The best way to pay off a mortgage when retired with money from RRSPs…
Does the title of this post intrigue you?
I’ll bet it does!
Why am I talking about this today?
Well, because “the best way to pay off a mortgage when retired with money from rrsps” was an actual Google search phrase that this person used and how they found us here at http://HowToGetRidOfYourMortgage.com
Now think about this for a moment.
Here is someone who is obviously retired and wants to pay off their mortgage and wants to know that best way to do it using their RRSPs.
Now I am all for Canadians looking for creative “out of the box” thinking for paying down their mortgage faster. Looking for useful information that is more than what their banks are sharing with them…
But using RRSP money directly to pay off a mortgage faster is certainly not the best strategy – in my opinion…
Do you agree?
In fact, that’s why I wrote “The UnCanadian Way To Get Rid Of Your Mortgage And Create Wealth”…
To share information and to illustrate a simple but powerful strategy where you can pay down the mortgage faster and create tax deductions while creating investments outside your home that can be used to pay off the mortgage at a future date.
Its all about creating options for yourself.
At retirement, there’s nothing particularly wrong with still carrying a mortgage – but its a large expense to have at that point in your life.
Most Canadians do everything in their power to have the mortgage paid off before retirement.
And you don’t want to be using your RRSPs – specially in retirement – to pay off the mortgage.
RRSPs are the “pension” pool of money that you have saved that are to take you through your “golden years”…
Also, anytime you take money out of RRSPs you lose the tax sheltered aspect and have to pay tax on the money.
So you are compounding the problem by taking out liquid, accessible, taxable money to pay off a non tax deductible debt for an illiquid investment – your home!
I suspect that like many Canadians this person (retired) has a home – with a mortgage and some money in RRSPs – and that’s it!
Now the only liquid accessible money is the RRSPs – to sustain them in retirement…
At some point this person may be forced to take on a “reverse” mortgage.
However, this will really run contrary to their desire to be “mortgage free”!
Don’t know what a reverse mortgage is?
You can check out my article that explains what that “lovely” financial product. Is A Reverse Mortgage In Your Future?
So the point of this is – don’t get into this situation in the first place!
Learn and act on better strategies than the banks and many in the financial community tell you to do.
After all – its your life. Make it the envy of your friends and family. Don’t follow “the herd”!
Otherwise years down the road you too will by typing, “the best way to pay off a mortgage when retired with money from rrsps” into a search engine…
I certainly hope not for your sake.
Paying off your mortgage faster is every homeowners dream.
Just think of what your life would look like without a mortgage to pay off.
But are you paying your mortgage off the right way?
To illustrate, let me tell you a story.
This story is all about me and you and our mortgages and 2 ways of paying your mortgage off.
As you read along ask yourself which one are you?
Lori and Lisa each earn $55,000 a year from their respective jobs. Both have $35,000 in savings. They live in Vancouver, British Columbia so a starter condo will set them back at least $350,000.
Both Lori and Lisa got pre approved mortgages and were able to go condo shopping knowing that their financing was in place. The pre approvals were no problem for the banks to OK as they felt that these women would be good “risks” for the loans and able to service the mortgage payments based on their respective incomes.
On the one hand, just as her parents had told her to do – Lori wants to get rid of her mortgage as soon as possible. She spent some time on her banks Web Site with their “Mortgage Freedom Calculator”.
Based on her inputs she decided on using her entire life savings of $35,000 as a 10% down payment, and chose a 5 year closed mortgage at 6% with an 18-year amortization period.
Her mortgage of $315,000 means that her monthly payment will be $2,375.
She will reach her goal of being mortgage free in 18 years – 7 years earlier than the standard 25 year amortization and saving a whopping $107,804 in interest costs alone!
Lisa on the other hand chooses the same 5 year closed mortgage term at 6% but with a 25-year amortization. She goes for the 5% “down” option with $17,500 of her $35,000 savings and finances the remaining balance of $332,500.
Lisa’s monthly mortgage payment is $2,127.
The monthly difference between the two mortgage payments is $248. (Let’s say $250 to keep it simple).
Lisa’s mortgage balance is higher than Lori’s, $332,500 compared to $315,000 but her monthly payment is just $2,127 because she went with the 25 year amortization.
Where as, Lori is sending that extra $250 each month to her mortgage lender, Lisa invests these savings of $250 each month for five years, earning 8% before taxes per year.
The result: At the end of five years, Lisa has a total in savings of $17,599. Lori has no savings.
Suddenly and without warning, both women are re-engineered out of their positions due to corporate downsizing. This comes as no big surprise given the instability in today’s job market. Who will survive?
But, is Lori or Lisa in a better position? Well, let’s see…
Remember, Lori wanted to get rid of her mortgage as soon as possible and so used all of her money as a down payment, so she now has no savings to rely on.
However, she has $57,369 worth of equity built up in her house because she started with such a large down payment and has been making larger monthly payments since the beginning of her mortgage.
Unfortunately, that won’t help her to put food on the table and she now has no money coming in.
The only thing that Lori can do to support herself is to use her credit cards, thereby creating consumer debt for which she cannot afford to pay because she has no income.
As she is now unemployed, she cannot refinance because her bank denied her application for a home equity line of credit due to lack of stable income!
If Lori is to access her home equity in order to support herself, she will have to sell her home. This would force her to do the one thing she wanted to avoid to begin with – lose her home.
Sadly, Lori has just discovered the biggest secret of home ownership the hard way:
“Your mortgage is actually a charge against your income – it is not a loan against the value of your home.”
With no income, you are powerless to borrow money against your equity.
Lori must land another job, and fast! Not something that is easy to do in an unstable job environment. Not only can she not afford to feed herself, Lori is about to lose the roof over her head!
Now, let’s see how Lisa is doing. Lisa has only $33,793 in equity built up BUT she has $17,599 in savings! She will be able to make her monthly mortgage payment with ease, even with no job.
In fact, she has enough money saved to make her monthly mortgage payment for 8 months! No worries here!
Lisa sleeps soundly at night without worry that she will lose her home.
Here is the irony: Lori wanted to avoid a large mortgage and did everything she was able to pay off her mortgage quickly. To her dismay, she has discovered that her plan backfired in her face.
Rather than protect her home, she now faces losing it!
The moral of the story?
You should never hand a large down payment to the bank. You should never be in a hurry to pay off your mortgage. The less money that you have and the less secure your income, and job situation the more important the idea of carrying a mortgage is to your financial well being.
Paying your mortgage off early may not work for you – just as it didn’t for Lori.
On the other hand, Lisa acted opposite the usual way that Canadians deal with their mortgage and is in much stronger financial shape.
Now here’s an interesting angle of an alternate savings program.
Lisa could have taken out a $50,000 investment loan and with an “interest only” monthly payment – based on 6% interest she could have used her $250 a month to service this – instead of just saving it.
The beauty of this program is that in Canada the interest cost is tax deductible because she borrowed to invest.
In this case, to the tune of $3,000 each year. She gets to deduct this amount from her taxes just as if she had put the money into an RRSP.
However, the real beauty is that she has more money immediately working for her AND her investment portfolio is not bound by the restrictive rules and taxes that come with RRSP investments.
Furthermore, each and every year she gets to “write off” the $3,000 so at the end of 5 years she has written off a total of $15,000 (and all things being equal received government refunds totaling $6,000).
And how has the investment done?
Well, if she were to achieve 8% a year in a conservatively managed investment portfolio her investment would be worth somewhere in the neighborhood of $73,466.
Let’s say that because of her job loss she prudently decides to cash out $50,000 from her portfolio to pay off the loan. She is still left with $23,466 remaining in her non registered portfolio.
This is $5,867 MORE than the more traditional “Canadian way” of saving monthly.
In fact, it is essentially 23 months of $250 a month saved – MORE!
Lisa still has the $33,793 in equity built up in her home as before, however now if she wants to dip into her savings (which is the investment portfolio) she does not have to fear the tax burden as if the money were in RRSPs.
Now, who do now think is the smarter of the two? Lori or Lisa?
Which one are you? Which one do you want to be?
This example reinforces what I believe to be true.
Do you know what it is?
Don’t tie up all your financial resources in your home!
Watch The Top 10 Myths Of Canadian Home Ownership Exposed Video.
Let us know what you think of the video…
Hey – want a reverse mortgage?!
Do you know what they are?
Did you know that if you continue to pay off your mortgage faster you may need to get a reverse mortgage?
To those Canadians who are “house rich and cash poor” their home is now their retirement lifeline… and a reverse mortgage may be in their future…
The family home that they have diligently paid the mortgage off on must now go on the auction block to fund their retirement years because they have no savings.
Because they were so focused on getting rid of the mortgage as soon as possible because they were told that this was the best financial strategy. They were told this by their banker, their financial planner (well not me – that’s for sure!) their family, friends and work colleagues. Well, just about everyone said “do it” and they did.
But now they must sell the family home to get cash.
They will downsize and bank or invest the difference.
The “difference” is the money that must fund their “golden retirement” years. And they are hoping that the money is enough.
Sound like fun?
Stop the insanity!
This is a house that they called home for 30 or more years. They like the neighborhood, they like and know all their neighbors. There is a lifetime of fond memories tied up in the home. What a shame to sell…
Yet this is what happens when you pay off your mortgage faster the wrong way – a reverse mortgage may be your future!
A reverse mortgage is a strategy of pulling equity out of your home by way of a loan. It is not necessary to pay on this loan, however, interest is calculated at market rates and allowed to accrue – increasing the loan amount outstanding each and every year until the home is sold!
How do you like this idea so far?
A reverse mortgage is available to Canadians living in large urban centers that are “serviced” by the promoter’s of this program. They must own their own home and be age 60 or older.
The specific amount that can be obtained with this program is 10% to 40% of the current appraised value of your home, based on your age and that of your spouse, and the location and type of home you have.
You receive the money tax-free. (I should hope so! After all, it is your many years of after tax mortgage payments money to begin with.) And may spend it in any way you wish. (Wow, isn’t that big of them.) No payments are required while you or your spouse live in your home. The full amount only becomes due when your home is sold, or if you move out.
If your heirs want to keep your home, they can repay the amount of the reverse mortgage loan from other funds. (Now how many kids would have this like of money?)
Read on – it gets even better.
Living in Vancouver, let’s take a standard example of your home being worth over 1 million dollars at retirement – when you reach age 60. OK?
Would you look at those numbers!
What do they mean
Well, based on the information at Canadian Home Income Plan the maximum loan on your clear title home worth $1.3 million is $261,097!
The interest rates on the loan default to what you see – in the neighborhood of 8.30% and 7.60%. (Certainly higher than current mortgage rates.) To keep consistent, I plugged in a 6% growth rate for your home and we see the results of this strategy.
In year one, $22,000 of interest is being ADDED to the reverse mortgage loan outstanding and escalating to $42,000 in year 9. After that, it’s anyone’s guess because the calculator just shows year 15 and then year 20.
Bottom line analysis at year 20 when you are age 80 is that you are enjoying retirement in a home valued at $4,169,276.
However, you may become a little squeamish when you think that the loan against your home has ballooned to $1,223,637.
But hey, if the kids really want the family home when you pass they can collectively pony up $1.2 million to pay off the loan.
Otherwise, your estate will sell the home for its appraised value of $4.1 million and leave $2.9 million in the estate for the kids to squabble over.
Sound like a plan?
If this excites you and if you or someone you know is interested in “unlocking” the value in your home and “enjoying life on your terms”, well….here’s that Web Site again. Canadian Home Income Plan
To many Canadians accepting a reverse mortgage in retirement is the only financial option left to them!
In my opinion, this is a true shame…
Again, I am not disputing the fact, that a home is an important pillar of the wealth creation process.
Unfortunately, it’s the ONLY pillar in many Canadian households.
Remember, the rules of investing hold even truer today than ever.
Don’t put all your eggs into one basket. Wouldn’t you rather be 50% right than 100% wrong?
You still need a balanced and well-planned approach to saving and accumulating wealth for your other goals in life. And money – or the quick access to money via RRSPs and non registered investment portfolios will be what funds your goals and retirement lifestyle.
Have you ever wondered how mortgage interest rates are set in Canada?
Well, read on …
With a mortgage being the biggest debt that you will assume – (and hopefully pay off), during your adult life – I thought that you would want to know how Canadian mortgage rates are set.
So I am here to set the record straight!
Mortgage rates are NOT set to the Bank of Canada rate (the “over night rate”)!
But first a lesson in Economics 101…
The Bank of Canada sets the “target for the overnight rate” meaning that The Bank of Canada operates a system to make sure trading in the overnight market stays within its “operating band”, which is one-half of a percentage point (or .50 basis points) wide, and always has the Target for the Overnight Rate at its centre.
For example, if the operating band is 2.75 to 3.25 per cent, the Target for the Overnight Rate would be 3.0 per cent. (Time of writing: September, 2008)
It is this “overnight rate” that is used as is the interest rate that banks charge each other to cover their short-term daily transactions.
Since the institutions know that the Bank of Canada will always lend them money at the rate at the top of the band, and pay interest on deposits at the bottom, there is no reason for them to trade funds at rates outside the band.
The Bank can also intervene in the overnight market at the Target rate, if the market rate is moving away from the Target.
However, the chartered banks use the overnight rate as a guide in setting their prime lending rate – the rate at which the bank’s best customers can borrow money.
When the central bank changes its overnight rate, it’s sending a signal to the chartered banks that it wants them to change their prime lending rates.
But the rates for fixed mortgages depend on the bond market.
This is because the banks rely on the bond market to raise money for these kinds of mortgages.
Interest rates on the bond market can move up or down more frequently than the prime rate because the bond market is far more sensitive to market fluctuations.
Rates also move when bond traders believe the central bank may be about to increase – or reduce – interest rates.
And how are bond yields determined?
By investors’ expectations for interest rates in the future.
These expectations are arrived at by assessing the state of the Canadian economy and predicting where it is headed relative to other world economies.
There is no science to such predictions (although some economists spend a lot of time trying to make it into a science).
At best the markets make their best guess and keep updating their guess every day.
The central bank moves to higher rates when it believes the economy is in danger of growing too rapidly.
Rapid economic growth could cause a cycle of rising prices and wages.
The central bank wants that growth to be moderate, so inflationary pressures are kept in check.
Conversely, lowering rates from the central bank show that it’s worried that the economy is weakening and people aren’t buying enough big-ticket items.
Lowering rates helps to spur economic growth because it makes it more attractive for businesses and consumers to borrow.
The central bank must be careful not to inject too much stimulus into the economy or it risks igniting inflation.
Of course, correctly forecasting this balance of risks is the central bank’s most difficult and most important task.
OK, now the economics lesson is over…
Sorry about that – however, it’s important to get a fuller understanding about the stuff that have a direct impact on us as Canadian consumers – but is not largely reported – let alone understood.
So, we now know that Canadian, fixed residential mortgage rates are determined by changes in the bond market.
But remember – banks are in business to make profit (oh, and how they do).
What’s their commodity? Money!
How do they make money?
They engage in an activity is called “arbitrage”!
They purchase money at cheaper rates than they loan the money out at – and keep the difference – their profit…
Essentially, they pay their depositors low rates of interest on their bank accounts, term deposits, and GICs and then lend the money out at higher rates through mortgages…often to the very same client – you and I!
The way that they do this is like this:
A Government of Canada bond represents a risk free investment to the banks.
Now, when the banks choose to invest in (loan money for) a mortgage, they are taking on added risk with their capital (our deposited money) and incurring costs to set up and service it.
Therefore, as a “prudent business practice” they will set their mortgage rates high enough above the equivalent bond yield to compensate them for their costs and to provide them with a profit margin for the added risk they are taking on.
The “point spread” (the difference) is usually 1-2%.
Additionally, because all Canadian banks are competing (bidding for) government bonds the competition any increased competition means that equivalent bond yields (the percentage return that the bank/institution/investor will receive) get much smaller.
For example: 3.50% – 5 year Government of Canada bond maturing in 1 July, 2013 (As of Sept08) 7.20% – Avg. 5 year fixed mortgage rate maturing 1 July, 2013 (As of Sept08)
As the example above, a 5-year Government of Canada bond is yielding about 3.5% today and most 5-year discounted mortgage rates are set at about 7.20%.
This means that the chartered banks are earning a whopping risk premium of 3.70% before expenses.
When it is costing banks more to get the money they lend to you – they transfer this extra cost to you by way of increasing their lending rates – 5 year mortgages in our example…
Conversely, when it costs banks less to get the money they lend to you – they reduce their lending rates.
However, they always have their profit margin built in there – no matter if rates are going up or down!
Bear in mind that all Canadian mortgage lenders are very aware that their current or potential retail depositors can choose to put their money into none of the financial institutions GIC’s and may instead opt for purchasing other “fixed income securities” such as bonds, which yield a higher rate because they adjust immediately to market changes and they can even switch their funds into the stock market if this is performing relatively better.
Therefore, in the truest sense of the word, the mortgage lending institutions are competing with other markets for the investor’s money.
If a bank doesn’t attract enough depositors to fund all the mortgages, they’ll have to go where their depositors go – the money markets – to make up the difference….and there, they pay the going rate!
But of course, we have always known this…but now you know: “the rest of the story”…
My suggestion to anyone who wants to predict when mortgage rates will rise and fall is to track Government of Canada bond yields daily.
Most financial papers list the bond yields for various terms each day.
It is normal for yields to change slightly from day to day, but if you start to see consistent increases or decreases then you can expect that the banks will be adjusting their mortgage rates accordingly.
If you are interested in a 5-year mortgage rate then track the equivalent 5-year Government of Canada bond; if you are interested in a 1-year mortgage rate then track the equivalent 1-year Government of Canada bond, and so on.
Now that I have told you that the Bank of Canada does not have an impact on mortgage rates, there is one exception to this rule.
Most variable rate mortgages are affected by changes to the prime rate as set by each of the chartered banks.
The prime rate will change, in the same direction and by the same amount, as any change to the overnight rate.
So if the Bank of Canada announces a decrease in the overnight rate by one quarter of 1% (or “25 basis points” in financial parlance), then you can expect most variable rate mortgages to also drop by one quarter of 1%.
So unless you have a variable rate mortgage, don’t pay attention to the hype surrounding interest rate announcements by the Bank of Canada.
If you want to know where fixed rate mortgage rates are headed, follow changes in the bond market.
Now you know how mortgage interest rates are set!
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