Mortgage

Canadian Tire One-and-Only Account, Part II

September 12, 2007

17 comments

Both The Toronto Star’s Ellen Roseman (thanks for the mention!) and Financial Post’s Jonathan Chevreau have pointed out that the Canadian Tire’s One-and-Only account has an advantage that I had overlooked: the mortgage can in paid in full at anytime, whereas a conventional mortgage has limited prepayment privileges.

Personally, we have a fixed-rate, 5-year mortgage that allows us to increase our monthly payment by 25% and make a total annual prepayment of 20% of the original loan value without any penalty. A lump sum prepayment of any amount (as long as the total annual prepayments stay within the 20% limit) can be made at the same time as the regular mortgage payment. Even though we pay down our mortgage aggressively, I find it difficult to make the maximum prepayment every year. I wonder if the open nature of the One-and-Only account, albeit at a higher rate, will appeal to many mainstream customers.

Canadian Tire One-and-Only Account

September 5, 2007

28 comments

Canadian Tire has decided to offer more financial services and is now offering mortgages and a combined mortgage, loan, chequing and savings product (similar to Manulife One account) called the One-and-Only account in Ontario, Alberta and BC. The idea behind combined accounts is that by consolidating your debts into one account, you take advantage of the lower interest rate on your mortgage and save some interest on the time lag between your incoming and outgoing cash.

In theory, the one account is a great idea. In practice though, there is one large problem: the interest rate on these combined accounts is at prime, whereas typically you can easily get a 0.90% discount to prime with a traditional variable rate mortgage. On a $200,000 mortgage, the traditional variety starts out with roughly a $1,800 per year advantage. Now, let’s imagine that your household net income is $5,000 that is paid into your account on the first of the month and everything is spent or saved by the end of the month. So, by keeping $5,000 in your account for roughly the entire year, you are saving $300 in interest costs with a combined account. In this scenario, your “savings” from a combined account does not make up for the cost of not opting for a traditional mortgage. You can check out different scenarios using the nifty calculator on the Canadian Tire website.

Call me skeptical but until these accounts start offering a discount to prime, the basic math just doesn’t work out. Still, the One-and-Only account is a significant new competitor to the Manulife One account (review by Million Dollar Journey) because there are no monthly fees.

The Smith Manoeuvre Debate

January 28, 2007

266 comments

About one year back, I did a review of The Smith Manoeuvre (SM) book and noted that the book should have talked about the pitfalls involved with the strategy. Many financial planners have left comments disagreeing with my review (though I reviewed the book, not the strategy) and I challenged one planner to show me how a client implementing the SM will come out ahead in the worst-case scenario (this particular planner uses segregated funds, so he tells me the worst case scenario is 0% returns).

The planner’s client (let’s call him Joe) owns a house appraised at $350K and has a $260K mortgage on it. His monthly mortgage payment is $1,520. To implement the SM, the planner takes out a secured investment loan of $55K and invests the proceeds (less expenses) in segregated funds. To service the investment loan, Joe pays an interest of $275 per month.

To make an apples-to-apples comparison, I am going to assume that Joe can make an extra payment of $275 towards his mortgage principal. If Joe can find an extra $275 savings for the SM, he can find a similar amount for a mortgage pre-payment.

After five years, let’s assume that Joe’s home is still worth $350K (the home’s value doesn’t affect the outcome). If he had opted for an accelerated mortgage pay down, he would have a mortgage balance of $211K and he has a net worth of $139K. If Joe had implemented the SM instead, after five years, he would own the $350K home, an investment portfolio of $99K and a loan of $321K, leaving him with a net worth of $128K.

What about after 10 years? With mortgage pre-payments, Joe’s net worth would be (Home:$350K – Mortgage:$149K) $201K. The SM would leave him with (Home:$350K + Investments: $160K – Loan:$321K) $189K. Even after 15 years, Joe would be better off with a mortgage pre-payment (net worth of $280K) than the SM (net worth of $270K).

Now, surely over 20 years Joe would have come out ahead, right? Not really. With pre-payment Joe now owns his home free and clear. The SM also results in a mortgage-free home, but Joe now has a portfolio of $346K and an investment loan of $321K and a net worth of $375K. But, the key difference is that Joe hasn’t made a mortgage payment for 17 months, which if he had saved would have added an extra $31K to his net worth.

The point of this exercise is not to show that the SM doesn’t work but that it entails taking a small risk, not any risk at all as many planners claim. You should also note that this particular SM example involves a higher leverage and would become risky if a severe real estate downturn should occur. Also, while segregated funds may give you peace of mind, it also comes with a higher price tag. If you are earning 8% in the markets and giving up 3% in expenses, you would probably just break even with the SM. I’ll close with a comment made by David Trahair, author of Smoke and Mirrors, in a recent Toronto Star column: “It’s a high-risk strategy because you’re betting the farm that some investment adviser can do better than you can. You have a guaranteed return from getting rid of the mortgage.”