

When kids are young and dependent on their parents, I don't think they need to know any more than is necessary. I think it is important to share with your kids if you have little or no money. That way you can temper their expectations. And more importantly teach them the value of every dollar. They can appreciate that while the parents may be able to provide the basics, there isn't much around to throw away. And this is a valuable lesson.

If you are the stereotypically middle-class parent, making enough to meet the basic needs of your family with some left over for the future, perhaps all the kids need to know is that you have a comfortable financial situation but not enough to blow it on regular ski vacations and spa retreats etc.

What if you have done well and are perhaps in the high income low spending category with a decent net worth and no financial troubles to speak of? Perhaps you are saving well for retirement and at the same time have your home paid off (or are close) and are also saving for your kids' education. How do you teach fiscal responsibility to your kids? Even in this situation, I would simply indicate to the kids that there is enough for needs but not necessarily for all kinds of wants.

If you see all the scenarios above, it is clear that I tend to be in the "its better to under-represent your financial situation to the kids" camp. And of course this is coloured from my personal experiences and situations as I grew up. But the reasoning is simple ...

You want your kids to value money. You want them to think before they spend. You also want them to not spend what they don't have. As kids, they do not have a lifetime perspective. Talking about retirement savings and saving for emergencies is pointless because those are alien concepts for a teenager.

You sort of want them to be careful with money while still being there for them if the situation demands it. For example, just because my child has $500 saved from gifts or baby sitting or lawn mowing cash, its not necessarily the best idea to blow it all on an iPad when there are better uses for that money. On the other hand, if its time to go to University and it would be beneficial in the long term for them to go to a pricier place or take a more expensive / longer program, you don't want to force them to take the local admission or a shorter course simply to save money.

So there is a delicate balance there. I would not want to underplay my situation so much that they stop considering options just because of the money. But at the same time I don't want them to assume that I have the Rockefeller fortune behind me and that they should go and lead the most expensive life.

Food becoming expensive

The Globe and Mail confirms today what we all know already. Food prices are rising and will continue to do so.

Of course when it rains ... it pours. So when the economy is not so good, and unemployment is high and wages are stagnant, of course the cost of living has to increase. It only makes sense.

So what are your options when it comes to your money. How do you lessen the blow? Get smarter. And by that I don't mean that everyone should line up for a brain transplant. I mean, get smarter about what you buy and how you buy and how you spend. Here are a few things you could do...

1. Watch the flyers - Stores continue to offer "deals" on certain items week after week. Make use of those offers. Buy extra butter when its on sale for $2.99 a pound so that you can avoid having to buy it when its back to regular prices at $4.99 a pound.

2. Do not waste what you buy - Very often when we visit the grocery stores we'll pick up 3 or 4 kinds of veggies or fruit because it caught our eye. Of course there is only so much we can eat. And with produce, it does tend to go bad a lot quicker than say butter (kept in the fridge of course). So only buy stuff that you need and will be able to consume before it goes bad. That apple or those bananas or that cauliflower that went bad because you never had a chance to eat, is money down the drain. And it costs you over and over again ... you paid for it in the store. Maybe you cooked it and then it went bad so you paid to cook it and to store it and then you also pay the city to haul it away and dispose of it either in the land-fill or their composting facility.

3. Buy in-season food items - if you like to buy strawberries in January, they're obviously not going to be as fresh or from a local farm because there's snow all around you. So you will likely have to pay $3.99 for a pound instead of the summer time when stores practically want to give it away. By trying to buy seasonal produce, you not only save money but also allow yourself to experience some much needed variety in your meals.

4. Try to mix and match stuff - If potatoes are 'cheap' (relatively) this week, try to add them to other items and prepare a different wholesome meal. Maybe you've only had broccoli steamed or raw on it own. Try throwing it into a pot with some potatoes and some zucchini perhaps and get a new dish that you may enjoy. Combining items like this lowers the average cost of your meal.

If you can think of other tips, please add to the list ...

Why is employing legal tax avoidance strategies a bad thing?

There is a tax code that all Canadians have agreed to (through their elected representatives who have voted on the various provisions and passed it into law come budget time). The Canada Revenue Agency enforces this tax code by making sure that everyone pays their fair share. But what is this "fair share". In my opinion, a "fair share" is what you must pay as per the tax code. You might think that I am just repeating myself. But there is a subtle difference.

Consider this scenario of 2 identical families with 2 adults and 2 children (say 5 and 9 years old). Both families have a single income and for the sake of simplicity let us assume that they both have employment income as their sole source of income. Both are neighbours living in the same kind of home as well so everything is identical between them. Again to keep things simple, neither has any RRSP deductions or any deductions for that matter except what I list below.

Family 1: 
Annual Income : $40,000
Charitable Donation deduction: $0
NET income after taxes, CPP & EI deductions: $35,073
Average tax rate: 12.32%
Net disposable income after accounting for Charitable Donation: $35,073

Family 2:
Annual Income : $61,600
Charitable Donation deduction: $21,600
NET income after taxes, CPP & EI deductions: $57,995
Average tax rate: 5.85%
Net disposable income after accounting for Charitable Donation: $36,395

As you can see above, Family 1 with a pre-tax income of $40,000 pays 12.32% of their income in taxes and takes home $35,073.

Family 2 on the other hand, in trying to be identical to Family 1, donates every dollar of their income that is in excess of their neighbour's income to charity. Their effective tax rate is 5.85% and after accounting for their charitable donation and taxes, they take home $36,395.

Most people will simply look at the tax rate and the pre-tax annual income and scream bloody murder.

How is it fair that a family making 50% more income pays taxes at a rate that is half that of the lower income family? And to add insult to injury, they end up with more money at the end of the year.

This is where all the "Occupy" folks are dead wrong. Family 2 is simply taking advantage of the tax code and coming out ahead. It is difficult to find fault with Family 2 in this example because they are giving away so much money to charity. So even the people who would normally have an issue with this case will likely hold back. But Family 2 could have very easily used other deductions to achieve similar results ex RRSPs, Dividend Investments, Capital gains, Public transit credits, Children's Activity credits, Medical expenses credits, tuition credits etc.

And I do not see anything wrong with that. They are simply paying their fair share of taxes and using the existing tax code to do what works best for them. If their effective tax rate turns out to be lower than their neighbours, its not their fault.

Millionaires and Billionaires like Warren Buffet likely use all these strategies and more to end up with an effective tax rate that is lower than what their chauffeur or secretary has.

So why do we frown on folks that follow the letter of the law and come out ahead?

Tax Rates

Here's an interesting article in the Globe and Mail talking about the why it is important to do a bit more thinking before making changes to laws and tax codes. The discussion stems from a proposal to hike the rates at which capital gains are taxes.

Here is the article.

A lot of people tend to take a simplistic view of things and tend to make snap judgements about whether something is a good idea or not. This if often coloured by their own situations, experiences, biases and political and financial affiliations. Something we all need to learn to do is to step back and take a "bigger picture" view of the situation.

Are Budgets really sexy?

A whole host of people out there swear by Budgets. According to them, if you don't budget you cannot be financially successful. You cannot ever be in the black.

I would beg to differ. I don't mean to say that Budgeting is worthless. But I don't thing they are super essential. Here's why...

What does a budget really do for you? For one it tells you exactly how much to spend on what and when. They sort of force you to live within relatively rigid lanes. But life is anything but rigid. No 2 days are the same. So how can one expect to spend a preset amount on the same things month after month?

On the other hand, budgets don't really help you control your spending. That's the job of your will power. All budgets do is give you a guide on what your spending should be. What actually happens is that for most people, month after month, the lines get blurred, and we have trouble drawing in the lines so to speak. And there are always the surprises, the oh-I've-been-waiting-for-this-sale-forever-so-I-have-to-buy-this-now situations.

Perhaps there's a better idea. Keep an eye on your spending. And as long as you're under the ceiling, you're good. This will allow you the freedom to do what you want while still keeping your bank account in the black.

My parents never kept a budget as far as I know. And I grew up in a typical lower-to-mid-middle class family. So we never really had a lot of money to go around. So we were always careful about spending. But I don't remember any budgets. And I guess that habit has continued in me. I have never kept a budget. I do keep track of what I spend on what. But its always after the fact. I do keep a general idea of where I hope to land on the monthly expenses. And I have been this way all the time ... even when I didn't have much in the bank account.

Thankfully things have turned out OK and I have never had to go into debt (well except for the mortgage). So I guess the question is ... am I right? Are budgets really overrated?