If there is something I hate about my job it’s dealing with rate shoppers. But before I start with why I hate them, let’s define a typical rate shopper:

The Rate Shopper:

The Rate Shopper, also known as “the little rat”, lives comfortably in your neighbourhood. It usually has a lot of free time on hand and spends most of its day wondering around. It likes to look at every minute detail and keeps its documents preciously in a file. Since the rate shopper is averse to risk, it feeds itself only with certificates of deposit. It has little financial experience and the only thing it knows is the 5 year certificate of deposit. The rate shopper likes its stable environment and doesn’t want anything else and only looks for the “best” rate.

Each time it has a hunger (maturity date), it comes out of its hole to see where it can get the most generous 5 year CD rate. It can spend a whole week going from bank to bank in order to find the most satisfiying rate. While the little rat is currently starving in the very low interest rate environment, it can walk miles to find a CD with 15 basis points more. The reason we commonly call it “the little rat” is because the rate shopper has no fidelity what so ever. It will seem willing to do business with you, ready to eat your 5 year CD but at the last minute, it will turn around with your “best and final offer” and get the famous 15 basis points more with a competitor without returning your call.

Why Rate shopping is not necessarily a good idea:

As you know already, I am a financial planner. When I started this career, I decided to run my book with one thing in mind: I am not an order taker. My job (and responsibility) is to provide solid and smart strategies to my clients according to their needs in order for them to make as much money as they can by considering their personal situation, their risk aversion and their financial goals. I hate when people call me simply to “get a rate”. Most of the time, I ask them why they want the famous 5 year CD or a 5 year mortgage (‘cause the rate shopper also looks for a great mortgage deal as well). They often don’t have a clue why they absolutely want a 5 year term…

”Because it is the best rate available on the market?”

True. Yes and no. 5 year term products will always provide a benchmark rate to clients at a specific time. However, what if your 5 year CD is due this year? You are stuck dealing a new 5 year CD below 4%… Are you getting such a great deal? I don’t think so. So Rate shoppers will traipse from one bank to another and ask the very same questions without listening to what advisors have to say. In the end, they get the best rate at that specific time giving in to a cash poor financial institution, and they end up with a poor yield strategy… The only strategy they had was to take a week and speak to as many banks as possible to renew their CD.

They not only get a poor strategy but they also might end up with poor rates too. I noticed a drastic change in the financial industry recently. In these rough times, branches take a closer look at their profitability. They started to realize that cutting off an arm and leg to offer a great rate to a new client doesn’t bring any additional income. It is awfully expensive for the branch to acquire this new client in this fashion and the banks nave learned they will lose these clients for a better rate when the CD comes due. This is why I never give my “best rate” to those calling me for a rate. I will give it to someone that is willing to meet with me and hear about other strategies (like a CD ladder or looking for Federal and Provincial bonds for example). Smart investing strategies are beneficial both for the client aa well as the bank. While there will always be branches who will give the shirt off their back to gain a new client, those branches may become harder to find.

Finally, since they are not loyal to any bank, no advisor will actually give them the “time of day”. They will usually end-up at the bottom of the priority list and have already (or soon will…) become frustrated by banks since “they” only want “this” money without providing a good service. Well, rate shoppers hear this: a good relationship with a banker is built through trust and confidence on both sides. Don’t get me wrong; I think you should shop around once in a while to make sure your advisor is on the ball and offers not only a good service but competitive rates. He will usually not be able to offer the best rate on the market each time. But if his offer is in the ball park, you will benefit much more from a positive relationship with a sound financial advisor than swinging your money from one bank to another every 5 years.

image source: turtlemom4bacon

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As the economy is pretty slow and most governments want to stimulate the economy through stimulus package and by decreasing their one day interest rate, we are currently benefiting from the lowest interest rate of the last decade (… century?).

We recently observed a small raise on long term mortgage rate (4 years and 5 years). Only a few months ago, it was possible to get 3.55% for 5 years in Canada. Now, we are back to about 4% if you can find a great deal.

So several people are asking: is variable interest rate going back up as well?

The short answer (and the long) is NO. So tell me why mortgage rates went up? Aren’t they following variable rates? Then again, the answer is no.

Long term mortgage rates are following the bond yields as they are similar (important debt amortized over a long period of time with a security attached to it). Since we recently saw an increase of yield in long term bonds, long term mortgage rates followed.

However, the variable rate depends on a totally different thing; the FED in the US and the Bank of Canada. Those entities have control over the monetary mass and the one day “inter-banking” rate. This is the rate at which banks borrow from each other at the end of each day in order to cover (the shortage) or lend (the excess) of money they have in their accounts. Historically, banks variable rate follow (almost) exactly the fluctuation ordered by the FED of the Bank of Canada. Therefore, if the Bank of Canada would raise its interest rate by a quarter, the next morning, all Canadian banks would follow by increasing their variable rate.

So is the variable rate will increase?

Over a short term period, the answer is clearly no. Bank of Canada expressed its wish to maintain the interest rate until June 2010 in order to give a chance to the Canadian economy. On the US side, many experts claim that the raise in the interest rate will only appear in 2011!

But if you want to go further, you must know what the main effect of a rate increase is on our economy. Imagine that you are driving a car at 100mph on the highway (and that cops (regulation) are having a drinking on you so they can’t stop you ). If you brake a little it, your car will slowdown. If you jump on the brakes like a maniac, you might crash your car in the landscape. Then, imagine the economy as your car. When you are driving too fast (and regulators our not “available”), one of the only way to slowdown the economy is to increase the interest rate by a few points (just hitting the brake gently). This is exactly what the Fed refused to do a few years ago thinking it would make our economy crash in the landscape.

But what if you car is driving 20 mph? If you brake, you will completely stop. And this is exactly what would happen in our economy right now. To be more accurate with my analogy, I would have to say that you are driving at 20 mpg, climbing a hill and if you ever brake, you will start going the other way!

So this is why I don’t expect to see the variable rates going up over the next 12 months…

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I read an interesting post about sex and money (hum… only the combination of those two words makes it interesting!) over at Million Dollar Journey. He was explaining what he learned about these two taboo topics from his parents. While he didn’t learn much about sex, his dad told him a lot about personal finance. That got me thinking about what I have learned from my parents about (sex?) personal finance. And if there is one thing I am glad is that they went bankrupt 13 years ago.

Funny enough, real experience is the greatest teacher of all. I was 14 when it all happened. Back in the early 90’s, my parents were not rich, but they were making a really good income. In fact, they were making in the six figures back then. We basically had everything we wanted; at the moment we wanted it. Being a teenager let me tell you it was a lot of fun!

The problem is that my parents (mostly my dad) were too busy to spend their money that they never figured that this wealth could go away at any time. So they were making 8K a month, but they were spending the very same amount as well. I remember that they were submerged by credit cards bills.

Unfortunately (or fortunately!), my dad lost his lucrative contract. As bills were coming in faster when rats run when there is a fire, it took only 3 months before my dad “pulled the plug” and declare bankruptcy.

We lost absolutely everything. House, cars, activities and my summer job (as I was working for my parents). We rented a small (and shitty) house (that looked like a cabin!). My mother was looking for spare change in house to buy the next pint of milk. There was virtually no money for anything. For people who were used to spend every dollar as they were burning their wallet when they stick around, this was cruel.

I remember getting blasted by my dad after I came back from the shopping mall with 3 posters and a pair of sunglasses. I actually took my “last” $100 to decorate my 6’X8’ room and I bough a pair of used Oakley with the rest of my money. He was so angry at me but not because I spent my money. Simply because he knew he couldn’t give me more so I can buy other stuff later on.

Even though we lived in poverty for about 3 years, this story has a very happy ending. My parents started a new company but didn’t go berserk on spending this time. They are now living a good life, working 3 days a week and they are almost debt free.

“Going bankrupt” at the age of 14 was a very important event in my life. I have learned a lot of things from this bankruptcy:

#1 Never spend more than you earn, this will slap you back in the face once day.

#2 If you don’t have a plan b with your personal finance, it will rapidly become your plan Bankruptcy!

#3 If you have more than one sources of income, you will fall down on your knees the day that you lose one, but you will be able to get up faster.

#4 Going bankrupt is not the end of the world. You are only losing things that you can buy again later on. Today, I don’t mind if I go bankrupt. But if it ever happens, I want to go bankrupt because I tried to create a successful business… not because I spent my money stupidly!

#5 What you loss after a whole life of work can be regain within a few years. Working smarter instead of harder will bring you a lot more money than you ever thought.

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You have already seen 24 and 36 payments without any interest when buying furniture. Even better, you can pay next year and you don’t have to pay any interest. We now have the similar type of marketing with cars with 0% over 5 years (I bought my Mazda Tribute with a 0.4% interest rate over 6 years!). And now, I just saw a shocking mortgage offer: fixed term 5 years fro 2.99% on new condos.

To put everybody in perspective, in Canada, the best deal around for a 5 years fixed rate mortgage is 3.85% as of late April. You would probably not even be able to get it from your bank but from a mortgage broker. So if the best deal possible on a fixed mortgage is 3.85%, how come they can offer 2.99%???? And the answer is….

A powerful marketing system!

The mortgage business is changing drastically in Canada due to the very low rate, poor economy and the rise of cost of funds for banks. For the very first time, it seems that some banks saw what is coming and realized that a blue suit and a red tie was not enough to sell mortgages anymore. The business has changed; it’s not an oligopoly anymore as more and more new players are working in the same industry. What happens when an oligopoly breaks? Each company needs a solid marketing plan to take advantage of this new open market.

But this doesn’t tell how they can offer 2.99% on new properties?

They are simply playing with the numbers:

Choice #1: The bank is willing to drop to 3.85% for those mortgages in order to still make money. It makes a deal with the contractor that he pays back the difference on a 5 year term mortgage at 2.99% and 3.85%. The contractor takes it from his profit and sells his condos much faster.

Choice #2: We have the same situation with the bank. The difference is that the contractor slightly increases his price in order to cover most of the gap between 2.99% and 3.85%. So the client end-up financing a higher mortgage rate without knowing… This is exactly as he does when he buys furniture at 0% for 24 or 36 months. The interest rate lies within the product! When the contractor asks 212K instead of 207K, nobody really notices as it is always harder to compare prices for a new construction. He can always bring some “builder bullshit” such as “the condo was made with higher quality materials” .

This is also why you will see this kind of offering on new construction and not in your branch for a regular purchase.

I think it is a smart way to present things. However, potential buyers must keep in mind that their mortgage rate will go much higher upon renewal. Therefore, they are better off calculating their budget with a 4.5% or 5% interest rate on their mortgage in order to not get caught off guard at renewal.

As I previously said: there are no free lunch in finance!

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The Financed Cash Down Technique

Then again, this cash down creation technique is quite simple: you take a line of credit of 10K,15K,20K (as you wish and as you qualify for ) and invest your money in a money market fund. I would not play with this cash since the purpose is known and is over a really short investment period.

Wait 3 months and then go see your banker for a mortgage. He will ask you for proof of cash down and this is where you will provide him with 3 months of money market statements. He should not ask any questions and process the mortgage application.

Please note that in order to use the financed cash down technique, you still have to qualify for a line of credit and then, qualify for a mortgage with the line of credit payment in your Total Debt Servicing Ratio (TDSR).

This technique is applicable to young couples with high income (young professional) who didn’t have time to accumulate cash down but have plenty of cash flow to reimburse their debts (line of credit and the new mortgage).

The advantages of the financed cash down technique

- You get your property faster

- You avoid CMHC insurance premium (can go as high as 3% if you finance 95% of your property).

- Provides more flexibility in regards to payment (you always have the option of paying down your line of credit faster without penalties… after all, it’s part of your mortgage!)

The disadvantages of the financed cash down technique

- Indebtedness level increase significantly

- Used of almost 100% of potential credit available

- Will affect your credit score (maxed out revolving credit)

- No emergency fund option over the first year (you should build one of pay a part of your line of credit as fast as possible)

As you can see, while you are saving money on premium and potential increase in housing prices, you will have several risks related to this technique. You better make sure to have a solid and well balanced budget with free cash flow before considering this method. However, this could be of a great help of you already accumulated 10% of cash down and you want to get up to 20% and avoid the CMHC insurance premium!

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