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I’ve always believed that anyone substantially mired in debt has no business fantasizing about retirement. For me, this extends even to a home mortgage, which is why I often say “the foundation of financial independence is a paid-for home.”

Sadly, however, it’s a fact that many Canadian seniors ARE attempting to retire, despite onerous credit-card debt and sometimes even those notorious wealth killers called payday loans. Compared to paying out annual interest approaching 20% (in the case of ordinary credit cards) and much more than that for payday loans, would it not make sense to liquidate some of your RRSP to discharge those high-interest obligations, or at least cut them down to a manageable size?

This question comes up periodically here at MoneySense.ca. For example, financial planner Janet Gray tackled it in March in a Q&A. A recently retired reader wanted to pay off a $96,000 debt in four years by tapping into her $423,000 in RRSPs. Gray replied that this was ambitious and raised multiple questions. For one, withholding taxes of 30% on the $26,400 annual withdrawals meant she’d have to pull out at least $37,700 each year from her RRSP, which in turn could easily push her into a higher tax bracket.

For these and other reasons, veteran bankruptcy trustee Doug Hoyes says flat out that cashing in your RRSP to pay off debt is an all-too-common myth. In fact, it’s Myth #9 of 22 outlined in his new book, Straight Talk on Your Money. Myth #10, by the way, is that payday loans are a short-term fix for a temporary problem. Hoyes says that apart from loan sharks, payday loans are the most expensive form of borrowing. In fact, while payday loan lenders can charge $18 for every $100 borrowed, that is NOT cheap money: annualized, Hoyes calculates it works out to a whopping 468%.

So forget about payday loans, which for seniors and anybody else is typically a desperate last resort. Compared to that, cashing out your RRSP seems a less pernicious option but it’s by no means a slam dunk decision. For one, and as Gray noted, there are tax consequences to withdrawing funds from an RRSP or a Locked-in Retirement Account (LIRA). If the withdrawal moves you into a higher tax bracket (as seemed to be the case in the Gray Q&A), “it’s possible you could lose half your funds to the tax man,” Hoyes says.

If you’re so in debt that you are considering bankruptcy or a consumer proposal, “It often makes no sense to cash in your retirement accounts,” Hoyes says. Besides, while RRSPs have fewer strings attached to them, “cashing out” of a LIRA is more problematic since, as the term suggests, the money is “locked in” for its true purpose: your eventual retirement. Pension regulators don’t want you tapping into them on a whim. For example, in Ontario if you wish to cash in a LIRA before retirement, you have to submit a hardship application to the Pension Commission of Ontario, and you’ll be permitted to withdraw a lump sum only if you can prove hardship. And sadly, Hoyes says that a lot of debt does not meet the definition of hardship.

It’s important to know what assets can and cannot be seized by creditors. Your house can be seized if you don’t pay your mortgage and your car can be seized if you don’t pay your car loan, Hoyes says. But in Canada, it’s almost impossible for a creditor (such as a credit-card company) to force you to liquidate a LIRA. Because a LIRA is locked in, it can’t be seized in a bankruptcy. And even for RRSPs, a trustee can only seize RRSP contributions made in the last 12 months preceding a bankruptcy.

A better source of funds, if you have them, are non-registered investment accounts. This also may have tax consequences (primarily capital gains) but they are likely to be less severe than plundering your RRSP.

One reason Hoyes prefers this route is that in a bankruptcy, unregistered assets are seizable by creditors. By contrast, it’s unlikely that you will lose your RRSP or LIRA in a bankruptcy. In a bankruptcy “you will lose the investments anyway, so it makes sense to cash them in, pay your debts, and avoid bankruptcy,” Hoyes writes in the book.

Even so, for those with more debts than they can ever hope to repay even if you do cash in your assets – and if you have registered assets that you wouldn’t lose in a bankruptcy – Hoyes doesn’t rule out the option of bankruptcy, which he says “may be preferable to cashing in retirement accounts.”

All of which suggests the seemingly easy answer of using your RRSP to jettison pre-retirement debt is fraught with potential pitfalls. As Gray suggested, it’s best to submit your plan to a financial planner or tax expert to determine whether this course of action makes sense in your specific situation.

Source: MoneySense - Jonathan Chevreau-founder of 'Financial Independence Hub' 

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For those having trouble qualifying for a traditional mortgage, other solutions are still available, one of which is a private mortgage.

And with increasingly stricter mortgage regulations and qualification requirements being introduced by the government, they’re growing in popularity.

Private lending accounted for approximately 4-5% of Canada’s overall mortgage market in 2015, according to data from Teranet. Anecdotally today’s number is higher and growing fast, and is set to grow even faster if the new B-20 guidelines are implemented as proposed.

“What makes interest only loans appealing is that you are not required to pay down the principal of your mortgage, therefore reducing your monthly payment,” said Maya Schenk, managing broker and owner of Pacific Lending in Vancouver. “Interest-only payments improve the monthly cash flow, but for obvious reasons they are not a viable long term solution.”

This is why private mortgages are meant to be short-term solutions—typically one to three years—to help borrowers achieve their goals while they improve their credit, or for emergency lending situations.

Private mortgages have their place in the market, and are commonly used in some of the following cases:

  • Borrowers with inadequate credit to qualify for a traditional bank mortgage
  • Self-employed borrowers with unverifiable or unsteady income
  • Non-residents
  • Emergency funding for those going through foreclosure, or those with property/income taxes in arrears
  • For mobile homes or micro-condos (less than 600 square feet) that often can’t be financed/refinanced through a bank
  • For second mortgages/investment properties

In terms of the key benefits of a private mortgage, Schenk cites the need for less documentation as part of the approval process, which he says can be useful for self-employed applicants who can have difficulty proving their income.

“Private lenders are also much more flexible when it comes to your credit history,” she said. “As long as you have sufficient down payment or equity in your property, private mortgages are relatively quick and simple to obtain.”

While traditional bank mortgages are qualified primarily on the borrower’s financial standing and his or her ability to service the debt, private lenders place more weight on the quality of the property itself, in addition to the down payment and the client’s ability to repay to loan.

Because properties in more marketable urban areas carry less risk for the lender in the event of foreclosure, they can offer slightly more favourable rates and go up to a higher loan-to-value compared to properties in rural areas or undesirable neighbourhoods.

The higher cost of private mortgages

Schenk notes that in addition to the interest-only payments, private mortgages typically come with higher interest rates to compensate the lender for the increased risk they are taking on.

Interest rates can range anywhere from 10-18%, making them much more costly compared to a traditional prime mortgage starting as low as 2.50% for a 5-year fixed term. For this reason private mortgages are usually considered a last resort.

Additional fees can be involved with private financing, including lender, legal and broker fees.

Whereas broker fees are almost always paid as a commission directly by the lender in the case of traditional mortgages, the borrower must cover this cost when turning to a private mortgage.

Adding in lender fees and legal costs, total fees can amount to anywhere from 1-4% of the loan amount, though this can be rolled into the mortgage.

“It is important to understand the risks before getting a private loan,” Schenk adds. “The first questions to ask yourself are, ‘Will my financial situation change in the near future so that I can switch to a conventional lender soon?’ and ‘Will I need this mortgage only for a short period of time?’ If your answer is ‘no’ to both of these questions, private mortgage might not be a suitable solution.”

For anyone considering a private loan, a mortgage broker can help weigh the benefits against the costs to determine if one is right for you.

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The prime lending rate at the country's five big banks will rise to 3.2 per cent, effective Thursday, following the Bank of Canada's rate hike  

Canada’s big banks will raise their prime lending rates to 3.2 per cent, effective Thursday, after the Bank of Canada boosted its trendsetting policy rate.

The Bank of Canada on Wednesday raised its target policy rate by 25 basis points to 1.0 per cent from 0.75 per cent.

“Recent economic data have been stronger than expected, supporting the bank’s view that growth in Canada is becoming more broadly-based and self-sustaining. Consumer spending remains robust, underpinned by continued solid employment and income growth,” the bank said.

After the central bank’s move, Royal Bank said that it will increase its prime lending rate to 3.2 per cent from 2.95 per cent, effective Thursday. Bank of Montreal, TD Canada Trust, Bank of Nova Scotia and Canadian Imperial Bank of Commerce will also raise their prime lending rates to 3.2 per cent.

Hawkish tone

More Bank of Canada hikes could be on the way. The bank’s statement accompanying the announcement strikes what several economists described as a “hawkish” tone, which means the bank is trying to tell the market that if the economy continues to outpace expectations and the data supports a move, it’s possible the bank could bring in another rate hike before the end of the year.

“The broad tone of the accompanying statement is generally balanced but it leaves the door wide open to further interest rate hikes,” said Derek Holt, head of capital markets economics at Scotiabank. “One should not rule out another hike over the duration of 2017.”

Dave McKay, RBC’s chief executive, told a financial summit in Toronto on Wednesday that increased payments on mortgages and other debts could hit the economy as people have less disposable income to spend elsewhere.

“That’s one of the effects that we don’t talk enough about,” McKay said. “As rates rise, as they did this morning, a greater amount of disposable income is coming out of purchasing power, which will slow down economic growth in other sectors. And that’s not a healthy thing in the long term.”

Wednesday’s rate hike wasn’t a huge surprise. Before the announcement, futures markets had pegged the odds of a 25-basis-point increase at about 50-50. Had the bank decided to hold rates steady, markets were of the unanimous view the bank would bring in a rate increase at its next meeting on Oct. 25.

The country’s big banks usually adjust their own prime lending rates in line with changes to the Bank of Canada’s target rate. Ahead of the Bank of Canada’s announcement, the prime rate at all five of the big banks was 2.95 per cent.

“We’ve been waiting for this for a long time,” said Rob McLister, founder of ratespy.com. “Rates have been rock bottom for an abnormally long time.”

Timing

So why did the Bank of Canada move rates now and not in October? Canada’s gross domestic product grew at an annualized pace of 3.7 per cent in the first quarter and 4.5 per cent in the second.

The Bank of Canada expected the country’s economy to slow a bit in the current third quarter, but things have been more robust than the bank had forecast in its July Monetary Policy Report.

The Bank of Canada said it is not following a specific plan to usher in future interest rate hikes. Rather, it said future decisions will be guided by economic data and financial markets, and the impact those might have on inflation.

In an interesting move, the bank added that it will pay “close attention” to the impact future rate hikes might have on household debt. The most recent Equifax national consumer credit trends report found that Canadian consumer debt climbed to $1.769 trillion during the second quarter, up from $1.666 trillion a year ago.

Regina Malina, senior director of data and analytics at Equifax Canada, said that for now, Canadian consumers seem to be paying back debt on time. That trend should continue so long as interest rates increase in a gradual fashion and employment markets remain strong, she said.

“It all comes down to how quickly it’s going to happen. If it’s going to happen slowly enough, Canadians should, in theory, be able to adjust to the changing environment,” Malina said. “Delinquency rates are still relatively low.”

Target rate

The Bank of Canada’s interest rate hike puts the target rate back where it was before the oil price shock in 2015. Two years ago, the bank cut the rate to 0.5 per cent to help Canada deal with the drop in oil prices. The bank’s rate hikes in July and on Wednesday reveal that the bank no longer believes the economy needs an emergency boost.

“The statement was replete with upbeat messages on the economy and the view that low inflation may not last,” said Douglas Porter, chief economist with BMO Financial Group.

Porter thinks its possible the bank might raise its target rate as high as 2.0 per cent by the end of next year. Prior to Wednesday’s announcement, BMO had expected the central bank’s policy rate would top out at 1.5 per cent in 2018.

“The somewhat aggressive hike and the upbeat view on growth point to more tightening than we previously expected over the next year,” Porter said.

Source: Financial Post with Canadian Press

 
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