29 Feb

Fixed, Variable, Closed, Open

General

Posted by: Gleb Tchani

Many of you may be aware of the differences, but I often come across this confusion, so I would like to clarify on what each of these mean.  Fixed and Variable are conditions that describe the interest rate on the mortgage, while Closed and Open describe the type of contract you are entering.  Also, I will add a quick note on what is a Term and what is an Amortization.

Variable Rate – this is a form of a mortgage interest rate that is determined by the Prime Rate, which in turn is set, based on the Overnight Lending Rate set by the Bank of Canada.  The Overnight Lending Rate is a government tool that is reviewed on quarterly bases to move toward a specified economic goal.  You can find more information, including future meeting dates, on the Bank of Canada website at the following link.  A change in Overnight Lending Rate, typically, triggers change in Prime Rate and, since there is a potential of change at any given quarter, the said rate is referred to as variable.

Example:

Today, February of 2016, you are able to obtain a Prime – 0.55%.  Current Overnight Lending Rate is 0.50% and current Prime Rate is 2.70% so the rate you are able to obtain is Prime – 0.55% = 2.70% – 0.55% = 2.15%.  Next Bank of Canada meeting for interest rate announcement is set at March 9th.  Let’s assume the overnight lending rate gets increased by 0.25% to 0.75%.  This move will likely be followed by banks increasing their Prime rate by the same increment of 0.25% to 2.95%.  The new Prime Rate will change your contract rate to Prime – 0.55% = 2.95% – 0.55% = 2.40%.

 

Fixed Rate – this rate remains fixed through the duration (term) of your contract.  No matter what happens with the economy and/or the market, you will continue your mortgage contract with the specified rate.  We all understand that, in the long run, it is more likely that the rates will increase.  Fixed mortgage rates offer us, the clients, a peace of mind.  For that reason, lenders will typically offer a slightly higher fixed rate over the variable rate.

Closed Term Mortgage – closed term mortgages are mortgage contracts where we are locked in to all conditions of the contract for the term of the contract.  One of these conditions is inability to repay the mortgage ahead of time.  This is important to the lenders because their income is determined by us, clients, continuing to hold a mortgage loan and hence, paying interest.  Because this feature is beneficial to the lender, we as clients are able to obtain a better rate that way.  Mortgage penalty is a very important issue that often comes up and is a result of breaking a closed term mortgage.  This details of mortgage penalties require a separate article that I will get to in the near future.

Open Term Mortgage – on the other hand, an open term mortgage allows us to repay full balance at any time.  Early prepayment actually has a negative impact on the lender as they are expecting us to pay interest over a certain period of time.  Since it is not beneficial to the lender, the open term mortgages rates are usually higher.

Term vs Amortization – both of these describe length of time and just to help you avoid confusion, Term is the length of current contract, where Amortization is the total amount of time it would take to repay a mortgage.  The length of amortization is one of the factors that determines amount of your payments.  That is why, even though you may be signing a contract for just 5 years, it is important to know what the amortization period is.  At the end of the term, you have an option to repay the remaining balance or make another arrangement for a mortgage loan.  If you do not refinance and simply switch to another lender, you now have a new mortgage contract for a new term, but with only the remainder of your amortization period.

Have any more questions?  Do not hesitate to contact me, I would be very happy to help.

26 Feb

What is an RRSP Loan and how can it help me with down payment?

General

Posted by: Gleb Tchani

I would like to present you with a brief overview on what is an RRSP loan and how it can help a first time buyer using Home Buyers’ Plan (HBP).  This article is not about how to incorporate RRSP into your retirement planning.

 What is an RRSP loan?

               RRSP loan is a loan that is given out for a sole purpose of contributing to an RRSP.  Putting those funds into an RRSP program is basically a requirement.  For that reason, these loans often come with a lower interest than regular personal loans.  For example, Manulife Bank currently offers Prime + 0.5% or 3.2% on the RRSP loan.

Where can I get an RRSP loan?

               The RRSP loans can be obtained through practically any financial institution.  I am able to assist with obtaining such loan through Manulife Bank.  Manulife Bank offers many benefits and flexibility.  Please contact me for more information.

How can RRSP loan help a first time home buyer?

               As you may know, Canadian Government allows First Time Home Buyers to withdraw as much as $25,000 per individual to assist with a purchase of their first property.  This program is usually referred to as Home Buyers’ Plan.  Here is a link to CRA webpage for reference.  The major requirements to qualify for this program are; to be a first time home buyer and, to have RRSP funds in the account for a minimum of 90 days prior to a withdrawal under the Home Buyers’ Plan.

               We are all aware that putting money into an RRSP triggers a tax refund.  For people with an income of between $45,000 and $90,000 the refund should be around 30% of the contribution amount.  Let me use a scenario to explain how it works:

John Doe has an annual income of $80,000, has $25,000 in savings but wants to have another $15,000 to bring his down payment to 10% on a $400,000 purchase.  If John borrows a $15,000 RRSP loan for a term of 2 years and a rate of 3.2%, his monthly payments will be $646.05.  If John simply makes his monthly payments for next two years, total amount of interest he would pay would be $505.10.  However, John will receive back a tax refund that would be approximately $5,000.  If John uses this amount to pay off a portion of his debt, the remaining balance will be $10,000 (Manulife Bank’s RRSP loan is an open loan and can be repaid at any time).  Now, John’s remaining repayment period is only a year and 4 months and total interest paid over that period would be $225.98.  Alternatively, John could simply use that extra $5,000 to help him with closing costs.  It takes a few days to process the loan and deposit into an RRSP account and the extra $15,000 can be used in 90 days.

When do I have to repay the amount used under the HBP?

               The repayment can be postponed for 2 years and then a minimum of 1/15th of the borrowed amount has to be re-paid each year for next 15 years.  Alternatively, the 1/15th can be simply added to that year’s income and you would just pay tax on it.  Since you are technically borrowing from your self, there is no interest on the amount used under Home Buyer’s Plan.

Some FAQs

  • – When you withdraw money from an RRSP using HBP, you get a cheque (or transfer into your account).  Often people are under the impression that the money has to go into down payment.  That is not true, the money can be used for anything, literally.
  • – The money can be withdrawn from RRSP using Home Buyer’s Plan between 30 days before and 30 days after the closing date.

Have any more questions?  Do not hesitate to contact me, I would be very happy to help.