Lock in now or stay variable
Mortgage rates in Canada are at historical lows, ranging from just over 2% for a variable closed 3 year rate to nearly 5.5% for a fixed closed 5 year rate (with 25 year amortization). It really pays to shop around as there is a wide variation between lenders and between terms.
Sometimes the cheapest rate is not always the best mortgage. You need to read the fine print and learn about the various options that are available to you. Can you double up your payments? Can you make a one-time large payment? What happens if you miss a payment? These are important questions as the answers can save you literally thousands of dollars over time.
How mortgage rates are determined
In Canada the mortgage rate that you are offered by your bank, credit union or other lender is determined by the Bank of Canada’s overnight lending rate. This is the rate at which banks will lend other banks money. From this rate your bank will determine what their Prime Rate will be. This Prime Rate is the overnight rate plus a certain percentage for profit. This Prime Rate is used to determine the variable rate mortgages that the lender will offer to retail clients (you and me).
Depending upon your credit history and the terms of your mortgage (number of years, variable or fixed rates, amount of loan, etc) your mortgage rate will be the Prime Rate plus or minus a percentage. This percentage is the lender’s profit margin and the amount required to take on the risk of you not paying the loan back.
Fixed mortgage rates are based more on the bond market. As such fixed mortgage rates rely on supply and demand issues in the market. In times of economic trouble most investors flee the stock market and look for the safety of government backed bonds. This lowers the yield that new issues of bonds pay (since more people want them they will still sell even with lower interest rates). When bond yields are low then mortgage rates head lower – minus the mark-up that your lender retains. The opposite is true as well. When the prevailing sentiment in the market is bullish (positive) then bond yields have to rise to attract investors (versus the stock market). When bond yields rise so to do mortgage rates.
The future
While no one can tell you with certainty where interest rates are headed it must be pointed out that the overnight rate is at one of the lowest points in Canadian history. The stock market has had a huge bull run since the financial crisis (which Canada weathered better than most nations). This would lead one to believe that mortgage rates are on the rise. To a certain extent Canada takes its cue from its largest trading partner to the South of us, and they are expected to keep rates low due to the housing crisis in the USA.
You would be wise to talk to your mortgage professional and get their take on where interest rates are headed. By switching from a very cheap variable rate to a slightly more expensive locked in rate you may in the long run make a huge savings as rates rise. Alternatively if you feel that rates will remain low for the rest of the year, you can hold off locking in until the fall. Whatever you decide be sure to read the fine print because the best mortgage is not just about the cheapest rate
What is investing? Wikipedia defines investment as the following: “Investment is putting money into something with the hope of profit. More specifically, investment is the commitment of money or capital to the purchase of financial instruments or other assets so as to gain profitable returns in the form of interest, income (dividends), or appreciation of the value of the instrument”.
So what does that mean? We all know what money is, it’s the stuff we carry around in our wallets (hopefully), so what are financial instruments? Specifically they are:
• Stocks,
• Bonds,
• Treasury Bills,
• Mutual Funds,
• Exchange Traded Funds (ETFs)
• Options and other derivatives,
• Property, or
• Currency.
Investing therefore, means that you spend your money and in return you receive one or more of the above financial instruments. ‘Profitable returns’ refers to:
• Interest – this is what a company will pay you for the privilege of using your money. Think of a savings account at a bank. You give the bank your money and they use it to lend to other people and businesses. The bank pays you a small amount of interest for the use of your money.
• Income (dividends) – this is a form of profit sharing. When a company makes a profit, they pass some of those profits back to the owners of the company (some they keep to reinvest in the company to help it grow or survive during down times). As a stockholder you are an owner of the business and entitled to a share of the profits that are distributed.
• Appreciation of the instrument – this refers to the increasing value of whatever it is that you bought. For example, if you bought your home for $100,000 ten years ago and today you could sell it for $150,000 you would say that your real estate (real property) had appreciated by 50% or $50,000 in this example.
This all sounds good, but there is more to consider before you plunk down your money and expect to earn a luxury vacation in Cabo San Lucas. Your education is just beginning and the fun is about to start.
You need to understand what your financial goals are and what your position is on risk management. Your goals may include:
• The need to draw an income from your investments,
• Saving for a vacation or major purchase, or
• Planning for your retirement.
Whatever the case, you need to find out, because the answer will determine how you invest.
Many people believe that the more risk you take with your investments, the more reward you receive. This is true to a certain extent. It is also true that the more risk you take, the more likely you are to lose your entire investment. What we are talking about is called risk management and it is very important to understand. Every person is different when it comes to risk. In general the older you are, the closer to retirement you are, the less risky you want to be with your investments. This is because the older you are, the less time you have to recover from a big loss.
For one to succeed in the stock market on their own, they need to commit to learning and commit to having fun. Yes fun. Investing on your own can be very liberating and very rewarding, but if done in ignorance it can be very dangerous as well. Beginners should scan the business section of the local newspaper and look for names of companies that they recognize. Read those articles and get a feel for what is happening with those companies and how they work. Even Warren Buffet, the greatest investor of all time, doesn’t invest in companies that he doesn’t understand.
I seem to be a little early when I’m trying to call a market top. Like 2 weeks early, and during those 2 weeks my positions are underwater. And I get nervous. Then the market reverses and I’m back in the black. This happened all summer long. I’m kicking myself to hold off making trades since I’m always a little early.
Back in April of this year (2010) the S&P 500 had made a huge run off the February lows, but by the middle of that month I had figured that that was enough and I started buying puts. (Recall that if you buy puts you are hoping for stock prices to fall so that your puts will profit). What happened? Well the S&P 500 kept rising and my puts kept falling in price.
Finally the first week in May occurred and prices crashed in a hurry and I made some very nice profits. But they could have been so very much better.
Again in June I was sure the market was going to drop once again. Once again I started buying puts and once again the market kept rising. Finally, the end of June came along and ravaged stock prices even worse than in May. I realized some profits, but once again it could have been so much better.
Additionally, several of my puts expired in June and the move didn’t occur until after options expiration day. My puts were worthless, even though I had been correct on the direction of the move (in stock price). How frustrating – I was right but I still lost money. This is why most people are scared of options.
What about right now (middle of September 2010)? I feel very certain that we are due for a pull back. Many of the leading stocks are over extended. Most are at or above the top line in the Bollinger Bands. All are way over their 50 day moving averages and hitting resistance levels. October is coming and that has been traditionally a bad month for stock prices.
I started buying puts late last week – and once again the market keeps rising. I had a few September puts that will expire nearly worthless tomorrow, but most of my puts come due in October.
The smart thing to do is to establish small short positions and slowly leg into new positions. This lowers your per unit cost (if you are buying puts and the market still rises) and allows you to fill out your position. As this market extends even further the technical indicators are screaming for a reversal. When it comes it will be swift and steep.
A swift downside move is coming. If you’re chasing stocks higher you’re likely to regret it in the days ahead.
Be careful. Plan your trade and trade your plan
According to Investorwords.com the definition of a hedge is “An investment made in order to reduce the risk of adverse price movements in a security, by taking an offsetting position in a related security, such as an option or a short sale”.
In plain English this means that if you have a position that you fear will move against you, you should employ a hedging strategy so that when it does move against you, you will not suffer a loss. In fact, a perfect hedge is one where you completely eliminate all risk, and also all chance of profit.
If you hold a long position in security A you are hoping that the value of A increases. However, you are afraid that A might fall in price thereby exposing you to a loss. To prevent this possibility you should take a long position in the opposite of A (let’s call it security Z).
Ideally A and Z are perfectly correlated so that a one point move in A corresponds to an opposing one point move in Z.
For example, suppose you have an investment in FXE which matches the performance of the Euro versus the US dollar. Every time the Euro moves up against the US$ FXE gains a point. To hedge against this position would be to take a half position in EUO which seeks to exceed the inverse of the Euro by 200% versus the US$. When the Euro falls by a half point, EUO gains by a point – theoretically at least. (There are some slight differences due to these funds having to pay their expenses and due to the fact that they attempt to match the daily performance and may be off by a fraction here or there, but these differences can add up over a long period of time).
Another possible way to hedge against a position in FXE is to buy a Leap put contract(s) so that when the Euro falls and FXE losses a point or two (or more) your put leap option will offset your loss. This is called a hedge and eliminates your risk. Keep in mind that you are not trying to profit on this trade; you are trying to get rid of risk.
Why would you do this? One possible example is perhaps you get paid in Euros but live in North America. In this scenario your purchasing power (your salary) would decrease every time the Euro drops in value (versus the US$).
Let’s suppose that you get paid $50,000 US per year in Euros. Today that would mean 40,600 Euros. (currency converter)
What happens if the Euro drops to parity with the US$? You would lose nearly 20% of your salary, not good. The thing to do therefore is to purchase a long term put contract on the FXE such that if the Euro falls to parity with the US$ your put contract will increase in value to $10,000.
When you buy in the money options contracts you can participate in a nearly dollar for dollar move in the underlying security. What this means is that the options contract will move in sync with the underlying security if the contract is deep in-the-money and also if there is plenty of time on your side.
Going back to our example: If you purchase 3 January 2012 put contracts with a strike price of 130 this will cost you approximately $14 or ($14 *100 shares per contract * 3 contracts) $4200. FXE currently trades around 122. If FXE were to move to 100 in the next 12 months you would have lost nearly $10,000 in purchasing power from your salary (remember the FXE reflects the value of the Euro, if it drops the Euro has also dropped).
Now let’s look at the value of your put contracts. With FXE at 100 your put contracts should sell for approximately $34 or ($34 * 100 shares per contract * 3 contracts) $10,200 which would offset your loss of purchasing power and be a nearly perfect hedge.
Your risk in this scenario would be if the Euro climbed versus the US$ and the value of your put contracts would fall. However your purchasing power would also have risen and therefore offset the loss in the investment.
My wife currently gets paid in GB Pounds and you can be rest assured that I will be running the numbers on the FXB (which is similar to FXE except in Pounds instead of Euros). Good luck and remember plan your trade and trade your plan.
There is another way you can earn income from the use of options. Earlier we talked about employing a covered call strategy to supplement your dividend income. You can earn money from selling a call, but you can also earn money from selling a put.
Recall that when you buy a put option you are making a contract to sell 100 shares at the strike price on or before a specific date in the future. Now consider the other side of this transaction.
Put-Selling: When you sell a put option you are agreeing to buy 100 shares at the strike price on or before a specific date in the future. Please keep in mind that you would only ever enter into this contract if you actually want the underlying shares. Don’t speculate or you may end up with something you do not want.
Ideally, the contract strike price is below the current price of the underlying shares. You are therefore agreeing to buy 100 shares of a company that you want at a price that you think is fair (or even below market value). You earn a premium for making this agreement.
The purchaser believes that the share price will fall even further and hopes to limit his or her loss. As the seller you believe that the drop in price is only temporary and that buying the company at this new lower price is a bargain.
However, it is entirely possible that the share price will not fall below the strike price before the expiration date, and you will never be ‘put’ the shares (forced to buy). In that case you will have earned a premium and never had to buy anything at all.
For example, Apple stock (aapl) currently trades for approximately $248 per share. You like Apple and think they are a strong company, but not at the current price. However, at $220/share Apple looks very attractive. You could sell the July $220 put for $3.60. Keep in mind that each contract controls 100 shares. Therefore, you would earn $360 from selling the put contract. And, if the price of Apple shares fell below $220 before the 3rd Friday in July (the expiration date) you would have to buy 100 Apple shares at $220 each.
If Apple never falls below $220 then you do not have to buy the shares, but you still get to keep the premium – in this case $360, which is a good thing. If Apple falls below $220 a share you get to buy them at a price that you thought was a bargain. This is also a good thing. Your only risk in this scenario is that Apple shares fall far below $216.40. Were that to occur you would be in a loss position, but you would own the shares and be able to take advantage of any later upswing in the stock.
Credit unions and banks are more similar than they are different. Both are financial institutions which offer a variety of services to their depositors, ranging from savings accounts to home loans. However, the underlying philosophy behind banks and credit unions is different, with the key distinction being that banks are run for the purpose of generating profits, while credit unions are generally run as non-profit, community-based institutions.
Credit unions certainly have fewer locations and are less common than banks. That doesn’t mean that they offer services of a lower quality, though. Consider the advantages offered by credit unions to understand what differences there are between them and traditional banks.
1. Who owns a credit union? A group of investors are the owners of a bank. The investors hire a professional management team and are responsible for decisions regarding business policies and administration. These same choices affect the ability of the investors to make money from the investments they have made in the bank. Conversely, credit unions are owned by their members and the decision making board members are volunteers that give of their time on behalf of other members. Still, each member of the credit union can vote on the policy that is to be followed since it will affect their money.
2. Do they keep your money safe? Any money being stored in a bank is guaranteed to be there by the Federal Deposit Insurance Corporation (FDIC) and this guarantee is backed by “the full faith and credit of the United States government”. (For whatever that is worth – see the unthinkable amount of debt the US is currently labouring under). The insurance limit is $250,000 per account until 2014 when it will revert back to $100,000 per account. Credit Unions follow a similar process and are 100% secure so long as they are federally insured (up to $250,000), but the Credit Union National Association (CUNA) is the organization backing them up.
In Canada it is the CDIC (Canadian Deposit Insurance Corporation) that insures savings deposits at banks up to $100,000. For credit unions your deposits are insured by the provincial associations and they differ from province to province. For example Ontario covers up to $100,000, whereas Nova Scotia covers up to $250,000 and in British Columbia all of your deposits are covered – no limit.
3. Who can become members? A financial institution like a bank or credit union can offer their services to anyone who meets the criteria they set for perspective members. Banks do whatever they can to get as many people as possible highly interested in doing their banking with them. This process helps banks build an ever growing customer base, but the people who sign up for accounts do not always decide to stay with the bank.
Credit unions, however, cannot be joined without first meeting some sort of prerequisite for becoming a customer. These can include factors like religion, workplace, geography, and civic affiliation. By keeping the total number of members low, credit unions can provide better, more personalized customer service. Generally speaking anyone can join a credit union simply by living in the community where the credit union operates.
4. Are they friendly? Banks do what they can to attract new customers, but their real loyalty belongs to the investors in charge of the bank’s care. This is why their customer service often waxes at the time you open a new account but wanes quickly.
Customers of credit unions are also making the business decisions for the company, so the customer service is traditionally better. To keep future interest rates on credit cards and loans low, money that exceeds the running costs of a credit union is used to maintain interest rates on money market accounts, savings accounts, and CD’s as high as possible, or are returned to members in the form of dividends.
All credit unions are involved in the communities where they operate and as such you can be assured that there will be some sort of charitable community activity that is ongoing. Some banks allow workers time off to pursue charitable activities and are also active in organizing donations for disaster relief, but these are usually of a more national or international nature rather than local.
Offering excellent customer relations skills and interest rates that are just plain better, credit unions are a notable threat to banks. Banks, however, have more money supporting them and are therefore able to offer bigger and better incentives to their customers. Deciding whether to store you money at a bank or credit union involves making an informed decision that relates to your personal situation.
Today Minister of Finance Jim Flaherty announced three new rules governing how Canadians apply for mortgages. There was speculation that he would increase the minimum deposit form 5% to 10% and/or reduce the maximum amortization period from 35 to 30 years, but the Minister did NOT do either of these things.
First off, all borrowers will be required to meet the standards as though they were applying for a 5 year fixed mortgage, even if they are actually applying for a variable rate short term mortgage. The idea here is to make sure that borrowers will be able to withstand interest rate movement (specifically upwards movement).
Secondly, when refinancing your home you may now take a maximum of 90% of the value of your home. This is down from 95%. Clearly this an attempt to prevent people from going underwater on their mortgages like so many have in the United States.
Finally in an effort to put the brakes on a hot housing market the government is requiring that for non-owner occupied (read here real estate investors) houses the deposit must be 20% of the value of the home (up from just 5%) to qualify for CMHC insurance. The exact quote from Minister Flaherty is: “We want to discourage the tendency some people have to use a home as an ATM, or buy three or four condos on speculation.”
The new rules will come into effect on April 19, 2010 and will probably stimulate some last minute buying by real estate investors. Clearly Flaherty is concerned about a possible housing bubble in Canada despite his assurances that there isn’t one. Actions speak louder than words – and he has acted in this case.