The problem with balance transfer credit card offers

 
 
I have noticed that there is one huge catch to making a balance transfer to another credit card. The catch is that we are human! What does this mean? It means that while I might only need to transfer 8 or 9K, I will likely transfer 12,000$ to my regular credit card to ensure I have enough room to pay everything. The problem is that I have just created a $12,000 debt at 1.99% payable in full 10 months (or pay through the nose)… I will have to be very careful to pay it off on time!
 
 
How the credit card balance transfer works
 
 
Once I get my card, I simply have to call to activate the card. Then, they ask me how much to transfer and to which credit card. They make the payment for you so you don’t have to worry about anything. The most important thing is to make sure that your credit card bill is not due on short notice. If you are planning to get a 1.99% balance transfer credit card, I would suggest that you start the process just after you paid your credit card bill. Therefore, it will give you about a month to complete the transfer. In my case, it will take about 2 weeks to have everything completed (the card approved, receive it and transfer the credit card balance over to MBNA).
 
 
I received my card only a few days after calling. When I called to activate the card, they were quite fast to complete the whole process. A big thanks to Trevor and Ticker for the comment on my previous posts about the credit card terms and balance transfer fees. This gave me the occasion to ask the guy what the exact process was. Here it is:
 
 
-         The balance transfer is done within a week. They send the money to the other credit card company by electronic transfer.
 
-         If you miss a payment on your credit card, the 1.99% rate disappears and you jump to the killer regular credit card rate.
 
-         If you go over your credit card limit, the balance transfer deal ends as well and you go back to a normal credit card rate.
 
-         You have 10 months at 1.99%, after that, it’s over. So you are better off not fooling around with this debt!
 
-         There is a fee of 1% of the amount transfered to organise the balance transfer
 
-         The payment to my credit card took 3 days (they say 2 to 5 business days).
 
-          The card is platinum but doesn’t look like one. The design  is not that great
 
-          But, the fact that the card is platinum doubles your warranty on your purchases up to 2 years.
 
 
Overall, the credit card balance transfer won’t cost me too much and it will help me paying off the loan from my parents faster than expected. On the other hand, I will shortly setup a payment plan to make sure I pay off and remove this debt from my balance sheet by the end of the year!
 
 
So if you are thinking about doing a balance transfer, I truly suggest to try the 1.99% MBNA Platinum credit card:
 
 

I don’t know about you but I am growing tired of the media telling us how high interest rates will become in a year or two. They keep writing in the papers about interest rate calculations affecting your mortgage payment if the prime rate goes up by 5%. Some of them even push the limit saying that the prime rate will be 7% within 5 years… how the hell would they know? Did they tell the world in 2003 that prime rate would it 2.25% for 18 months in 2008? Who was right back in 2003? Please, give at least one name!

So today, I’ll do something different. I’ll use the very same math to perform interest rate calculations that affect your mortgage payment, but on the other hand. Since the mass media always tend to show you how much you *might* pay if the prime rate goes up by 2% compared to a fixed rate, let’s take a look at how much you *paid* in excess since 2008 compared to a fixed rate.

So let’s take an easy example:

Mortgage; $200,000

Amortization: 300 months (5 years)

Negotiated 5 year Fixed rate: 3.85%

Negotiated Variable rate: P+0 = 2.25% for the first year, now at 2.50%

Before I start with my calculation, you can argue that you were been able to lock your 5 year rate at 3.69% or even lower, but I could argue back that some of my clients are paying way less than P+0, so let’s keep it this way.

So during the first year, you would pay $12,430.08 in mortgage payments if you had taken the 3.85%. With the variable rate of 2.25% during the first year, you would have paid $10,454.64… so 2K less for the first year.

Let’s assume that the prime rate will go up during the next 12 months with an average of 3% (which includes that it increases from 2.50% to 3.25%). Your mortgage payments will go up to $11,357.88 for the year. So you will be saving another 1K during this year.

So you start year 3 by paying 3K more in interest with your fixed rate or by applying the very same 3K on your mortgage to create a safety net. Let’s assume that you just took the 3K in your pocket and you keep the same strategy (either paying 3.85% fixed rate or 3.25% variable rate). And let’s imagine that the prime rate goes up to 4.50% (with an average rate of 4%). Your mortgage payment with this new interest rate increase would be $12,624.48.

So after 3 years, and a lot of interest rate increases, you have still saved a total of $2,853.32. So let’s push the interest rate higher to 5.5% with an average of 5%. Mortgage payments for the year totals $13,958.52.

So after year 4, your overall mortgage payment is still lower and you have still saved $1,324.88.

When we look at this scenario, you will be a loser if interest rate keeps increasing for 5 years in a row which is unlikely to happen. And if it does, you will have lost about $1,000 compared to the fixed rate. Then, if you keep with the variable rate for another 5 years instead of locking a very high 5 year term fixed rate (because if Prime = 5%, the 5 yr fixed rate could be around 7 to 8%). You are almost sure to see a decrease in interest rates during the next 5 years since we always go through economic cycles.

Final thoughts on interest rate calculations and mortgage payments

Based on these calculations, I am a firm believer in the variable rate but by simulating 5yr fixed rate mortgage payments. i.e. , you pay low interest rates (prime) but you make higher payment (simulate it a 4%). Therefore, you are building a huge safety net to compensate if the variable rate goes higher.

See, the future is not always black when we talk about variable rates

The recent positive economics datas (economic growth, inflation and drop in unemployement rate) are the most important reasons leading to this interest rate increase.  The Bank of Canada doesn’t consider that the economic problems from Europe should affect its future economic growth that much and I guess this is why we see a interest rate increase of 0.25% today.

The next schedule for the interest rate revision is due on July 20th. While this interest rate increase was expected, any further increase should be done very carefully as we are still going out slowly of the previous recession. Some economists report that they are afraid to see the Bank of Canada increasing their interest rate too fast as they did in 2002.

In my opinion, I am not very surprised about today’s increase. I was expecting no change to an increase of 0.25%. on the other side, I don’t think this event is the signal of the low rate party ending. I think we have another good 6 months to 12 months of low interest rate

Next Tuesday, The Bank of Canada will announce the new (or unchanged!) Prime Rate. For several months now (since the credit crunch of 2008), The Bank of Canada has maintained its prime rate at the virtually lowest level possible; 0.25%.

We started to read about potential rate increase in late 2009 when Australia had increased its rate several months in a row. However, the Australian reality appears to be quite far from that of the Canadian economy.

Controlling Inflation

The most important reason why the Bank of Canada would increase their interest rate would be to maintain the inflation at an “acceptable” level. This level is currently set between 1% and 3% with a “ideal” rate of 2%.

Since we have been flirting with the 2% inflation rate for a while (currently at 1.9% as of April 2010), many economists have predicted that the Bank of Canada would start increasing its interest rate as previously mentioned by Mark Carney, Governor of The Bank of Canada.

There are more clouds in the sky than expected

The Bank of Canada was ready to stop the low interest rate party this summer but recent events in Europe might cause the Bank reconsider its strategy. Considering the economic problems stemming from the PIGS (Portugal, Ireland, Greece and Spain), the stock market has responded negatively.

Therefore, the economy may slow down again and reduce the inflation risk. Considering this scenario, there is no urge to increase the prime rate right away.

The general demand for resources is slowing down as the price of oil has dropped significantly. This will also have an important effect on inflation (even though they consider the inflation rate with and without the price of oil).

What is my bet on the Canadian Prime Rate?

I bet it will increase by 0.25% but I would definitely not be surprised if it stays at 0.25% until July. The only point I am quite confident of is that we won’t see an increase of 0.50% or 0.75% as some economists were predicting a few months ago.

It’s not that they were wrong in the predictions; it is just that today’s economy evolves so fast that your 5 year projection are probably right when you do them but they go wrong 2 weeks later .

I hope to benefit from low interest rates till the end of 2010. This would help me stabilize my finances after my moving in June. This fall, I will seriously attack my mortgage so it starts decreasing faster than it has been for the past 2 years!

At first, somebody wants to buy a house but doesn’t have any cash available for a down payment. So, banks create mutual funds to help him save.

Then, this same individual can’t manage his budget so he can’t really save. And, banks come up with RRSP loans.

Now that he has a 5-10% cash deposit saved, he now wants to buy his house right away. Therefore banks offer him a mortgage.

But the guy wants more flexibility as he wants to make home renovations and buy a new car. So the banks create the home equity line of credit.

And guess what? The same guy doesn’t want to manage notary/lawyer’s dates while buying and selling properties. This is why banks created a bridge loan.

What is a bridge loan?

A bridge loan is a very interesting product for individuals who don’t want to bother about dates when selling/buying their properties. A bridge loan is a short term loan that advances the amount of your cash down temporarily between the sale of your current house and the purchase of the new one.

Why do you need a bridge loan?

Picture this: you have a house selling on June 13^th (the moment you will receive your check) and you give the keys to the new owner on June 17^th. You finally find the home of your dreams and you are getting the keys on June 12^th. Therefore, you will have to give the seller your check before that date. Let’s say that you have to pay him on June 9^th. The bank will disburse your mortgage on June 9^th, but where will you find your cash down if you are getting the money from the sale of your house on June 13^th? This is why you have 2 options:

#1 You ask your buyer to accelerate the process and go to the notary on June 6^th so you can get your money ready for June 9^th. However, if the buyer pays upfront,  he will want to possess the house faster. If he only gets the keys on June 17^th, he will request compensation for the 11 days that you live in “his” house for “free” (since your mortgage will be paid off on June 6^th at the time of the sale.

#2 You keep the dates as is and ask for a bridge loan from your bank! The bridge loan will be disbursed on June 9^th (the date you are buying) and the bank will also disburse your new mortgage so you have the whole amount to buy your new property. Therefore, on June 9^th, you will be responsible for the 2 mortgages (since you haven’t sold your house yet) and a bridge loan (which is the equity lying in your previous property that is not sold yet).

On June 13^th, you will receive the check from the sale of your house but the bank will demand from the notary/lawyer to be paid first for #1 the outstanding mortgage and #2 for the bridge loan.

What is the cost of a Bridge Loan?

They used to have a basic fee for a bridge loan since it is a temporary loan where banks don’t make much money on it (imagine the interest rate of 5% on $50,000 for 5 days… you don’t get much from it!). However, since competition is pretty rough, banks tend to wave bridge loan setup fees in order to make sure they get the mortgage!

What is the interest rate on a Bridge Loan?

It is usually comparable to the interest rate on unsecured personal loan. In fact, bridge loans are unsecured loans (but they are set on a very short amortization).

What is the maximum amortization for a Bridge Loan?

There are no specific rules about bridge loan in terms of amortization. Since the bank is still taking a risk, they usually don’t extend bridge loan for more than 90 days. Otherwise, your bank will require that you renegotiate your possession dates instead of asking for the bridge loan.

What do you need to get a bridge loan?

Basically, the bank will require that the 2 transactions are almost certain. Therefore, they will need your purchase and sale contracts with financing approval for all parties involved. The bridge loan will be disbursed at the same time as your new mortgage and you don’t have to do anything to manage it. The repayment date of the bridge loan will be set according to your sale date at the notary/lawyer. The bank’s main requirement in order to grant the bridge loan is obviously to get the final mortgage (we don’t work for nothing after all ).

After giving some thoughts about it, I will be going for the bridge loan instead of managing date with buyers and sellers. The bridge loan won’t cost me much and it is definitely an easy way to get everything done without headaches!

But before sitting in your brand new couch in your brand new house, you need to get a brand new mortgage . This is when you come across a huge billboard advertising a cash back of 5% - 5.5% on your mortgage. Man, this is perfect! You were just thinking of renovating the kitchen! Hey wait… your mortgage is $200,000… this means that you will get $10,000 in your pocket to buy that house! VIVA EL CASH BACK! Not so fast buddy…

Why are you getting huge cash back on your mortgage?

Before we start about whether mortgage cash back is good for your situation or not, you need to understand how a bank does its pricing for mortgages. There are 2 things that can be adjusted: interest rates and the amount of cash back. Since the interest rate war has been pretty rough on any banks these the past 12 months, some banks are starting to play on the other side of the equation; they are talking cash back. The more cash back you get in your pocket, the less you can negotiate the interest rate (and vice-versa).

The easiest way to know if you should take the cash back or the low interest rate is to do a small math calculation by comparing both options. Let say that you have a $200,000 mortgage. Therefore, you have 2 options:

-         get a cash back of $10,000 (5%) and an interest rate of 5.85%

-         get no cash back and a low interest rate of 4.35% (you can usually get about 1.00% to 1.50% off the posted rate).

When you see huge cash back mortgage promotions, they usually offer it on 5 year term mortgage (fixed) and give you the posted rate. Then, you just have to calculate (roughly) how much you save in interest over the next 5 years: ($200,000*(5.85%-4.35%)*5years = $15,000. While this is a gross amount (since your principal will decrease according to your payment), you can see that the cash back is not that of a great option. If you decide to go on a variable rate, you will be able to save even more money .

Why take the cash back promotion then?

There are a few situations when cash back is a good thing (while most of the time, cash back mortgage is just another marketing gimmick ).

#1 You need money now

If you need money to renovate or to buy a second car since you are moving away from your job, the cash back option can help cover those costs right now. Don’t forget that if you save $15,000 instead of $10,000 in my previous example, you don’t get the $15,000 in your pocket, it is just decreasing your mortgage payments over the next 5 years. So if you need a few thousand for a specific project, it may be worth it.

#2 Cash Back for a cash down

Young couples often use the cash back as cash down on their property. It may be a good strategy to buy a house in a hot market. If you wait 2 or 3 years to buy the very same property, inflation will work its magic and it will be more costly than taking the cash back today in order to boost your cash down.

#3 Cash Back for rental properties

This may be a really good strategy for rental property owners. Since the interest rate is tax deductible (and mostly paid by your renters anyway), you are probably better off with additional cash in your pockets (that can cover maintenance, an empty apartment, etc.).

So the Cash Back mortgage promotion is not that bad after all

As is the case for many financing or investing products, cash back mortgages can be a really good idea for some people in specific financial situations. All I am saying is don’t get hooked by the 5% cash back without asking questions and without asking what other mortgage options are  offered. In the end, you could take a variable rate with appraisal and notary/lawyer fees paid instead of taking a huge cash back… just discuss your options with your banker

During my last coaching session, I had discussed with my sales coach how being a financial planner was a great job:

#1 You enjoy a flexible schedule.

#2 You have the feeling of helping people with good financial advice.

#3 You get paid well .

#4 And one of the most important things; you get to meet and know very interesting people.

One of the things I like the most about being a financial planner is the opportunity to develop great relationships. On the other hand, the thing I hate the most about my job is when people think I am there to take orders and that I can’t help them. Sorry… I don’t deliver pizza!

I truly believe that clients have all the reasons in the world to get to know your banker personally and work together for the long term. While he will be in a better position to explain things and provide you with solid financial advice, you will also be in a better position to understand what he is doing and getting a better grip over your personal finances.

Another advantage? Who do you think is gets better service? The guy calling for a rate and doesn’t want to hear about any strategies and doesn’t care about the relationship with the banker or the guy that makes an appointment and explains his whole situation to his banker? I’ll let you guess…

In order to develop a great relationship with your banker, I thought of providing a few good tips:

#1 Pick the right one

Dealing with money is dealing with a person first. So you need to find someone who understands you and that you feel comfortable with. Since he needs to be one of your closest confidents (financially ), I think it is only normal to meet with a few bankers before making your decision.

#2 Chose him for the right reasons

While personality is very important, you should also look for a banker with an impeccable sense of integrity and professionalism. You want someone who will take your calls and get back to you within the very same day. Drop anyone who can’t do that. Financial background or diplomas are important too. While they are not a guarantee of competency, it is still better than nothing .

#3 Work with him

Some people go see their banker and think that hiding things is a good idea. They think that he won’t find out or that it will slow down their application. In fact, if you don’t work with your banker, you are just making his job harder… and getting something approved harder to get too!

#4 Talk numbers – learn his language

Bankers evolve in a world of numbers and ratios. While he must teach you how it works in a bank (how we calculate stuff, understand your investment statements, etc.), you should also answer his requests with your numbers. Bring statements with you, it will help to establish a greater strategy with real numbers.

#5 Meet him twice a year

You probably see your mechanic a few times per year for oil changes and car maintenance, you should see your doctor and dentist for an annual check-up. This is the same thing for your banker. Twice a year is just enough to keep track of your plan and financial goals. You can take the time to review your financial situation and if there are any better products to improve your balance sheet.

Developing a relationship with your banker is a really good financial move as you will now be part of his priority when there is important news that comes out.

Before I start with this morning’s article, I want to ask you to vote for me in the Free Money Finance March Madness contest. The best personal finance article will win the right to give $1,000 (generously provided by FMM) to a charity of your choice. I have selected a charity that helps children. Please comment on this post with the word “figures”. Thx a million!

The Prime Rate, or Prime Lending Rate, is a term used in many countries to describe an interest rate reference used by Central Banks. This key rate has been a major discussion for the past 6 months, as we realized that the sky is not falling and soon talk about economic growth and prosperity will dominate again. The prime rate is the starting point for all discussions involving mortgage rates (especially variable rates that are directly linked to prime). When discussing interest rates, we usually address debt management and how tough it would be if mortgage rates would climb to 6%+ again …

I don’t really like to play Nostradamus with regards to market trends or interest rates and I’ll show you why today. Recently, Bloomberg asked several economists their opinion on the Canadian Prime Rate and at where it would be at the end of 2010. You can see their predictions in the following table:

Out of 8 highly paid and hopefully knowledgeable economists, we notice predictions of a Canadian Prime Rate between 0.25% (no change) and 2.25% (an increase of 2.00% within one year… or should I say 10 months!) for an average prediction of 1.18%.

So my question is quite simple: how can someone predict no change and another (with the same level of knowledge/competence/tools of analysis) forecast a rate that is 9 times higher? I even read that some economists from Desjardins see the Prime Rate at 7% in 5 years… I guess I should call them to know which stocks will give me a 20% annualized return over the next 5 years. They probably have it written in their black book of prophecy This is why I spoke about Nostradamus!

So what is the point of this post if it’s not to predict the Prime Rate?

The point is to tell you that you will read a lot of apocalyptical scenarios about the interest rate going up since semsationalism sells. The very same people that were convinced that capitalism was dead 12 months ago will try to convince you that we are going to back to 12% interest rates as seen in the 80’s.

In fact, you will probably see a smooth increase in the interest rate as the economy gains its second wind. However, it won’t happen overnight

We still have a fragile economy, high unemployment rate (8.3%) and job creation doesn’t reflect reality as most of them are part time or under paid compared to the lost jobs. In addition to that, do I have to mention that the loonie is strong enough compared to the US dollar that we don’t really need interest rates to give it the final push to parity?

What if we see 10 years of near to zero economic growth as Japan experienced? Oh shoot…. That’s it! I am writing about another apocalyptic scenario on the other side… see how easy it is to predict the future based on rationale?

image source: Xurdle

I had read in an interesting report published by well known firm, Breton Woods, comparing the cost of a prepaid debit card vs a regular checking account in the United States. While prepaid debit cards are not a big deal in Canada, I was curious to learn more about why scores of Americans are turning their backs on traditional banks by trying alternatives.

Who doesn’t have a bank account?

There are around 60 million adults that do their transactional business while avoiding banks. I guess that the recent recession helped increase this number and therefore, the popularity of prepaid debit cards.

Most of them are found within minority groups; poor people, people without college education and those who do not really use their bank accounts. As many individuals now work with a day-to-day money management budget, they prefer to keep their cash in pocket instead of having to transact with a financial institution. As making money under the table and receiving cash in an envelope became reality for many of them, a regular bank account seems to be a money-eating-box-of-fees with aggressive appetite!

No bank account, what are your alternatives?

As I previously mentioned the prepaid debit cards gained a lot of popularity in the past decade. It allows an individual to load money on a debit card that is accepted almost everywhere (the access is comparable to a regular credit card). While this option may seem expensive since you have to pay fees each time you reload the card, Breton Woods showed that it is a great alternative for specific individuals helping them save up to 35% in banking fees.

Other marginal options include using check cashing services (like ACE’s), payday loans (very expensive!) and pawn shops. It really seems that we are going backwards as these individuals prefer having cash in their hands regardless of the fees (check cashing services can easily take more than 4% of the amount you want to cash).

So if it expensive, why are they doing it?

In my opinion, there are 2 major reasons why some Americans have decided to give up their banking accounts. The first one is because they have completely lost their faith in the banking industry (can you blame them?). There is an uncomfortable sentiment towards banks since they “got the country into financial trouble”, they were saved in extremis by the Government and paid themselves fat bonus check as early as 2009. Let just say that they didn’t behave like socially responsible corporate citizens!

The other reason comes from a lack of financial education. People who have a hard time managing their money get easily frustrated when paying overdraft fees, NSF checks and other banking fees related to poor money management. Cash or prepaid debit cards won’t “let them down” as once there is no money left, you just can’t do anything!

In the end, I still believe that you are better with a checking account but in some cases, financial education has to start with cash in your pocket!

image source: Sam Howzit

Yesterday, I wrote an article about the different compensation structures for financial advisors. Another way to know if your financial advisor is working for you is the end result of his follow-up calls. When I call a client, I always make sure that there is an added value for the client. There are 3 major reasons why your financial advisor should call you:

#1 To Offer To Make More Money for You

The main purpose of having a financial advisor is to have someone looking for opportunities while you are working. There are tons of ways to make more money on different things. For example, your financial advisor can offer you:

- A better product for your investment strategy. As the financial industry evolves faster than our brains can understand, there are often better investment products on the market. One shouldn’t jump from one fund to another all the time. However, if you have reach the required amount to gain access to a better investment solution, your financial advisor should be the first one to call you and make sure you benefit from this opportunity.

- Tax strategies that decrease the tax bite. Sometimes, a simple transaction can help you earn a few thousand on your next tax refund.

- To offer a better rate on fixed income. By doing a CD ladder or offering a municipal bond instead of a certificate of deposit, you can earn a better yield without necessarily taking more risk.

#2 To Help You Save Money

This is probably the area where there is a lot of room to improve for many financial advisors. How many times do we realize as clients that we are paying too much for something? Wouldn’t it be nice to have someone suggest switching products before we realize what is going on?

There are plenty of ways to save money with financial services:

- Bank account fees

- MERs on investments

- Mortgage and other lending rates

- Appraisal and lawyers’ fees

- Account merging to reach minimum amounts required for more sophisticated solutions

#3 To Help You Save Time (time IS money, isn’t?)

When someone shows me a trick to save time and become more efficient, that person gets a lot of my attention! So if your financial advisor can help you save time by navigating through the sea of red tape in the financial world, this can mean a lot.

There are always “better” ways to do things. Your financial advisor should be aware of the most productive and effective way to do your financial business. By saving a few minutes or hours here and there, you will be able to do a lot more interesting things with your time.

So, if your financial advisor calls you to offer a new product or give you information, ask yourself: can make money, save money or save time with this phone call. If your advisor gives you good tips on a quarterly basis, you will continuously improve your financial situation ;-D

If he doesn’t do that, there is nothing stopping you from calling him and asking for more help

image source:

sparktography’s