Canadian Personal Finance Blog

Bank of Canada Stays Pat

Experts, shmexperts! All the major sites were calling for a cut to 2.75% on the overnight rate, well the Bank of Canada saw some sense and held their ground and did not cut the rates this time. I think this is a good idea given the Inflation Boogie Man is out there and I suspect he is going to come and stay for a while too!

The comment from the Bank of Canada States:

If current levels of energy prices persist, total CPI inflation will rise above 3 per cent later this year. However, with the Canadian economy operating in excess supply, core inflation is expected to remain below 2 per cent through 2009. Both total and core inflation should converge on 2 per cent in 2010 as the economy returns to balance.

Against this backdrop, the Bank now judges that the current stance of monetary policy is appropriately accommodative to bring aggregate demand and supply into balance and to achieve the 2 per cent inflation target. There continue to be important downside and upside risks to inflation in Canada, which the Bank will monitor closely.

Mortgage That’s the Ticket!

In my humble opinion, for me, I should be paying down my mortgage and debt load, and not concentrating on my retirement.

Until about 1 year ago, I had the potential to get a very good pension from my employer (the pension was capped and a new pension system put in place, although I still have some equity built up in my now capped pension), so I was actually investing heavily in a Spousal RRSP to ensure an income splitting model when I retire.

Currently I save about 8% of my income in RRSP or retirement funds (without including the new Pension that I am currently part of, that I am not sure what value it has yet).

Saving 8% annually approaches what I should be saving for my retirement as a minimum (last I heard most “experts” said 10% is a minimum you should save for your retirement). I suspect I am ok for retirement, whatever that actually means to me (given I don’t think I can retire for a long time, due to family commitments).

Wait a Minute, you said….

What do I mean by the title of this post then? I actually am on the “RRSP That’s the Ticket” side of the question of whether to invest in your retirement or pay off your debts? My answer is I think I made a mistake, and should have been much more aggressively paying off my debt load (which is not as low as it should be currently).

I make this statement as my opinion of how my debt load is affecting me. Let me be clear, carrying debt is making me sick, it keeps me up at night, it distracts me and worries me every day since I went into debt many years ago. I am confident this worry has affected my health directly, worrying about this debt and the scenarios that come from still carrying this debt, this late in my working career.

What should I be doing now is the next interesting question? I think I need to sit down with my wife and figure out how to change all of this, but we were going to do that anyhow given it is almost the end of this home finance quarter.

After last week’s “show and tell” about Mortgage worksheet calculators, the next question to ask yourself is which is more important to pay into your Retirement Fund (RRSP or 401k) or pay off your Mortgage (and debts)? Since the U.S. model has tax implications for paying off your Mortgage, and I do not wish to mention the Smith Manoeuvre for Canada, let’s just concentrate on the Canadian model.

In a lot of cases this question is of no real value since a lot of people can only afford to pay for their living expenses and do not have free money to pay for their retirement or speed up their debt payments, for those folks, the job is hard enough, but I encourage you to find savings somewhere and do something more with your found money than “party” with it.

Arguments For Paying Down Mortgage

Some of the reasons I have heard and espouse for paying down your mortgage first would be:

1. Carrying debt is dangerous no matter what the economic times, and the sooner debt is removed from your plate, the sooner you can relax about your finances.
2. Once your mortgage is paid off then you can start saving for your retirement, knowing that you will not have that expense in your golden years.
3. Paying off your Mortgage is like investing in Real Estate, which is usually a good investment.
   • I don’t view my house as an investment, I view it as an essential of life, as in shelter is somewhere you live, not where you invest.
4. You are increasing your liquidity, by having more credit available to you, in case of emergencies.

Arguments For Retirement Money

The reasons to put money in your retirement funds are many as well:

1. Retirement saving is like Golf, the sooner you start doing it the better you will be at it later. Money saved at age twenty has much longer time to double than money invested at age 50.
2. With current interest rates, you can invest your money and make more with it, than if you pay off your Mortgage (typical Mortgage rate is about 6% whereas the Stock Market’s normal rate of return is about 7%, so you are ahead in the game).
3. You get tax money back for putting money in your RRSP, but you don’t if you put that same money into your mortgage. This is important since the major expense for most of us, is still taxes.

Best Choice?

That would be telling, I’ll write some more about this tomorrow, but I am open to discussion, pointers to good articles, and any other comments folks might have about what the right choice for them was and is (remember at the end of this, it is a personal choice on your part).

Now that we have figured out how to track our Mortgage using this Mortgage Work Sheet with Excel , we can now start doing some interesting tricks to see what we can do with our Mortgages.

The Power of Overpaying

I have some dear friends who paid off the houses they lived in, very quickly each time they moved from house to house (as their family grew). They both had good paying jobs, so they set up a simple goal with their Mortgage, each Mortgage payment they made, they were going to “double up” (i.e. pay a double payment to the bank). They had chosen the type of Mortgage (so there were no penalties to make extra payments) and sure enough they paid off their houses incredibly quickly.

How quickly could this be? If we go back to the model I have been using all week, this is how fast our family could pay off their house if they doubled up on their payments.

That’s amazing, you pay off the house in 8 years (give or take a month or two). Can most people do this? Not very likely, but it is something to think about and play with. Can you pay off your house early if you give up going out as much, and instead pay your Mortgage down? That is the question to ask.

More Mortgage Fun

With this worksheet you can explore the following interesting scenarios:

• Interest rate changes and what that might do to your pay back capabilities
• What happens if you take your tax refund and put it on your Mortgage, instead of into savings.
  • This is an interesting scenario, where you put money in your RRSP, you get money back from your taxes and then put that money on your Mortgage, a Win-Win proposal!
• And other interesting fun games.

Use this worksheet as a tool, and learn about what you can and cannot do when you buy your house.

Yesterday I showed how the simple PMT() function in Excel can be used to estimate your periodic mortgage payments, if you have all the pertinent information. Today we can use that information to build a schedule to show your mortgage payments and how they change your Mortgage Principle over time.

First a clarification, as was pointed out by one of my commenters, the PMT() function gives you the wrong periodic payment, due to Canadian Mortgages having their interest compounded semi-annually (twice a year) whereas in the U.S. it is compounded annually. The fix for this is to change the first entry in your PMT function from:

• Annual Interest Rate/12 months: which assumes only an annual compouding
• ( (Annual Interest Rate/2 + 1) ^ (2/12) -1 ) which compensates for the semi-annual compounding

Mortgage Table

I like a Mortgage Schedule Table, just because it gives you the ability to understand where you stand in terms of paying off your loans.

Each row of the table will show a payment, how it breaks down in terms of interest and principle payment and how much principle remains after each payment (sounds simple doesn’t it, well it is):

Let’s try this example and show some of the sheet. Assume a $100,000 Mortgage, with an interest rate of 5.95% compounded semi-annually, with a 25 year pay back with monthly payments. We use the PMT() function to find out that our monthly payment will be $636.84.

The sheet will be laid out in the following way:

• Column 1 is the date of each payment
  You can do this for bi-weekly, but I did monthly to make it easy to increment from month to month you simple do =DATE(YEAR(A12),MONTH(A12)+1,DAY(A12))
• Column 2 shows the actual monthly payment
  We already calculated that using the PMT() function
• Column 3 calculation of how much each payment goes towards the Interest
  This is = Previous balance * Interest rate for that payment period
• Column 4 calculation of how much each payment goes to the principle
  Total payment - Interest Payment = Principle payment
• Column 5 the remaining balance on the loan
  Previous Balance - Principle Payment
• Column 6 total interest paid on the loan so far.
  Previous Interest total + Interest Paid on this payment

Simple isn’t it?

You just keep going line by line for 25 * 12 times for all the payments and you will see the loan drop to zero. Hopefully tomorrow I will have a link to the example worksheets I set up, for both US and Canadian Mortgages.

More interesting versions of this is if you add an OVERPAYMENT column and then start seeing what happens when you add extra payments early on and how much faster your mortgage gets paid off!