Entries from January 2012 ↓

Basis instinct

Susan says this mortgage war is making her hot. “Seriously, how can you not love it?” she asks me in an email I swear smelled like Victoria’s Secret Dream Angels Heavenly eau de Parfum spray. (I know of such things.) “How can you not buy something when it’s just 2.99%?”

How indeed? When the evil-doers at BeeMo dropped their five-year fixed rate by fifty basis points, it plunged to a 195-year-low. That’s even before Sherry Cooper worked there. The move was matched within hours by other banks desperate to maintain market share. In fact, cheapo rates broke out for six, seven, even ten-year terms. You can now lock up for a decade at less than 4%. The last time that happened was never.

Over at the Globe they sent out for more Depends.

“There’s a brilliant reason to get into our expensive and quite possibly weakening housing market right now,” finance columnist Rob Carrick gushed. “Why consider buying now? Because you can borrow money at 3.99% or a bit less for 10 years. It’s like freezing time at the exact best moment ever to finance the purchase of a house. If the price of your home declines, it’s bound to be on the rise again a decade from now.”

Well, of course. It’s different here. Canadians have found a secret way to suspend the laws of economics. Any real estate decline will be temporary. All you need to do is make loans cheap enough that everybody continuously borrows, keeping house prices aloft forever and supporting sustainable personal net worth. What’s the problem?

According to the International Monetary Fund and lots of other people whose faces smirk a little when you mention Canada, plenty. This is called credit easing – when commercial lenders ride the bond market and slash borrowing costs. The lower borrowing costs go, the more people borrow (think of a big sale on glazed Timbits). This is not good news in a country where debt has swelled to 153% of disposable income (compared to 146% in the States). Where F is considering killing the 30-year mortgage to stem the housing bloat. And where women get aroused when their men whisper about fixed versus variable.

It’s exactly the infatuation with debt that the mortgage wars are promoting, along with fat house prices, that has the IMF worried about us. “Adverse macroeconomic shocks, such as a faltering global environment and declining commodity prices, could result in significant job losses, tighter lending standards, and declines in house prices, triggering a protracted period of weak private consumption as households reduce their debt,” says the agency.

As this tormented blog has asked, when real estate and related activities make up 27% of our entire economy – and that’s supported by $1.2 trillion in mortgage debt and runaway personal borrowings – how could there not be substantial risk? Isn’t this exactly the pickle America found itself in circa 2006? And once a housing correction starts, shattering the ‘we’re different’ myth, what’s to stop it as people rush to get out from under their ill-conceived loans? After all, six years on, Americans are still searching for the bottom.

No doubt. BeeMo and the boys stepped in it this time. “It could increase the housing bubble,” says economist Sheryl King. “The lower interest rates are, the more speculative demand you will have in the market.” And that’s a sobering thought, when an estimated 80% of all existing condo sales in Toronto, for example, are already made to flippers and speckers.

And where’s the Bank of Canada as the orgy continues? Just days ago Mark Carney warned of our coming condo implosion, and for almost two years has been imploring people to stopping binge borrowing. But this week the central bank once again decided to hold its key rate pat. Like every successful bureaucrat, he’s opted to let a politician wear it. And so the mortgage war just about guarantees F will have to act in the coming weeks.

Meanwhile there’s new evidence even market-share-greedy bankers can be hilarious. Like John Turner (no relation), a big tamale at BMO. When asked why the bank decided to hand over crack cocaine mortgages to a nation of wasted users, he replied: “We’re giving a low rate with a shorter amortization to help people reduce their debt quicker. It’s about doing prudent things for customers that want to be debt-free sooner.”

I ask you. Have you met any modern young couple who, given the choice between granite c-tops with SS apps and debt freedom, would choose the latter? Do they exist?

Some people are arguing this week that the cut-rate loans are an attempt to wean Canadians off those cheap variable-rate mortgages they’ve been in love with, and to lock them up with five-year terms. This way they can be spared the carnage in store when Brother Carney finally grows a set and brings rates back to normal levels. There’s truth in this. But let’s think about what happens in 2016 when somebody with a 2.99% BeeMo Special faces renewal at, oh, 7%. And that will be about the time wrinkly Boomer desperados are trying to turn their fading suburban temples into cash for groceries.

Yes, it’s different here. We’re hooped.

Don’t save

Yesterday I told you why RRSPs suck. In Canada, this is dissing Tim’s. Calling Don Cherry a nutjob. Pitying Saskatchewan. Hating snow. Envying America. Renting.

But the fact is, most people make their financial lives worse because they RRSP  just to secure a tax refund. They stick the money into dead-end GICs, then pull it out years later and get whacked with tax. In fact, seems most people think an RRSP is a thing that you buy at the bank, rather than a financial tool. So they screw it up.

In the previous post I gave you eight reasons to be careful. The banking and mutual fund industries will hate me for this, but it’s a long list already.

Nonetheless, there are some uses for registered retirement savings plans, which have a lot more to do with tax avoidance than actually retiring. Avoidance, by the way, is legal. Hell, it’s a moral obligation. Let’s dig in.

First, the baby-friendly RRSP. One of the best uses for this thing is to finance a maternity leave, but you’ll have to do some advance planning (good luck). So at least three years before your little family pops, set up a spousal plan in the wife’s name and start whacking money into it. You are allowed to contribute to a spousal up to your own contribution limit (18% of income, or about $22K), and deduct that amount from your taxable income. But after three years the money becomes the property of your spouse. So, during a mat leave year she can withdraw it for family expenses. And because her income tanks, there’s virtually no tax.

This is an example of income-splitting. The guy gets to deduct the contribution and slash his taxable income. The gal gets to use the money, and yet pay little or no tax. This is right up there with making a ‘contribution in kind’. In that case you can put an asset you already own (like an ETF) into an RRSP, and it will act the same as if you used fresh cash. For selling yourself something you already owned, the feds will send you a cheque. Is this a great country, or what?

An RRSP, as the baby thing shows, is a good tool for evening out income during various stages of your life. For example, throw money in during your working years if you plan on going back to school and become a pole dancer or financial advisor (roughly equivalent, but one has better tips). Or you might work in a shaky job or a sunset industry, when it makes sense to contribute to a plan, get a tax refund, then live off the collapsing RSP while you find other work.

Of course, an RRSP can also fatten up your regular paycheque. Most people wait until a tax year is over to make a contribution (like now), which is dumb. In that case you’re simply buying back some taxes you paid months earlier. A much better route is to make regular contributions throughout the year and get a refund in each pay. Go to cra.gc.ca and click on Form 1213, Request to Reduce Tax Deductions at Source. Fill it out. Send it to your local tax office. They will instruct your boss to reduce withholding taxes on your cheque. Presto, you have more money to spend drinking with The Smoking Man.

RRSPs can also make sense if you work for a company which matches contributions. This is like free money. Take it.

One other strategy to consider is an RRSP mortgage. The system allows you to hold a residential mortgage inside your plan, and if it happens to be your home loan then you get to make payments to your plan, instead of the dudes at the bank. This is a highly sexy idea, but not without considerable hair on it. Setting up a plan takes time and money. You must insure your RRSP mortgage with CMHC. You can’t charge yourself a ridiculous interest rate, or default and foreclose on yourself. But it works. I’ve met people who took this advice from me 20 years ago, and never looked back.

Of course, there’s the Home Buyer’s Plan. The feds let house-horny, lusty young things suck $25,000 from an RRSP to use for a down payment (or $50,000 for a couple). This is a tax-free loan, but you have to pay it back over 15 years. Miss payments, and it’s added to your taxable income. One strategy to consider: Beg or borrow the whole fifty and dump it into your plans a few months before you start house hunting. That will earn you a refund of $15,000 or so. Now you have a downpayment of $65,000.

And what happens if you end up being a wrinkly geezer with a fat RRSP? At age 71 it must be cashed out or turned into a RRIF, which means you’re forced to take about 7% a year as income – fully taxed and possibly pushing you into a higher bracket. In that case, you can meltdown your plan.

Borrow money and invest it in a nice balanced non-registered portfolio. Now make the interest-only payments on that investment loan from your RRSP. The RRSP money is taxable, but the loan payments are 100% tax-deductible, so over time you are transferring money from the registered plan into the after-tax one.

Finally, understand that when some blessed, miraculous MP (who should have a statue, by the way) invented the TFSA years ago, it was the beginning of the end for the RRSP. In a stroke, the upstart tax-free savings account provided tax-free growth inside the plan, but eliminated the nasty tax grab when you actually spend the money. There’s no deduction for making a contribution, but as I explained yesterday, that ‘refund’ everybody is hot to get only gives you back taxes you already paid – and will pay again.

So, the first five grand extra you get should go into the TFSA. But don’t wimp out and stick it in the orange guy’s shorts, or be seduced by [email protected] Invest, don’t save.

Okay, I’m done. You’ve been a very ruly class. Now go break something.