Month: June 2018

Lessons from the Teller’s Wicket

After my obtaining my undergraduate degree, I took a year off before going back to school. I got a full-time job in a bank, and boom! My financial education really began. Despite the good example set by my parents, working in a banking institution is where I really learned about banks and how to use them to my advantage when it came to my day-to-day money.

 

My first lesson was that the bank’s products might not be in the customer’s best interest. Each month, there was a marketing promotion where we – the tellers – were required to sell products to customers. The first campaign that I was involved in was selling home-equity lines of credit (HELOC). A HELOC is a debt product where the collateral is your home. By using it, the customer is able to spend down the equity value of their home up to the HELOC’s limit and the customer pays the bank interest for the privilege of spending their own equity. It took me a little bit to understand that the bank was essentially asking people to buy debt, but I eventually got the gist of the product. One of our suggested hooks for selling the HELOC was to tell customers that they could borrow money from a HELOC to invest in their RRSP and then repay the borrowed money in monthly equal instalments. All I could ask myself was: why not simply make that same monthly payment to your RRSP directly instead of paying that same amount to the bank in the form of a loan repayment, which comes with an interest penalty? (Obviously, I was  restricted from asking the customers this question. Doing so might have led the customer to not acquire a HELOC, which meant that the customer wouldn’t go into debt and the bank wouldn’t get paid interest.)

 

It took me a long time to realize that the hook of depositing the money to the RRSP now instead of later was simply a form of immediate gratification. My method of making payments to one’s RRSP over the upcoming year was a form of deferred gratification. Of course, my method meant that the bank didn’t make money from the interest charged on the loan from the HELOC so I was not permitted to suggest my method to the customer even though my method was in the customer’s best interest. Since the bank was paying my wages at the time, part of my job was pretending that what was important to the bank was also important to me. (That particular lesson has served me well in every employment position I’ve had since leaving the bank!)

 

The second thing I learned from my time as a teller is that banks care more about customers’ money than customers do. It wasn’t that the customers didn’t care at all about their money. It was simply that the bank cared more and was far more effective in keeping the money than the customers were. Surprisingly to me, it wasn’t very hard at all to get people to sign up for credit cards and credit products. People craved credit, which is another way of saying that people very much wanted the ability to go into debt to the bank. I don’t know what they did with their credit, but I was always surprised that they wanted credit more than they wanted to have money in their bank accounts.

 

The third thing I learned at the bank was that paying off a mortgage was a smart move. I’ll never forget one customer who came in on a Saturday to make a lump sum deposit of $20,000 against his mortgage. When I asked the loans officer why the customer had done this, I received my very first lesson about how the act of making lump sum payments immediately decreases the amount of interest owed on a mortgage. Right then and there, I promised myself that I would make extra payments against my mortgage once I had one. When I worked at the bank, an interest rate of 7% was not uncommon. This was well before 2001 when rates started dropping to historic lows.  (One of my friends was able to secure a 5-year rate at 2.39% on her rental property – sweet! I doubt I’ll ever see rates drop that low again in my lifetime.) When I obtained my first mortgage in 2001, the rate was 6.5% and I took advantage of prepayment options to pay it down quickly. I then re-mortgaged my property for a rate of 4.79% in 2004. When I re-financed my most recent mortgage in 2015, I was able to secure a 5-year rate at 2.99%! Sadly for me, I’m quite certain that I will be renewing my mortgage at a rate of atleast 4% in 2020 given that the mortgage rates have started to climb.

 

Fourthly, I learned about bank fees and how to avoid them. Essentially, you can keep a large amount of money in the bank as a float to ensure that you aren’t charged bank fees. That float ranges anywhere from $2500 to $7500, depending on the bank and the type of account on offer. Alternatively, you can open an account with one of the online banks. Right now, Simplii (formerly PC Financial) and Tangerine offer free banking. If you aren’t already with them, make the switch and keep your bank fees for yourself. Why are you paying bank fees if you don’t have to? Aren’t you better-served by keeping that money for yourself to be used to achieve your personal goals? Never ever forget that paying bank fees is a choice that you make as a customer. Bank fees are not an addiction. You have the power to open a no-fee bank account and to use it the same way that you use expensive, fee-generating bank accounts. You might have to use a bank but that doesn’t mean you have to pay service fees or interest to do so. As a customer, you have choices and you have the power to keep more of your own money.

 

I worked at that bank every Saturday for roughly three years after I went back to school full-time. It was not a particularly glamorous job and it definitely cemented my belief that working directly with the public is not for me. However, my time spent at the bank was invaluable because it taught me a great deal about how the banking industry systematically and ever-so-efficiently fleeces its customers and what steps customers can take to level the playing field. These lessons will stay with me for a very long time.

Priorities

Based on my own experience and decades of observation, I am convinced without a shadow of a doubt that priorities guide how we spend money. To paraphrase Paula Pant at www.affordanything.com, every spending decision you make is based on priorities because choosing to spend on one thing means that you’re not spending on something else. I think a lot of personal finance problems could be solved if people created their own priorities, but they don’t. Many people allow others to set their priorities for them, whether through marketing or peer pressure or societal expectations. People adopt the priorities of others and spend their money accordingly. Sometimes, this method works for them and sometimes it doesn’t.

Ideally, you create your own set of priorities and you’re in a position to pursue them with the support of your friends and family. I haven’t always been so lucky.

After I finished university and started my first professional job, my closest friends would give me a hard time about how I chose to spend my money. In short, they didn’t like the fact that I didn’t spend money on things that didn’t matter to me. They felt entitled to tell me that I “could afford it” – whatever “it” happened to be at the time. I heard their message loud and clear: my spending choices weren’t the “right” ones in their eyes. At the time, I had student loan debt. I had car debt. I owed money on my mortgage. I chose to allot my paycheque to various spending categories and I was very rigorous about paying down my debt while starting to save for my retirement. These were my priorities, and my closest friends at the time didn’t share or respect them.

Only one friend understood my priorities and supported me wholeheartedly. The vast majority of my closest friends did not. They were definitely more spend-y than I was but I couldn’t let their spending choices derail mine. What was my solution? Well, I didn’t get rid of those friends and I still spend time with them today. Over time, I simply stopped talking to them about my priorities and my money. In essence, I cut them out of the financial part of my life because I didn’t trust them to respect my personal goals and dreams. My goals were to establish a habit of saving for retirement, to pay off my student loans, to pay off my car loan, and to pay off my mortgage as fast as humanly possible. I only had so much money to work with and I wasn’t going to let their opinion that I “could afford it” derail me from focusing on my priorities. I was the only person who knew what my goals were and how I wanted to spend my money to achieve them.

Over the years, I read personal finance books and discovered the world of personal financial bloggers. It was in the books and the blogs that I found a niche where my priorities were the norm, where my goals were supported, and where strategies to achieve my hopes and dreams were shared by people who had already achieved similar hopes and dreams. As a result of what I learned from the books and the blogs, I was completely debt-free by age 34 and had achieved a solid six-figure net worth. By the time I was 40, I’d entered the double-comma club.

I also strengthened my relationship with that one friend who’d totally understood my desire to get out of debt and to pay cash for everything. We talked about money and shared what we learned. I remember when she confided to me that she and her husband would put off any and all purchases to the last possible moment in order to focus on paying off their mortgage. I was as excited as she was when they hit that milestone, just as she had been thrilled for me when I became debt-free at age 34.

It took me many years to craft a money system that funds my priorities with minimal decision-making on my part. Right now, I use automatic transfers to ensure that a portion of each paycheque is allocated towards each of my priorities.

– Retirement accounts? Check.

– Investment portfolio? Check.

– Emergency fund? Check.

– Utilities, property taxes, insurance premiums? Check

– Charitable donations? Check.

– Day to day spending? Check.

– Saving for next vehicle? Check.

– Saving for travel? Check.

– Saving for home renovations? Check.

These are the priorities that I have defined for myself and I have honed them over the years. I’ve learned to put very little weight on the priorities that others try to set for me. Their priorities won’t make me happy, but they will drain my wallet and get me into debt. I don’t want that for myself so I stick to what I know will get me closer to the life I want to live.

Over the years, there have been many times when I’ve had to re-order my priorities to ensure that I was doing what I really and truly wanted. Even today, I’m debating with myself about whether travel is more important than home maintenance.

I love travel, but I also need to renovate my basement bathroom and laundry room. These rooms aren’t in complete disrepair, but they will be if I don’t do something in the next 3 years. However, I realize that if I want to see, taste, touch as much of the world as possible then I have to get out there and do it. These priorities are both important to me right now and I see them in my mind’s eye as the two ends of a pendulum. I’ve been trying to figure out how to pay for both in 2019 and it’s just not going to happen unless I win the lottery or discover that a wildly-benevolent stranger has left me a sizeable bequest. I have to pick one priority over the other. In other words, one of the two is going to take a higher priority for me in 2019. I will still accomplish both goals, just not at the same time. I only have so much money and I refuse to go into debt, so something has to wait until I have the cash on hand to make the purchase. Right now, the pendulum is swinging towards the home renovation…but there’s a very good chance that it could swing back towards travel. All I am certain of right now is that one of my two priorities will be satisfied with the cash that I save up in the next year or so.

I’m not perfect, but I am definitely older and wiser now. I have to bite my tongue until it bleeds when I see others making what I view as “bad decisions” with their money. I remind myself that they’re spending their money in line with their personal priorities and that they’re under absolutely no obligation to have the same priorities that I do. Until they ask me what I think of their choices, I keep my opinions to myself. I do not want to do to my friends what was done to me because I didn’t like the feeling of knowing that I didn’t have their support. I don’t have to agree with my friends’ priorities and spending choices, but I do have to respect them.

The world isn’t ideal and you can’t always count on others to support your hopes and dreams. All you can do is figure out what you really want and go get it.

Credit cards are a tool

Anyone who knows me also knows that I hate debt. I particularly hate credit card debt because most cards carry usurious rates of interest if the balance is not paid in full. So this post is for people who pay their monthly credit card balances in full EVERY SINGLE MONTH!!!

If you carry a balance on your credit cards, then this post is not for you. This post will not help you to stop accumulating credit card interest, which should be your priority if you’re carrying a balance. Credit card interest is a cancer that will stop you from achieving your financial dreams so please start working on how to get out from under the burden of credit card debt. Please come back next week when there will be a new post for you to read. 🙂

Credit cards are a tool. They are not meant to charge me interest. Rather, they are meant to minimize my need to carry giant wads of cash as I go through life buying the things I want. The money stays in the bank until the time comes for me to pay for my credit card purchases. At no point should I ever be in the position that the amount of money owed on my credit cards exceeds the amount of money that I have in the bank to pay off my credit card. That is a recipe for disaster!

To those who never carry a balance, please keep reading. I view my credit cards as a tool. (For full disclosure, I collect cash back on one card and travel miles on the other.) I pay recurring monthly bills with my credit card. I put all of my gas purchases on my credit card. I use my credit card to pay for meals with friends and my annual theatre subscription. Truth be told, I really do enjoy the purchasing power that comes with my credit cards.

That said, I never carry a balance. I’m one of those weird freaks of nature who checks on her credit card’s monthly running total every other day. Once a charge has hit my credit card statement and I’m rewarded for my purchase, in the form of travel miles or cash back, then I go to my online bank and send a payment in the amount of my purchase to my credit card. More often than not, I put several thousand dollars through my credit card each month yet the statement’s balance is only for a few hundred dollars when all is said and done.

Why do I pay my credit card charges before they’re due?

I do it because I’m human and I know my own foibles. I do not yet have the discipline to keep large amounts of money in my chequing account. I’ve had the distinct pleasure of only having $0.01 in my account the day before payday. I don’t encourage this but I share my experience so that you know I’m not the sort who can keep a buffer of several thousand dollars in her main bank account! It works best if I make the purchase, i.e. $50 to fill my tank, wait to see the charge posted to my credit card account, and then pay off the $50 immediately. I owe the money to the credit card company, so why not pay off the charge while I have the money in my account? The bill is paid and I never have to think about it again. I don’t have to worry about something unexpected happening in the future which will prevent me from paying off the charge on the due date. I’ve got gas – I’ve got my reward – I’ve paid my bill – life is good!

I can hear you asking – “But what if you need that $50 for something else before the credit card bill is due?”

Should this happen, then I go to one of my other accounts to find the money. Or I cut back on my groceries for that week. Or I decline an invitation to something fun that I otherwise would have accepted. The bottom line is that I borrowed $50 from the credit card company and they will charge me 17% per annum (or more!) on that $50 if I don’t pay them back. Trust me, I would rather miss out on a dinner and a movie that pay than kind of exorbitant interest to pay for my gas.

My bottom line is that my credit cards are a tool that I use to make my life easier. There is no need for me to pay interest on my purchases. My main responsibility is to stay on top of my charge by checking my credit card statement online every few days and by making frequent payments to cover all my credit card purchases. I’ve been controlling my credit cards this way for over 20 years. My system works for me. Try it out – you might find that it works for you too!

A little something about mortgages

I love talking about money…and the word is spreading at the office. I have two very close friends at work and they have patiently listened to me talk about money for years. One of them has a young assistant who was looking to buy her first house with her fiance. My friend told the assistant to come and see me. I was more than happy to talk to her about mortgages, prepayment options, insurance options, and ways to minimize the amount of interest owing on her mortgage.

 

So I spent about 40 minutes talking to my friend’s assistant. I found out that she was using a mortgage broker.  I tried not to ask for too many details about salary and savings, but I wanted to find out if she had considered pre-payment options (she hadn’t), the difference between mortgage insurance vs life insurance (nope!), rates offered by banks vs mortgage companies (yes), and whether they had considered paying bi-weekly rather than monthly (nope).  I was also encouraging her to wait until after her probationary period at the office had expired, but I lost that battle.

 

a) Prepayment Options Matter

 

If ridding yourself of your mortgage is a priority, then you’ll want to ensure that you get the best prepayment options that you can.

 

In Canada, borrowers can increase their mortgage payments one of two ways. Firstly, they can increase their mortgage payment by a fixed percentage amount every calendar year. When I first obtained my mortgage, I was able to increase my bi-weekly payment by up to 20% once each calendar year.  Some banks allow borrowers to increase their payment by a maximum of 10% or 15%.  There is no need to increase the payment by the maximum, but I encourage people to go with a lender who allows for up to 20%. The higher the payment, the faster the mortgage balance disappears and the less interest that is paid overall. Paying less interest to the bank on a debt as huge as a mortgage is a goal worth striving towards.

 

Generally, once a payment is increased, that increase is in place for the remainder of the term of the mortgage. A bank does not allow a person to decrease the mortgage payment later on down the line.

 

Here’s an example. The original mortgage balance is $100,000. The annual maximum mortgage payment increase is 20% of the original mortgage payment. The bi-weekly mortgage payment amount is $500.  The mortgage term is 5 years.

 

Year 1: $500 x 20% = $100; new bi-weekly mortgage payment = $600 ($500 + $100)

Year 2: $600 x 20% = $120; new bi-weekly mortgage payment = $720 ($600 + $120)

Year 3: $720 x 20% = $144; new bi-weekly mortgage payment = $864 ($720 + $144)

Year 4: $864 x 20% = $172.80; new bi-weekly mortgage payment = $1,036.80 ($864 + $1,036.80)

Year 5: $1,036.80 x 20%= $207.36; new bi-weekly mortgage payment = $1,244.16 ($1,036,80 + $207.36)

 

Of course, there is no requirement on the borrower to increase the mortgage payment by 20% every year. The bank would far prefer it if you simply paid the minimum required amount because doing so insures that they squeeze as much interest out of you as possible over the life of the mortgage! A borrower might only be able to increase her payment by 5% each year, or only be able to increase it in years 2, 3 and 5, or might only be able to increase it by the maximum amount at the very start of her mortgage, or any other combination.

 

It’s a decision that cannot be taken lightly. While making the higher payment as soon as possible is good for minimizing the interest paid the bank, the fact of the matter is that the borrower is going to have to come up with the new higher payment amount every two weeks. As you can see from our example, coming up with $1,244 every two weeks is going to be approximately 2.5 times harder than coming up with $500 every two weeks!

 

The other prepayment option available to borrowers is to make annual lump-sum payments against the outstanding mortgage balance up to a fixed amount. Lump sum payments are in addition to the regular mortgage payment. They are applied directly the mortgage balance. The larger the lump sum, the more effective it is in decreasing the amount of interest paid on the mortgage.

 

In my case, my bank allowed me to make a lump-sum payment of up to 20% of the original balance. Again, there is no obligation to make a huge lump-sum payment. Most banks require a minimum lump-sum of atleast $100.  Further, lump sum payments can be made throughout the year so long as they cumulatively do not exceed the maximum amount.

 

Let’s go back to our earlier example. The original mortgage balance is $100,000. The annual maximum lump sum mortgage prepayment is 20% of the original mortgage balance.  The mortgage term is 5 years.

 

$100,000 x 20% = $20,000;

 

The amount of $20,000 is the maximum annual lump sum mortgage prepayment that can be applied to the mortgage during the term of the mortgage. This means that the borrower can apply lump-sum amounts up to $20,000 to her mortgage in each of the 5 years of the mortgage term.

 

Full disclosure – I never took advantage of the lump-sum payment option. Instead, I chose to increase my bi-weekly mortgage payment by the full 20% every calendar year. I committed myself to higher payments to avoid the temptation of “forgetting” to set aside money for a lump sum payment. A dear friend of mine made the opposite decision. She made lump sum payments every two weeks. She and her husband had a young family and she wanted the option of not paying extra money to her mortgage in case those funds, which would have gone towards the mortgage as a lump sum payment, were required elsewhere in the family budget.

 

b) Bi-Weekly Payments

 

You’ll note that throughout my example, I’ve referred to “bi-weekly” payments. This is because I personally hold the opinion that bi-weekly payments are best for paying off a mortgage. Monthly mortgage payments mean that you, the borrower, are paying the maximum amount of interest on your mortgage loan. While this is good for the banks, this is terrible for the borrower. One of the few ways to pay less interest on your mortgage debt is to repay it as fast as possible. Paying your mortgage bi-weekly will allow you to do that.

 

There are other payment cycles. I’ve already mentioned monthly payments, but there are also weekly mortgage repayment plans. For my part, I’ve always paid bi-weekly on my personal residence. On my rental properties, the mortgage is paid monthly for two reasons. First, rent from my tenant pays down the mortgage. Second, the interest on the mortgage balance is tax-deductible, so it’s to my advantage that the mortgage balance is not paid down as fast as possible.

 

I’m not a fan of weekly mortgage payment schedules. This is because the amount of interest saved on a weekly payment schedule is only marginally less than the amount of interest saved on a bi-weekly payment schedule. To my mind, it’s hardly worth the added stress of insuring that the money is in the bank every 7 days. Play around with a few mortgage calculators on the web and come to your own conclusion. If you’re headset on paying as little interest as possible, then a weekly mortgage payment schedule might be for you.

 

c) Get Life Insurance instead of Mortgage Insurance

 

Most people don’t realize this but mortgage insurance is a rip-off. The insurance pays the bank the amount of the outstanding mortgage balance in case the borrower dies. However, the premium for mortgage insurance stays the same every single month. This is a problem because it means that the borrower is paying the same amount of money for a lower amount of coverage each month as the mortgage balance decreases.

 

Assume that the mortgage balance starts at $100,000, that the beneficiary of the mortgage insurance is the bank, and that the monthly premium on that mortgage is $5. Every month, the borrower will pay $5 to the bank to insure that the mortgage balance gets paid if the borrower dies before the mortgage is paid off. If the borrower dies the day after taking out the mortgage and the insurance, the policy will pay out $100,000 an the mortgage gets paid off.  Ten years into the mortgage, the mortgage balance is now down to $81,000. The borrower is still paying $5 per month in premiums on that mortgage. If the borrower dies ten years into the mortgage, the insurance policy will only pay out $81,000 to the bank.

 

Do you see the problem? The premium stays the same but purchases less and less coverage each month. This is not a good deal for the borrower. The monthly mortgage insurance premium remains the same even though the remaining mortgage balance is decreasing as each mortgage payment is made.

 

Instead of taking out mortgage insurance through the bank, get a life insurance policy on the life of the borrower that is equivalent to the starting balance of the mortgage. If the borrower dies before the mortgage is paid off, the full amount of the life insurance policy is paid to the beneficiary. After paying the mortgage in full, the beneficiary can keep the rest of the life insurance proceeds. This is a much better deal all around and the mortgage balance still gets paid.

 

While I was on holidays, I received a very excited email from my friend. Her assistant and the fiance had put in an offer on a house! And a week after I got back to my office, the assistant came to me and told me that she was only a few days away from taking possession. Of course, I couldn’t resist giving her even more advice – get a locksmith to meet her at the house on the day of possession to have the locks changed immediately – but I was deeply happy that my words had helped them in making one of the biggest purchases of their lives.