It is not just the latte (factor)

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David Bach popularized the “latte factor” term. The concept emphasizes the long-term cost of small, everyday purchases such as coffee, cigarettes, magazines and so on. There are lots of debates in the PF community as to whether this concept is valid. I personally believe it is, to some extent.

The very first post I wrote was about the cost of eating-out. I had estimated that someone eating 3 meals out five days a week will spend over $ 8 000 per year on food. For simplicity, let’s say this amount never changes for a period of 25 years. The cost will be $ 200 000. I sure could find a lot of better uses for that amount of money!

For simplicity again, let’s say that half of it is invested, i.e. $ 100 000, for 25 years at a conservative 5% interest rate. At the end of the 25 years, it would turn into close to $ 194 000. I don’t know many people who can pass up $94 000. Do you?

No, the latte factor won’t make you a millionaire, but it can certainly help your financial goals. That being said, in order for this to work, you need to actually save and invest the money. If you spend it somewhere else, it will get you nowhere financially.

You also need to look at bigger expenses, namely house and car. Don’t buy too much of these, they can drain your accounts in no time and prevent you from replenishing them. It is also a good idea to review and compare insurance quotes or call your cable to company and ask for a discount. You will be surprised at how much money you could save by doing all the aforementioned.

To put together a successful financial plan, you need to look at the bigger picture and at other elements such as your income – does it exceeds your expenses?-.

Spending an occasional $ 4.00 on a fancy latte will not derail your retirement plans. Spending $ 8 000/year on take-out or taking on a too large mortgage might.

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Financial things to do (and not to do) in your 30’s

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The 30’s are definitely an interesting decade. Chances are they are a mixed bag for most people in them, including myself: wedding, kids, house, career…etc. This decade is probably the most taxing on hard-earned dollars.

The good news is that your 30’s are also your top-earning decade. Without further ado, here is what you should – and shouldn’t- be doing in your 30’s:

  • become established in your career. You probably have a few years of experience under your belt by now. Make the most of them to negotiate your salary and promotion or to find a better job. If you are considering a career change or want to become self-employed, you will need to plan for this. Keep reading.
  • make use of work benefits: benefits are basically free-money, and even more so when they are employer-paid. If your employer offers extended health and/or disability insurance, please enroll. Same goes for a pension or a group RRSP plan.
  • track your expenses and income. There is no way you can budget and set goals if you don’t do this.
  • have a sufficient emergency fund. Whether you want to call it a back-up fund or an opportunity fund, it is all the same. It needs to be adequately funded. Chances are $ 1 000 are not going to cut it anymore, particularly if you have dependents. Most people aim for 3 to 6 months of living expenses. Aim for what is right for you, given your circumstances.
  • have adequate insurance coverage. Unless you are loaded with cash you need insurance. Check my previous entry on this subject.
  • plan and save for items: whether it is car repairs, your wedding or your annual vacation, these are neither emergency nor a surprise. If you are unable to save the money, then you may have to postpone or consider other options.
  • don’t keep-up with Joneses. You should be way past this.
  • you are really saving for your retirement. This should be the top-priority, before your kids’ education, if you have them. Ultimately, your children won’t pay for your retirement.
  • you are investing in the stock market. You still have a few decades before retiring. The stock market has always provided the highest returns. Educate yourself and invest your money. Do not let it sit in your savings account earning 0.5% interest.
  • you have your debt under control. It is unlikely you will be able to completely avoid debt in your 30’s. Your student loans should be on their way out, if not paid off. You are not racking-up credit card debt to buy stuff or to pay for living expenses. When borrowing, it should be to buy an appreciating asset, when the cost of the loan does not impact other saving goals and will be paid off before retirement. Anything not under that category should be off-limit.
  • Don’t buy too much house. If you decide that home ownership is for you, do not become cash poor over it. Too many Canadians make their home their entire financial plan, including to retire. This is a mistake. You also need highly-liquid, easily disposable assets.
  • have your legal affairs in order. You need a will, even more so if you are married and/or with children. Ensure you designate a beneficiary for your life insurance and other registered accounts.

 

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RRSP myths debunked

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As 2016 is slowly but surely coming to a close, it will soon be tax season again.

I want to broach on the biggest RRSP myths that are still circulating around.

  • A contribution equals a tax refund. Sorry to disappoint you here, but this is simply not true. A contribution will lower your income tax payable, but does not necessarily trigger a refund. It depends on your income and situation in general. Also, your refund will never be for the full amount you contributed.
  • RRSPs are tax free. No, they are not. An RRSP is a tax-deferred account. It is like “contribute now, pay later”. You only pay taxes when you withdraw from the account. The only 2 exceptions when you won’t pay taxes is within the Home-Buyer Plan or the Lifelong Learning Plan. That being said, under these 2 programs, you have designate a minimum repayment amount each year when filing your tax return. If you don’t, you will be taxed accordingly.
  • Dividends and capital gains within an RRSP are not taxable. This is by far the biggest myth around. If you have stocks, ETFs or mutual funds, you may be paying taxes on any dividends or capital gains. It all depends on the country the stock/ETF/mutual fund is from. If Canadian, then yes, you will not pay taxes on any dividend or capital gain. Canada also has an agreement with the United States regarding dividend-paying US stocks held in a Canadian RRSP. These are not subject to taxes either. For the rest, the area can definitely be more gray. Many countries levy a tax on dividends paid to non-residents. If there is no tax treaty with Canada, CRA will levy additional taxes. Because an RRSP is a registered account, you won’t be able to claim the Foreign Tax Credit.
  • Everyone needs an RRSP. If you are in a low tax bracket or have a pension plan at work, you won’t benefit from an RRSP. If you are in a high tax bracket, you need to figure out what your tax bracket will be when you retire. If it is expected to remain the same, the RRSP is probably not the way to go either. With the clawback on the Guaranteed Income Supplement, you may end-up paying more income taxes! The RRSP is best suited for medium or high earners whose tax bracket will be lower upon retirement, and who don’t have an employer pension plan.
  • An RRSP loan is a good idea. Not necessarily. As I indicated above, your refund will never equate the amount you contributed. Unless you can reimburse your loan in full quickly, you will pay interests on said loan. You also can’t deduct the interests paid on the loan, because you can’t do so on registered accounts. Your RRSP also needs to return quite a bit more than the interest rate on your loan.

There are plenty of other misconceptions about RRSPs, but these 4 are probably the most common ones.

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Back to life and financial basics

I can’t believe it is already Thanksgiving here, in Canada. As always, I do my best to practice gratitude on a regular basis, and not just on a particular day.

Recently, I have been thinking that, when I was younger, life was much simpler and cheaper.

I am probably dating myself but, back then:

  • We didn’t have cell phones or Internet
  • We didn’t have cable or Netflix
  • We didn’t have a dishwasher, at least for a good portion of my childhood
  • We didn’t have a dryer for our clothes; we air-dried them
  • We only had one bathroom for the whole family
  • We only ate out for special occasions, such as birthdays
  • We lived in the same house for decades
  • We didn’t trade cars every other year
  • We only replaced items when they could no longer be fixed or no longer worked at all
  • We didn’t throw away clothes just because a button went missing or because they had a tiny hole; my Mother would mend them
  • We only bought things that we could actually afford to pay for right away

And you know what the best part is? I am alive and well.

I have also kept quite a few of the above for my life as it is today. It wasn’t always that way.

It can be very challenging in these times of instant consumption and gratification, “must have & must be”, where bigger is perceived as better and each kid “needs” their own bathroom. I used to be in that line. Not anymore.

By doing most of the above, I have saved a lot of money over the last few years and I was able to do what really matters to me.

Perhaps, you can do so too. It can be a good starting point for anyone trying to get their finances back on track.

Happy Thanksgiving to all my Canadian friends and compatriots!

 

Mortgage penalty explained

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It has been over a month since my last entry. My life has been crazy-busy this year and I really needed a break. I took time-off work and I also had family visiting, which was exactly what I needed. I realized I also needed a break from my daily routine.

I am definitely more settled in my condo and new city. I enjoy living there and I know I made the right move by selling my previous condo.

Going through the madness that is real-estate in Vancouver, I have to write another post on the subject of mortgage penalty.

In Canada, when you pay-off your mortgage early, lenders have the right to charge you a penalty for doing so. Mortgages are a huge business here, and even with low-interest rates, lenders are turning massive profits.

The penalty you will be assessed depends on whether you have a fixed rate or a variable rate mortgage. As indicated in their names, the interest rate on a fixed rate mortgage will remain the same during the term of the mortgage. A variable rate, on the other hand will fluctuate.

This is because the interest rate on a fixed mortgage is determined by the bond market whereas the variable rate is determined by the prime rate set by the Bank of Canada.

This also explains why there are 2 different penalties: 3-month interest or Interest Rate differential -IRD-.

For a variable rate mortgage, the penalty will always be 3-month interest, as mandated by the National Housing Act.

For simplicity, let’s say you have $ 100 000 left on your mortgage with an interest rate of 4.00%. The penalty would be:

4.00  X  100 000  X  (3/12)  = $ 1 000.00.  Pretty straightforward.

There are 2 different ways of calculating the IRD. One could impact you in a significant way.

Once again, for simplicity, we will assume  a $ 100 000 mortgage at 4.00 % with 24 months remaining on the term.

With a standard IRD calculation, the lender will take the current interest rate for a 2-year term fixed rate mortgage, matching the 24 months left on your mortgage.

Let’s say the rate on this is 2.75%. The lender will the calculate the difference between this rate and your mortgage rate. i.e 4.00 – 2.75 = 1 .25.

The penalty is then calculated as follow:

100 000  X (1.25 /12)  X  24  = $ 2 500.00.  More than double the 3-month penalty!

A few lenders use a loophole in the Interest Act for the second way to calculate the IRD. The Act does not specify which rate should be used to calculate the penalty.

Let’s keep the same numbers as above. Some lenders use the posted rates instead of the contract/discounted rates, i.e. the rates you actually pay or would pay.

You obtained a rate of 4.00% but the posted rate on the day you got your mortgage was 5.25 %. The lender gave you a discount of 1.25 %.

The posted rate for a 2-year mortgage is now 3. 00%.

The lender will use an IRD factor of 2.25, i.e. 4.00 – (3.00 -1.25).

In terms of penalty, it amounts to:

100 000 X (2.25 /12) X 24 = $ 4 500.00, more than quadruple the 3-month penalty!

I know all these calculations look boring but it is crucial to understand how your lender calculates your mortgage penalty if you have a fixed rate mortgage.

I was lucky that my previous lender did not use the posted rate. They charged me a 3-month penalty as it was higher than the IRD. Had they used the posted rate, I would have paid over $ 4 000 in penalty. When I signed the documents, I did not pay attention to this.

Most people don’t, unfortunately.

For my second mortgage, I went with a variable rate.

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Closing costs in real-estate

I am finally all moved-in in my new home sweet home. I am glad this whole “real-estate thing” is finally over. I decided to sell my previous condo in mid-April. By the time it was ready for sale, it was the end of May.

It was listed early June and sold on the 14th at over-asking. I was lucky to be able to buy my current home shortly after. That being said, the completion and possession dates were mid-August for both condos.

I had been living in boxes and more or less camping since the end of June. I was happy to take all my belongings out of those boxes.

Closing costs are payment for all the necessary items to conclude or “close” a real-estate deal. These fees are paid by both sellers and buyers but are different.

For the 2 transactions, I had budgeted $ 29K in closing costs….they came in at just above $ 25K. Staggering, isn’t it?

These fees creep-up very easily and add-up to big dollar amounts. They are always a surprise for most people, including myself. Here is a non-exhaustive breakdown of them:

When selling

  • Realtor commission:  in BC, it is usually 7% on the first $ 100K and 2.5% on the remaining balance
  • Legal fees: to clear the title. The fees are lower when selling as there isn’t much involved.
  • Mortgage penalty, if applicable: if you break your mortgage before term, lenders will charge you a penalty, either 3-month interest or Interest Rate Differential -IRD-
  • Mortgage discharge fee, if applicable: most lenders will also charge you an administrative fee to discharge the mortgage

Upon selling, the buyer will usually reimburse you for your share of the property tax and strata fees -if you buy a condo-.

When buying

  • Legal fees: these will be higher for purchasing, as more work is involved
  • Property transfer tax: cash grab from most governments. In BC, the rates are: 1% on the first $200K, 2% on the remaining balance up to $ 2 millions, 3% up to $ 3 millions. If you are a first-time home-buyer and your property is under $475K, you are exempt from this tax in BC.
  • Down-payment
  • Mortgage default insurance: if you buy with less than 20% down
  • Mortgage application fee: most lenders will waive this, but some will charge you an administrative fee to process your application
  • Title insurance: most lenders will require this. It is to insure you are the rightful owner of the property
  • Appraisal fees: if you buy a detached house, the lender will ask for an assessment of its value to insure you are not overpaying. It is less common for a condo
  • Land survey: for detached houses only. A lender may require a detailed plan of the land showing property limits, easements and rights of way.
  • Interest adjustment: You need to pay the interests on the mortgage for the month you close
  • Other adjustments: you will most likely have to reimburse the seller  for their share of the property taxes and strata fees
  • Fire insurance: lenders require to be first payee in case of a fire. Insurance companies will charge a fee to prepare the applicable document

Other fees that are not included in the statement prepared by lawyers/notaries:

  • Home inspection: if you can do one, that is great but it costs around $ 500.00
  • Moving company: unless you have willing friends, you will need people to move your belongings to your new place
  • Home insurance 
  • Utility hook-up & transfer: BC hydro charges $ 12.50 to transfer your account. Your cable company may also charge you fees
  • Locksmith: it is probably a good idea to have the locks of your new place re-keyed

As you can see the list is pretty long! When it comes to closing costs, you are better off thinking “high” than “low”. They will always be higher than what you think.

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New Canada Child Benefit explained

 

The Liberal Government has made huge changes to the Canada Child Benefit program (CCB) last month. It was actually part of their electoral campaign.

Under the old system, the CCB -actually called CCTB-was $ 100 per month, taxable. Needless to say this didn’t get any parent far in terms of child rearing.

The new CBB also includes the child disability benefit (if applicable) as well as any provincial programs parents may be eligible for. It is also tax-free.

The amount is based on income, number of children and status in Canada. Basically, you and/or your spouse must be considered as residents of Canada and be the primary caregivers. In case of divorce/separation the CBB is split 50-50 between the parents.

If you haven’t received any child benefit before, you need to apply. After, your situation is reviewed every year by CRA in July and you don’t need to fill-in further paperwork.

In terms of amount, the maximum is $ 6 400.00 per year and child – $ 533.33/month- for children under the age of 6, and $ 5 400.00 per year and child -$ 450.00/month- for children up to 17.

If you are making over $ 30 000 per year, the amount will be reduced. The system is designed to help lower income families who need it the most.

That being said, all families will receive higher payments. If I had a child now, I would receive $ 370.00 net/month vs $ 155.00 partly taxable under the old system. It is still not much but definitely a step in the right direction.

Child-rearing in Canada is incredibly expensive. In cities like Vancouver and Toronto, daycare costs for infants can be over $ 1 000/month, basically a second mortgage or rent! After school care and activities are not cheap either.

You also have to factor in the costs of taking maternity leave, coming with a huge pay-cut, as well as the ongoing costs of food, clothes etc….Did I mention anything about saving for university?

It is no wonder more and more people decide not to have children or to have them later on.

What about you? What do you think about this new program? Does it help you and your family?