However, it technically comes down to the same thing once it is time to withdraw money from the company… until you know about the split dollar strategy.

The thing is when you withdraw money from a corporation or a holding; it is taxable as income (additional to your current revenue) at your marginal tax rate. Therefore, unless you are retired and live off your company’s dividend, you will pay your share of taxes.

But, there is good news for those who want to benefit from the fruit of their labour while they are still working and earning money. The good news is called the split dollar strategy.This method requires cash flow within the company (you need water to drink, don’t you?) and that the company’s owner is healthy (huh?!?).

So here how the split dollar strategy works:

#1 you take a critical illness insurance contract on the company owners with premiums paid by the company.

#2 you take an option in the critical illness to get full reimbursement of the premiums if the individual doest not have a critical illness after 15 years.

#3 you name the individual (not the company) as the beneficiary or the premiums reimbursement.

#4 in 15 years, you will receive a nice cheque from the insurance company in your name that is not taxable.

Isn’t this too cool to be true? Not really. However, there are some things to know about the split dollar strategy:

#1 the insurance premiums require stead cash flow to be taken out of the company

#2 if you stop the strategy half way, the benefit won’t be that great (full reimbursement option seems to be only available after 15 years).

#3 if you ask for a premium reimbursement prior to the end of the contract, penalties occur.

#4 you will personally get taxed on the “benefit” received from your company in regards to the premium reimbursement option. However, the taxation is minor compared to a regular tax rate.

#5 this insurance is not to be considered as insurance by itself but as a tax saving tool. If you require critical illness insurance, you should do it separately as this contract is meant to be terminated in 15 years.

I’ll run some calculation and come back with a complete example of the split dollar strategy later on.

Disclaimer: I am not telling you to do the split dollar strategy and I am not selling insurance. Please contact a professional in order to determine if this strategy is applicable in your situation.

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Cash Down for a house purchase

That will definitely be the first thing to look at if you plan to buy a house. The ear of 0% cash down mortgages is over and you better put money aside before meeting with your banker. A house cost always more than an apartment (for the same size) and saving money will be a good indicator if you can afford a house or not. In Canada, you can withdraw from your RRSP up to 20K per person in the case of a first buy. There are several techniques to increase your cash down and this topic will be discuss in a further post.

TDSR (Total Debt Servicing Ratio)

Your TDSR will definitely be another key point for mortgage qualification. In fact, your debt servicing ratio should not be over 35%, including your new mortgage payment. Some institutions will play with the numbers until 40% depending on the global picture. So you are better off consolidating your credit card into a personal loan and decrease our other debt before going to a banker. In order to calculate your TDSR, I suggest you click on the TDSR title to get a full post on this topic.

Credit Bureau

Do you make your payment on time? All the time? This is what the bank wants to know when you apply for a mortgage. Even though they are backed by a security, they certainly don’t want to repossess your house these days . I actually created another blog exclusively on credit called The Credit Tool Box. You can go there for a better understanding of your credit bureau. I also write about building, improving or repairing your credit score.

Job History

If you are planning to do a career switch, I would suggest you do it after getting your mortgage. Employment stability is something banks love because it shows stable capability of making mortgage payments. The longest you have been in a job, the less (mathematically) chance you have to lose your job.

The next post on this series will be about different ways to have a sufficient cash down.

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Equity options are as you can guess an “option” to buy or sell a given amount of stock at a given time for a given price. You will see call and put options. Simply, call options are the option to buy while put options are options to sell. In every such transaction, there is of course a buyer and a seller of an option.

The best way to understand how these products work is to compare them to lottery tickets. If you buy a lottery ticket, you cannot lose much, you can only lose the value you paid for your ticket. However, if you sell one, then you might be in for a big loss. The same applies to options. Buyers have a limited loss while in general sellers have a much greater potential loss.

The price that will determine if the option is exercised (lottery ticket is won) is the strike price. The price of the stock is greater then the strike price, then the call option (buy) would be exercised while the opposite is true for put options. And finally, the options have a maturity, a month at which time the option becomes worthless. The specific day is the 3^rd Friday of that month.

Here are a few strategies that could be used with options:

-Long call: A risky but simple gamble. Basically, you will be able to take a much greater position in a stock you believe will rise because you are not paying for the stock, only for the option. However, if the stock does not rise, you will lose your money.

-Long put: same for a stock you believe will go down

-Covered call: This strategy had been discussed in a previous article (a play on volatility – it has returned 3.5% so far) – you use this when you already have a stock, and want to gain additional return. The risk you have is that you might sell your stock for less than it is worth but the upside is more money in your pocket every time you use it

-Protective put: Let’s say you felt a few months ago that some of your stocks might have a steep decline (yeah, you are smart in that way), you could have bought a put option, which in effect is a like buying an insurance for your portfolio in case of a downturn…

A lot more could be discussed but this was a good start wasn’t it? In the meantime, you can always check out Market Club Video section about options (see add below)

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Life is beautiful. You just turn 55 and you are finally able to say “bye bye boss!”. You have accumulated enough money to trade your office for a golf cart and your pen for a Callaway X Driver (that’s my dream anyway!). You thought you would have to work until the age of 60 but that cool guy from that mutual fund company you met at a “informative retirement meeting” told you about a revolutionary product.

This amazing product is a well balanced mutual fund giving you 5%, 6%, or 7% guaranteed in your pocket year after year! Is it because they were able to clone Buffet brains? (Actually Validea Capital is trying to do so). Do they found the last GIC on earth giving a 7% yield? Or are they simply not telling you the whole story? GOT IT!

I recently met a client with this “wonderful product” in his portfolio. He told me how the “financial analyst” who presented the product answered all his questions and that everything seems pretty good. In a world where the stock market is diving faster than Michael Phelps during the Olympics, who would ignore such investment proposition?

So the guy invested 50K in early 2006. He never made a single withdrawal (the 7% return was deposited in his cash account which he used to buy more shares of the same fund). So technically, his investment should worth 59K (50K*7%/12month*32 months). However his investment portfolio was showing 55K! Where the other 4K disappeared? What happen? Where is that 7% return Guaranteed?

The 7% return is actually a fixed amount of $3,500 (7% of 50k) that the client did receive in his cash account. When the fund is not making 7%, where to do you think they found the money to send the client 3,5K? A Donation? Return on Capital (ROC) !

Imagine, you are receiving 7% return and you are not even fully taxed on it! For someone who doesn’t understand ROC, this sounds like a perfect world. Unfortunately, there is no free lunch in finance. The poor guy was getting his capital back to buy more shares of a fund not making the promised return.

The idea itself is not bad, but you must be aware that you might touch your capital and that the nice graph showing 8% returns might not happen. I know, life sucks and financial advisors are part of life Fortunately, you have The Financial Blogger to help you out seeing those things before they happen to you!

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Well, partially. Many funds have been having very volatile returns of their owns. For a while, commodities were usually going in only one direction, up… But as they start to have less of a clear direction, funds invested in them have had very volatile returns of their own.

One example that has been making headlines (partially because one of its big owners is Lehman Brothers (LEH) who already had enough issues of their own is the biggest hedge fund ran by Ospraie Management LLC. The fund has been closed after a dismal 39% loss this year!!

The Ospraie Fund lost 26.7 percent in August, after a “substantial sell-off in a number of our energy, mining and resource equity holdings,” Anderson, 41, wrote in the letter today.

“I am extremely disappointed with this result and the fund’s sudden reversal in performance,” he said. “After nine years of striving to be a good steward of your capital, I am very sorry for this outcome.”

Another good example was Amaranth, a fund ran by Canadian Brian Hunter that got into huge positions thanks to a 8 to 1 leverage on 9 billion dollars. And guess what…? They ended up losing 6.5$B out of the 9$B and closing their fund.

And guess what, Brian Hunter did not even have to wait long to get a new job as he joined Solengo Capital Advisors although the fund managers said they would keep him on a tight leach… yeah right. Read an interesting article about it here.

Of course, some other funds have been on the other side of these trades and been putting on great returns. But usually those funds try to stay out of the spotlight as such big fund are usually not looking for new investors..!

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Ok, I am now taunting your creativity; imagine an investment where you can withdraw money up to the amount of your initial investment without paying taxes. And I will continue to push the limit: imagine that this investment will only trigger capital gains instead of interest and dividend income!

Now you can open your eyes again and read the rest of this post. Unless you want to take down your financial advisor’s phone number to call him right after this read because such investment exists. It is called Corporate Class Funds.

How does this work?

Corporate class funds can be viewed as a big bag with several mutual funds. You have the possibility to select the funds you want according to your investment profile. You are also able to switch funds in the same family (same bag) without triggering capital gains.

When you withdraw money from the bag, you are first deemed to take back your capital. This option is called ROC (Return of Capital). This allows an individual to withdraw all his capital first and therefore report taxes in the future. One of the basics of tax planning is deferring taxes as far as you can.

Once you have taken all your capital, you are left with the investment growth. Regardless if it was created through capital gains, dividend or interest income, it will become capital gains when you take them out of the bag.

Where is the catch?

Honestly, I didn’t find it yet. In fact, Corporate Class Funds have higher MER’s than regular funds. They are usually about 0.30% more expensive than a regular mutual fund for the same category. They are also not sold by banks either (unless you are dealing with a broker). In fact, I really don’t know why they are not really promoted in our industry. I guess the market is just not ready to answer their clients as of to why they didn’t sell such product in the first place!

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As it is the case with the Klondyke, linked notes may seem delicious during the first lick but it hides trans fat and a thousand of calories. This is the price to pay to have performing guaranteed investments .

How does it work for the client?

The client purchases the note and the amount is frozen for a 5 to 8 years term. The note is linked to a predetermined asset (i.e. TSX index or a basket of international stocks). At the end of the term, the client is 100% assured to get his capital back, plus the investment return of the asset, minus management fees. At mid term, the bank usually has a clause allowing the financial institution to buy back the notes (if the underlying asset outperforms their prediction). If they do so, they have to pay a predetermined return to the client (let say 9-10% per year).

How does it work for the bank?

In order to cover their risk, they take about 60% to 70% of the money and invest it in fixed income at a 5% to 6% rate. In 8 years, this amount will give enough to pay back the client’s capital. The other part (the 30% to 40% of the amount) is invested in the market (without management fees since they manage the money for themselves). So if the underlying asset does 11%, they make the 11% and take off about 3% in management from the client. This is the price to pay for having capital guaranteed investment doubled with unlimited potential of return. If the asset did more than 9% at mid term, they simply buy back the note from the client and take the difference from themselves. If investments (both on the fixed income side and the market side) are done carefully, this could be a very profitable business for both the client and the bank.

So is it an evil product or not?

Depending on the type of investor you are, linked notes maybe represent your only chance to beat the 3.5% GIC rates without taking risks or it could result in a total waste of potential return. In theory, if you invest 70% of your investment into fixed income and invest the difference in the asset yourself, chances are that you will make as much or more than the linked note. However, if you can’t stand fluctuation, you will probably choke after 6 months of bear market, sell everything and then, cry that you didn’t make money with the stock market. If it’s your case, then, the linked note is a really good investment for your portfolio. If you are able to take market fluctuations without losing your sleep, then, linked notes are totally useless.

Nothing is black or white in the world of investment…

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Well banks and other financial institutions improve what used to be a simple line of credit backed by a property into the most flexible mortgage product you can ever see! In this post, I go over several improvements on this innovative way to finance a house.

Create of more than one account

This happened a few years ago, you now have the possibility to split your line of credit into smaller but separate flex lines. While the total of them must always equal less than the authorized amount, you can select variable or fix limits for each of them.

Add a third party user

Even better, you can even add a third party for one of your line of credit. So let say that you want to give you child a 5K flex line in order to manage his tuition fees, you can set a fixed 5k line of credit within your HELOC and add him as a user of this portion only. Therefore, you are able to monitor his college expenses and he doesn’t have access to your whole 300K line of credit!

Include a mortgage within your home equity line of credit

You are too nervous about short term interest rates and you would like to freeze a part of your mortgage at a determined rate for a determined period; you can include it within your line of credit. For example, if you have a global credit limit of 300K and you wish to have a 200K at 5.5% for 5 years, you will sign paperwork for your fixed portion and your HELOC will decrease to 100K. With this option, you will benefit from a good rate on the variable side and you sleep well at night!

Your fixed mortgage can now communicate with your HELOC!

The most recent feature offered with lines of credit backed by a property is that you can increase the limit of your HELOC while you are paying down your fixed or variable rate mortgage. So every penny applied to the capital in a regular mortgage payment can increase your global credit limit. You can then have the possibility to use the equity underlying within your house at anytime without even the permission from the bank! This is obviously perfect for leverage strategies such as the Smith Manoeuvre or simply to manage your personal finance.

With these improvements, the new and re-designed HELOC constitute on of the best mortgage product offered by any financial institutions. I strongly suggest you meet with a financial planner in order to get all the necessary information about a home equity line of credit.

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Definition

An HELOC is a flex line secured by a property. Financial institutions will grant a line of credit that can go up to 75% of the market value of your residence. In some cases, this amount can go even higher than 75%! The HELOC works the same way as a regular line of credit in term of rate and minimum payment. However, the amount granted is much higher.

Once you are approved, an appraiser will visit your property. He will make two kinds of calculations. One is based on the cost of rebuilding and the other is based on recent sales in the area. He will average both of them and provide the bank with a final value. Once this step is completed, the file is sent for registration and you will then sign the final paperwork.

Needs

The most common need for an HELOC is definitely to finance the purchase of a property. However, this mortgage offers more flexibility than any other types of loans. You can use it for renovation, buying a car, traveling and event to invest on the stock market. Since the granted amount is revolving, you have the option to withdraw up to the limit any time you want. Therefore, you can finance a variety of projects without going back to your banker everything.

Another interesting characteristic of this product is that it can be divided into more than one account. Each account has their number and credit limit. Therefore, you can easily separate your HELOC according to your needs and apply different payment on each payment.

Qualification

In order to qualify for an HELOC, several criterions will be looked at. The first one will be the TDSR. As it gives more flexibility than a regular mortgage, the HELOC requires a debt ratio lower than 40%. The credit rating represents an important factor also. Because an individual might end up with a three hundred thousand flex line, bankers are looking to people that are very diligent with their credit. Liquid assets as stocks and mutual fund can compensate for a higher debt ratio. Finally, the net worth will also play a role as it will show the client’s ability to manager his assets and to have them grow overtime.

Negotiation

Unless you are not approved for the full 75% of your property value, there is nothing much to negotiate. Interest rate will be at prime most of the time. In regards to the appraisal value, banks use accredited appraiser in which they have faith. They might increase the value by another 3% as a bigger increase would represent an unethical act for them.

In conclusion, the HELOC could be use for different projects and can also be included in financial strategies. Even if the flex line is secured, a good credit rating and TDSR will be necessary to qualify for. In the end, the HELOC could be an amazing product but will require self control and maturity in its usage.

Definition

The mortgage is an amount of money granted to an individual purchasing a property. This property can be a house, a condo or even a rental property. In order to secure its loan, the financial institution will take a 1sr rank lien on the property. In other words, the lender is legally binding the property to the mortgage. In the event of default, the creditor will obtain legal possession and right of use of your property. You would therefore loose your asset and the bank will pay itself with the sale of the property.

Since mortgages are contracted for significant amount, they have also bigger amortization. Mortgages have a term and an amortization. The term determined the date of renewal. It usually goes from six months to ten years. As previously mentioned in another article, the amortization represents then length of the loan. As we are dealing with more substantial amount than with the personal loan, the amortization is longer. It was recently increased up to forty years depending of the institution and the type of product.

Needs

The most common need for a mortgage is obviously to buy a property. However there are other needs that can be fulfilled by this product. As an example, an individual could apply for a mortgage to purchase another asset. If he has enough equity in his main residence, he can give it as collateral to purchase a second residence, a rental property or even a car. He would definitely get better lending conditions (amortization, rate, flexibility, etc). Another usage is to consolidate debts. Since de loan will be secured, the individual will get a better rate than with a regular consolidation loan.

Qualification

As mortgages are secured loans, it is easier to qualify for. Most banks will look at your TDSR (Total Debts Servicing Ratio). This ratio should be lower than forty percent. However, if your ratio is higher, financial institutions might approve a lower percentage of financing. Liquid assets like mutual funds, GIC’s or stocks will also be considered to compensate for a high debt ratio. Credit rating and net worth will also be part of the picture. Showing a growing net worth on your balance sheet will demonstrate that you can accumulate assets. Therefore, you are financially mature enough to respect a mortgage contract and all other property expenses. Adding your spouse on the loan will also help out. Banks are more comfortable with more than one individual on the mortgage documents.

Negotiation

The mortgage industry is highly competitive. Therefore, it gives you the opportunity to negotiate several points on you loan. I would suggest you meet with two to three different institutions in addition to meeting a mortgage broker. They will offer different products, rates, terms and one might suits your interest more than the others. The mortgage broker will take your file and shop around for the best rate in town. That requires less effort and you might end up with a better rate than with your negotiation skills. As mentioned in my previous articles, consolidating all financial products with the same institution will give you better lending conditions. A good credit rating could also help to reduce the interest rate. In the end, it is really important that you understand different products offer by banks in order to select the kind of mortgage that suits you best.

The mortgage is probably the biggest loan you will ever sign for. Therefore, it is really important you understand every characteristics of each mortgages. You can negotiate the rate, the term and the amortization in order to get the best deal possible. In the end, you mortgage will bring you to your dream: ownership.