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Archive for 2012

How Reverse Mortgages Work

 

What is a Reverse Mortgage?

–        A Reverse Mortgage allows a homeowner to access equity in their home while living in it.

–        Their home equity is used as collateral for a loan where, in some cases, the loan principle and interest becomes due on the homeowner’s death, or sooner if the individual sells their home.

–        The minimum age is 62 and the loan value ranges between 10% – 40% of the appraised value of their home.


There are 3 Common Types of Reverse Mortgages:

–        Reverse Annuity Mortgage:

  • Comprised of 2 parts:
    • A mortgage; and
    • An annuity.
  • The homeowner borrows a lump sum of money using their home equity as collateral. The loan proceeds are used to purchase an annuity which pays the homeowner a monthly income for the rest of their life.
  • The repayment of the loan is due at the time of the homeowner’s death, or sooner if they sell the home.

–        Line of Credit Reverse Mortgage:

  • The homeowner borrows a lump sum of money using their home equity as collateral. The loan proceeds are used to create a line of credit which the homeowner can borrow from when needed.
  • Debt repayment commences when the money is withdrawn from the line of credit.
  • This type of plan is valuable for people who require money at specific times and not on a regular basis.

–        Fixed Term Mortgage:

  • The homeowner borrows a lump sum of money using their home equity as collateral. The loan proceeds provides’ the homeowner with cash flow for a specific period of time, usually 5 to 10 years.
  • The repayment of the loan occurs at the end of the fixed term.
  • This is values for people who require cash flow on a regular basis for a short period of time.


Taxation?

–        Simple reverse mortgages and lines of credit are not tax-deductible since they are similar to a loan advance from a traditional mortgage.

–        When reverse mortgages are used for investment purposes the accruing mortgage interest is tax-deductible against any investment returns generated with the mortgage proceeds, providing individuals with tax-sheltered income.

–        While annuity income is taxable, annuity income generated from a reverse mortgage is not taxable.

 

 

*** Please note, a Reverse Mortgage may not be the ideal plan for everyone. There are certainly pros and cons, but for some people, it can be a feasible way to augment retirement income.

Build an Effective Portfolio: Understanding Measures of Risk

 

Investors constantly look for new ways to measure and manage the many risks affecting a portfolio. However, in order to manage risk, an investor must be able to identify it and have some methodology for measuring its reduction.

 

The standard risk reduction strategy is portfolio diversification. Diversification attempts to reduce potential loss by using a selection of assets. By reducing the prospect of suffering losses from one asset, the portfolio has reduced risk. Some studies have shown that a portfolio of stocks begins to experience the benefits of diversification with just a few stocks in the portfolio, provided that the assets in the portfolio provide adequate diversification. However, in order to actually reduce portfolio risk, it is necessary to combine assets that complement each other.

 

Correlation
measures the covariance between two assets and is expressed as a number between -1 and 1. Zero expresses no correlation, with 1.00 expressing perfect correlation (the assets will always move in the same direction) and -1.00 expressing perfectly non-correlated assets. Ideally, a portfolio should contain assets that have low, zero, or negative correlation. By reducing the correlation between assets in the portfolio, the investor can achieve reduced risk and improved returns.

 

Standard deviation
measures the dispersion of data surrounding an assets mean price, systematic risk. Standard deviation provides a likely range of prices or returns above and below the average price or return. The greater the standard deviation of an asset, the more volatility it will see.

 

Beta
measures the change in a stock’s price given a change in the price of the broad market. A stock with beta of approximately 1.0 moves in the same direction and magnitude as the general market. Stocks that move less than the general market (defensive stocks) have a beta of less than 1, while stocks that move more than the general market (aggressive stocks) have a beta of greater than 1. Of course, using beta to measure risk makes the assumption that history will repeat itself, which it may not.

 

Alpha
measures a stock’s performance compared to its benchmark on a risk adjusted basis. A stock with an alpha of 1 indicates the stock outperformed its benchmark by (1%); an Alpha of -1 indicates that the stock underperformed its benchmark by (-1%).

 

R-Squared
measures how much of a stock’s performance can be explained by the performance of a particular benchmark index. The data ranges from 0-100; a value of 100 indicates that the stock’s performance is directly correlated with the benchmark index. Typically a stock that has an R-Squared between 75 -1 00, behaves like an ETF to the index being measured. As an investor, who has a stock with an R-Squared of 75 – 100, it might be economical to move to an ETF since they have lower management fees compared to an actively managed fund.

 

Sharpe Ratio
measures how much of the stock’s performance is due to good management rather then systematic risk. It is calculated by subtracting the rate of return for a risk-free investment (i.e. Canada Savings Bond) by the stock’s rate of return, and then dividing by the standard deviation of the stock. The higher the Sharpe Ratio the more it’s performance is due to good management. The values used in the calculation will be in relation to the time frame which is being measured. ex. 1 yr, 3 yr, 5 yr etc.

 

** Please note that I have been referring to stocks.  Mutual funds, portfolios etc. can also use the above calculations to measure risk**

Is debt-freedom a part of your vision for retirement?

 

What comes to mind when you think about a “successful retirement”?… Travel? Golf? Time with family? If you’re like most Canadians, at least part of that vision involves being debt-free.  A recent survey by Manulife Bank[1] found that nearly nine in 10 homeowners list being debt-free as very important to their vision for a successful retirement.  This was second only to “good health” and about the same as “having sufficient retirement income”. 

Unfortunately, the same survey indicates that many are struggling to get out of debt.  For example, just over half of survey respondents had less debt than a year ago.  Even among homeowners in their 50’s, just 15% have successfully paid off all of their debt.  For many, this can be an increasing source of stress as retirement approaches.  The survey found that half of homeowners considered the idea of retiring with debt to be extremely stressful.

As most of you already know, getting out of debt can be a challenge.  The good news is, it’s not impossible and you’re not alone. In today’s lucrative financial world there are many products available that’s sole purpose is to provide a debt-free environment much quicker than traditional methods. It is ideal to include a discussion on this topic when creating/reviewing your retirement plan.  



[1] The Manulife Bank of Canada poll surveyed 2,003 Canadian homeowners between ages 30 to 59 with household income of more than $50,000. It was conducted online by Research House between March 5 and March 16, 2012.  Full survey results are available at manulifebank.ca/debtresearch.

Understanding Your Credit Report

A credit report is a history of how consistently you pay your financial obligations. It is created when you first borrow money or apply for credit and is built over time.

The companies that lend or collect money or issue credit cards (banks, finance companies, credit unions, retailers, etc.) send credit reporting agencies specific and factual information about their financial relationship with you. Details, such as when you opened up your account, timeliness of your payments and  if you have gone over your credit limit are shown in full.

Although this information is confidential, you have the right to see your credit report and no one else can have access to the information in the report unless you allow it.

Typically, when you apply for a loan, a credit card or even a mortgage you will need to allow this organization to check your credit history.

The credit report summarizes information about the different types of accounts you have. It will include the following account types:

  • Revolving accounts, like credit cards and lines of credit
  • Installment accounts, like loans
  • Other accounts, eg: cell phone
  • Collection accounts

There are many ways to order your credit report, such as by phone or fax. The easiest and safest method is by internet through a credit-reporting agency such as Equifax or TransUnion Canada.

When you receive your credit score it’s important to make sure that the information in the report is correct. If the score is lower than you want, read the report carefully to find out which factors are most likely having a negative influence on the score, and then work to improve them.

  • Make sure you have a credit history: you may not have a score because you do not have a record of owing money and paying it back. One way to build a credit history is by using a credit card.
  • Always pay your bills on time
  • Don’t go over 50% of the credit limit on your credit card
  • Apply for credit in moderation

Learn Before You Leap – Borrowing and Budgets

How Much Can You Borrow?

Before you start looking at homes, visit your lender for a pre-approved mortgage. The lender will look at your finances and determine the amount of mortgage they are willing to give you. The maximum amount you can qualify for depends on a number of factors but the most important are your household income, your down payment and the mortgage interest rate.

Remember Your Budget

Quite often you will qualify for more than you expected. This is where preparing your budget beforehand is so important. Remember, your goal is to not over-extend yourself financially. Let your budget be your guide in determining how much mortgage to take on. You now know how much you have to spend, but not all of it can go towards the purchase price of your new home. Some of it will have to be used to cover costs associated with buying a home.