Good timing, for once

I've bragged in the past about my market timing acumen, which tends to favour the party sitting opposite me in any transaction. I tend to dwell on my past decisions, but only to the point of nodding sadly in lament of my knack for choosing the wrong time to pull the trigger. These decisions don't consume me, but I can easily count them off for you on a moment's notice.

Not this time, however.

The Loonie household mortgage was up for renewal last month, so Ms. Loonie and I checked out the rates available to us. We were able to renew with our current lender for a 3-year fixed rate of 2.65%, more than 2% lower than our previous rate. The day after we signed the papers, rates jumped by 50 basis points, so we literally slid in just under the wire, and guaranteed ourselves three years of low-rate home ownership. I'm sure a strong negotiator with excellent credit could still have secured a lower rate, but given the ease of the transaction, I'm pretty confident in saying that we locked in "at the bottom".

But that's not all. Since I was at the branch anyway, I decided I would talk to the bank about managing our own property tax payments. Since our mortgage is high-ratio (more than 80% loan-to-value), the bank has been collecting property tax payments from us, and paying the city on our behalf. Now that we've mastered the art of partitioning our savings, we decided that we'd rather pay the city directly, and have more control over the balance in this account (and hey, why not earn some interest on it while we're at it?). This change turned out to be very straightforward as well. The tax portion of our bi-weekly mortgage payment has been eliminated, and I've set up a bi-weekly transfer of the appropriate amount to a dedicated savings account.

We're now making much faster progress on the mortgage, and we're in control of our property tax payments. Easy as pie, right?

Until I realize that, as a side-effect of the CUPE strike currently underway in the GTA, there's nobody manning the phones in the city revenue office to take our lender off the tax account.

Great timing.

The value proposition of a premium chequing account

Million Dollar Journey has a post today comparing the big five banks' high-end chequing accounts. These accounts charge a substantial monthly fee, and in return provide a number of "value-add" services, including the following:

• Unlimited transactions


• Free drafts/certified cheques


• Discount on safety deposit box rental


• Discount/waiver of credit card or discount brokerage annual fees

Some of these accounts offer a waiver of the monthly fee if a minimum balance is maintained in the account. For example, BMO's Premium account has no monthly fee if the account's balance never drops below $4,500 (otherwise the fee is $25 per month). The thinking behind these minimum balance fee waivers is that, while the customer avoids paying a fee, they also miss out on interest they would have earned on that balance in a savings account.

I was curious recently as to just how favourable the fee/interest trade-off turns out to be, so I decided to run some numbers. Using the BMO account as an example, I worked out what APR would correspond to $25 per month on a $4,500 balance. Assuming a 40% marginal tax rate (since interest income is taxed at the full marginal rate), I came up with the following:

• $25 = $4,500 X ((1 + APR / 365)^³⁰ - 1) X (1 - 0.4)


• APR = 365 X ((($25 / 0.6) / $4,500 + 1)^^{(1 / 30)} - 1)


• APR = 11.22%

This means that, in order to earn $25 per month after taxes on a balance of $4,500, you would need to find a guaranteed 11.22% APR. Since the market is currently swimming in 11.22% savings accounts, it's a no-brainer, right?

One of the best rates currently available for a Canadian savings account is Canadian Tire's 2.00%. At this rate, a $4,500 balance would earn a mere $4.44 per month after taxes. This means that, with today's interest rates, keeping the minimum balance in this account essentially means that you're "paying" a $4.44 monthly fee for the use of the account. If you take advantage of the features of the account, this can turn out to be extremely worthwhile (a safety deposit box rental can easily run $4 per month).

This doesn't mean that a high-end chequing account is automatically worth it, but it does mean that, at least for the foreseeable future, the cost of such an account is significantly reduced by maintaining the minimum balance.

HSBC has stupid account dormancy rules

Back when I first started testing the waters of online savings accounts, HSBC had one of the better rates out there. That, combined with their numerous access methods (including online bill payment and no-fee ATM access at BMO/HSBC machines) made them a strong choice for parking the lion's share of my Emergency Fund. For over a year now, I've basically kept just over $1,000 of my savings in my HSBC account, on the basis of a decent (though far from stellar) interest rate and easy access to the cash.

Fast-forward to today, and HSBC is offering a whopping 1.05% rate on their Direct Savings account, and I decide that maybe I'll move a chunk of that cash over to Canadian Tire, where I can earn twice as much interest. So, I login to my HSBC account (as I have at least once a month for as long as I've had the account), enter the details to transfer money to my primary chequing account, and am met with an error message that they can not complete the transaction at this time.

Wait, what?

This account currently has a balance just over $1,040, and I'm able to login and view the account details to my heart's content. Why are they barring me from making a withdrawal?

A quick call to customer service brings to light that, if you have no debits on the account over a 12-month period, they flag the account as dormant, and you have to re-activate it by faxing them your signature and waiting 24 hours before you can complete a transaction.

Looks like HSBC will no longer be my Emergency Fund container of choice.

I'll keep $150 with them, and set up recurring transactions to churn $15 in and out once every six months to keep the account "active", but I'll be looking to put the bulk of my balance elsewhere.

I realize that $1,000 isn't exactly big potatoes, but my Emergency Fund is growing, and they had been my preferred savings institution. I was willing to overlook their low rate in favour of their access methods, but now they've driven me out the door.

Maybe CTFS will be happier to have me as a customer.

Big day

There was something significant that was supposed to happen today, but I'm having trouble remembering what it was. :)

Congratulations to our friends in the US on your new president. Whatever your political leaning, it's a fascinating time to be alive. The next four years should generate some great discussion, and hopefully a good deal of positive change in North America and the world at large.

Back on our side of the border, the Bank of Canada today cut its interest rate to 1.00%. In the fastest response I've seen to date, all five of the big Canadian banks immediately matched the rate drop, lowering their prime rates by 0.50% to 3.00%. This puts the banks 0.25% behind overall in terms of passing on the rate cuts to the customer. Not too shabby, when you consider that interest rate spread is a bank's bread and butter.

As always, interest rate news is good for some, and bad for others. Borrowers are finding that their cost of borrowing is reduced even further (my line of credit currently sits at 3.25%), but savers will no doubt also be hit with a drop in the APR on their savings accounts. Now might be a good time to lock in any mid-term savings in a GIC before the rates get any lower.

A question about interest rates

Well, although they took their time, the Canadian banks have indeed dropped their prime lending rate in response to yesterday's Bank of Canada rate cut. With the overnight rate at 3.00%, and bank prime at 4.75%, let's see what happens with online savings account rates. Will we see an ING rate below 3%?

In previous discussion about the impact of rate cuts on mortgage and loan rates, I've seen a lot of talk about LIBOR as a benchmark for the cost of lending. This seems to be a more universal version of a central bank interest rate, and I've heard reference to loans and mortgages that are actually indexed to LIBOR as opposed to bank prime.

I don't know a lot about this, so I put the question to you: do you know of any institutions in Canada that offer loans indexed directly to either LIBOR or the BoC rate?

Another rate cut: will the banks follow suit?

As expected, the Bank of Canada announced another interest rate cut this morning, taking the key interest rate from 3.50% to 3.00%.

The BoC cites a "deeper and more protracted economic slowdown in the U.S. economy", which is expected to continue to hit our exports. This rate cut is hardly a surprise, but there is some question as to whether the Canadian banks will balk at lowering their own prime lending rate. We've grown accustomed to seeing the banks adjust their own prime rate whenever the overnight rate changes, but the banks may be looking to change this expectation. Shrinking spreads on the borrowing business certainly make the banks less enthusiastic about lowering their prime rate, so I'm curious as to how they'll respond to this latest announcement.

Will borrowing rates drop by the full 0.50% to stay in lockstep with the BoC, or will they see a smaller drop, or even hold steady at their current 5.25% level? What will savings account rates do in the next couple of weeks? I think the most interesting thing to see will be the contrast between the two. If lending rates stay put, and deposit rates drop, then the banks will be in for some serious backlash.

As for the impact this change will have on the market, the TSX is down following the announcement, so at least things are staying interesting.

Mortgage options: is Cash Back a good deal?

With this weekend's balmy double-digit temperatures, we Canadians have finally been given a taste of spring. The sun is rising earlier and setting later, temperatures are rising, and our SAD is finally lifting.

And, of course, the mortgage advertising is once again beginning in earnest. With the majority of home sales closing between April and August, spring is the prime season for banks to push their mortgage lineup. Now that we've survived RRSP season, and are wrapping up our tax returns, it's time to be bombarded with mortgage rates and special promotions.

One of the products I've seen advertised this year is a "cash back" mortgage. Basically, when your bank advances the mortgage, you receive a percentage of the principal as a cash reward. You can then use this money for whatever you want. The banks want you to use this to pay for furniture, renovations, or vacations, but you can also use the full cash amount as a lump sum mortgage payment.

The typical trade-off with cash back mortgages is that you have a longer term and higher rate than a standard mortgage, so although you get some immediate cash in hand, you end up paying more in interest in the long run. I thought I'd have a look at the numbers, to determine just how good or bad this offering really is.

Example

To illustrate the trade-off between a cash back and standard mortgage, I'll look at the costs of the cash back mortgage, and compare them to the costs for a standard mortgage with a lower rate. For my calculations, I made the following assumptions:

• $300,000 mortgage, with 25-year amortization


• 5-year term, with 7.20% posted rate


• 5% cash back vs. 1.50% discount on mortgage rate

Note that, since I'm looking at a Canadian mortgage, I'm using the Canadian convention of rates being calculated semi-annually, not in advance. The calculations would work out slightly differently for homeowners south of the border, but the basic idea is the same.

Assuming that the borrower is making bi-weekly rapid payments (i.e. paying half the monthly amount every two weeks), the principal remaining at the end of the term will be $256,132 for the standard mortgage holder (5.70% rate), and $258,710 for the cash back borrower (7.20% rate). When you factor in the $15,000 cash reward, the cash back borrower ends up $12,422 ahead of the standard mortgage holder. If the $15,000 amount earns 3% interest in a savings account during the 5-year term, this increases to a $14,842 spread. If, on the other hand, the full $15,000 is used to make an immediate lump sum payment on the mortgage, the spread is even higher, at $18,600.

On the face of it, cash back seems to be an attractive option.

However, we're only looking at one side of the picture. The higher interest rate paid by the cash back borrower translates to a higher bi-weekly payment. In this example, the cash back borrower has made a total of $138,999 in mortgage payments, whereas the standard mortgage holder has paid only $121,307. That means the cash back borrower had to pay $17,692 more than the standard mortgage holder, which puts them behind by $2,850 unless the $15,000 was used as an immediate lump sum payment, in which case cash back comes out ahead by a mere $909. Even that $909 spread is barely a 2% return on the extra $136.09 in payments made every two weeks throughout the term.

Conclusion

Clearly, when you take into account the larger minimum payments that come with a cash back mortgage, it becomes a lot less appealing. The only way to come out ahead versus a standard, lower rate mortgage, is to throw in the whole cash reward as a lump sum payment at the beginning of the term. Even if you do this, however, you're not likely to keep up with inflation, so it's a far better idea to take a standard mortgage with a lower rate.

If you can afford the extra payments that would come with the cash back mortgage, then you can always increase the bi-weekly payment amount on your standard mortgage, and make even faster progress in paying off the principal.

More good news

Looking back at last night's 1,542-word post on Canadian income tax, there's only one conclusion that I can reasonably draw:

I'm a nerd.

Just thought I should clear that up.

In other news, HSBC Direct has joined the club in lowering interest rates on savings accounts. Effective yesterday, their rate has dropped from 3.70% to 3.30%. They are now exactly on a par with ING Direct. The one upside here is that their promotional rate on new balances until May 2 now represents a 1.45% bonus over their regular interest rate. That's nothing to sniff at, if you have substantial balances to move over.

I'm always reluctant to "chase" rate offers on credit cards, mainly because of the impact that opening and closing credit accounts would have on my credit rating. Case in point: it took me months of fence-sitting to decide to take advantage of the 0% MBNA offer. When it comes to savings accounts, however, I'm far more inclined to "try out" a given account, because there's no concrete downside to having no-fee savings accounts with multiple institutions. Of course, managing these multiple accounts significantly complicates my finances. I have four distinct savings account logins to remember, and four distinct balances to check at the end of each month.

Given that the interest rates on online savings accounts seem to be converging just below the Bank of Canada rate, I'm not sure it's worth my time to chase minor rate advantages from bank to bank. The important thing is, my Emergency Fund and short-term savings are earning more interest than they would in a brick-and-mortar account, and they're with institutions that give me convenient access to the funds as I need them.

That'll have to be enough for now.

Watch your step: savings account rates falling

Tuesday's rate cut by the Bank of Canada has already led to a 0.50% drop in bank prime rate, and now it's being reflected in online banks' savings account rates. As of today, ING Direct and Canadian Tire Financial Services have rates of 3.30% and 3.75%, respectively. HSBC Direct is holding at 3.70%, and ICICI Bank is still at 4.10%.

This makes HSBC's rate promotion a little more attractive, except for the fact that the promotion is so brief: the 4.75% promotional rate on new deposits only lasts until May 2.

It looks like we're in for some tough sledding ahead; my consolation is that, with more revolving debt than liquid savings, I still benefit from falling interest rates. I wonder how this will play out over the next couple of years.

Another rate cut

This morning, the Bank of Canada announced yet another rate cut, taking the overnight rate target down from 4.0% to 3.5%. This marks a departure from the conservative 0.25% cuts we've been seeing over the past few months. Assuming that the banks follow this move, this will take the prime rate down from 5.75% to 5.25%.

As with any rate cut, this is good news for borrowers, and bad news for savers. If you have revolving debt, then you will be paying less interest on it ($5 less per year on a $1,000 debt). However, you will also earn less interest on cash savings, since the online banks also lower their savings account rates when the BoC cuts its rate.

Here's a quick review of the BoC and bank prime rates over the past year:

• January 16, 2007 - BoC rate = 4.25%; bank prime = 6.00%


• July 10, 2007 - BoC rate = 4.50%; bank prime = 6.25%


• December 4, 2007 - BoC rate = 4.25%; bank prime = 6.00%


• January 22, 2008 - BoC rate = 4.00%; bank prime = 5.75%


• March 4, 2008 - BoC rate = 3.50%; bank prime = 5.25%

Of course, there's always the possibility that the banks won't follow suit with a cut to the prime rate, or that they may lower prime by less than 0.50%. This announcement marks the biggest single change to the BoC rate since 2001, so it will be very interesting to see what effect this has, on savings account rates, the stock market, and the Canadian economy at large.

HSBC Direct rate promotion

I've written before about my decision to move my Emergency Fund to HSBC Direct. Their rates have been quite competitive in the past, and they have very flexible access methods, including bank-to-bank transfers, ABM withdrawals and online bill payment. Granted, their rates have been slipping lately, but they still offer a very convenient place for your savings to keep up with inflation.

Well, I have received two e-mails in the past week, drawing my attention to a promotion going on at HSBC. The first message (to my personal address) was from HSBC proper, telling me to "tune in on February 4" for an exciting interest rate promotion. The second (to this blog's address) seems to be from their PR firm, inviting me personally to check out the rate. The second, more spammy e-mail kind of irks me, but I already deal with HSBC, and I've been happy with my experience, so OK, I'll bite.

Here's the deal: any new deposits into an HSBC Direct savings account between now and May 2 will be subject to a 4.75% APR until May 2. Whether you already have an HSBC account or not, any net-new money you deposit will earn 4.75% interest. This interest is compounded daily and paid monthly, just like the regular interest (currently at 3.70%). You don't need any promo codes or anything; this automatically applies to any new deposits.

If you're interested, then you should open an account or transfer your balance now, so that you can start earning the higher rate as soon as possible. The account opening process at HSBC can be a bit slow, but the account is easy and convenient once you've jumped through the appropriate hoops.

Remember that the promotional rate expires at the beginning of May, so if you're a rate chaser, plan to look for greener pastures at that point.

Did I call it, or what?

Behold the awesome foresight of Loonies And Sense! Four days ago, I predicted that other Canadian online savings accounts would follow HSBC's lead and lower their rates. As of today, ING Direct and ICICI Bank offer rates of 3.65% and 4.10%, respectively. That's a 0.10% drop for ING, and 0.15% for ICICI. Canadian Tire is still hanging in at 4%, but I don't know how long that will last.

OK, so it's not exactly rocket science to predict that banks will lower their savings account rates in response to a rate cut by the BOC, but it's interesting to see how the various institutions respond. Since November 2007, here is the trend in Canadian interest rates:

• BOC down 0.50% from 4.50% to 4.00%


• Bank prime down 0.50% from 6.25% to 5.75%


• HSBC down 0.50% from 4.25% to 3.75%


• ICICI down 0.40% from 4.50% to 4.10%


• ING down 0.10% from 3.75% to 3.65%


• Canadian Tire steady at 4.00%

Aside from HSBC, the online Canadian banks seem to be trying to avoid cutting rates as much as possible. I wonder how this will play out?

Feeling the Bank Of Canada rate cut

By now, I'm sure you've heard that the Bank Of Canada cut its rate by 0.25% this week, and the banks have followed suit with a 25-point cut of their own. Our mortgage and student loans are all fixed-rate loans (our mortgage is up for renewal next year), but my line of credit and savings accounts are subject to the whims of the banks and changes in prime rate.

Here's the impact of this latest cut:

• My line of credit interest rate dropped from 6.25% to 6%, which will save me money every month.


• My student loan, currently at 5% interest, remains below the 5.25% that I would be able to get from my bank today; Ms. Loonie's loan is currently at 5.75%, so it may be worth looking into renegotiating this loan.


• ING Direct, Canadian Tire Financial Services and ICICI Bank have all held steady through this most recent rate cut, with savings account rates of 3.75%, 4% and 4.25%, respectively.


• HSBC Direct have dropped their rate again from 4% to 3.75%. This puts them on par with ING in terms of rate, so their abundant access methods are now the only reason for keeping my Emergency Fund with them. This is interesting, because they have gone from having one of the highest rates to having the lowest rate out of the primary players in Canada.

Overall, the rate cut is beneficial to me, especially given that my debts are a lot larger than my savings. This really just gives my debt reduction a boost, as more of my payments will go toward principal. I'll be interested to see if the other savings accounts lower their rates to follow HSBC.

Transfer complete, pay down when ready.

I wrote in November that I had applied for an MBNA MasterCard with a 15-month, 0% balance transfer offer. Well, I've received and activated the card, and last Friday I requested the a balance transfer of $14,800 into my chequing account.

I've now received the funds, and made a $14,800 payment to my line of credit. This effectively converts $14,800 of my revolving debt to interest-free debt. The terms of the balance transfer are as follows:

• One-time balance transfer fee of 1% of balance ($148 in my case), which will be part of the balance due on my first payment


• Monthly minimum payment of $10


• Provided I keep the account in good standing, my 0% APR will end in March 2009 (at which point I will use my line of credit to pay off the remaining balance on the card)

The $148 fee means that my $14,800 has actually been converted into $14,948, but this move should cut my monthly interest charges by nearly 75%, so in the end I'll more than make up for this one-time charge.

The most important thing now is for me to keep up my reduction of my line of credit debt. If I take this opportunity to rack up new debt, then this will all have been for nothing. I'll be keeping my bi-weekly debt payments at the same level, but with the smaller interest charges, I'll make much faster progress. This is essentially a debt snowball.

If I manage to wipe out the line of credit before the 0% offer expires, then I'll start socking away my debt payments into a savings account, for some short-term credit card arbitrage. In the meantime, however, I'll enjoy the tax-free interest savings on my line of credit.

Playing the 0% balance transfer game

It's hard to make it through a day without reading something online about 0% balance transfer offers from credit card issuers. Many bloggers have used these offers to make money using credit card arbitrage, wherein you take your interest-free loan and park it in an interest-earning vehicle until the 0% offer expires, at which point you "cash out" and take your interest winnings. Others use 0% offers to consolidate higher-rate debt, helping to accelerate their debt paydown.

From what I've read, these offers seem to be far more prevalent in the US than here in Canada. However, I've seen a lot of people talking about MBNA Canada's 0% promotional rate, and I thought I'd take a look at it. The offer is not listed on MBNA's website, but if you call a toll-free number and give a four-character promotional code (listed in the thread I've linked), they'll process an application for the card.

I called last night to apply for the card, and was approved on the phone. I was given a $15,000 limit, which I will use to consolidate a big chunk of my current revolving debt (which currently sits on my line of credit). This balance will sit on my MBNA card for 15 months, accruing $0 in interest (there's a one-time 1% fee for transferring the balance), which should save me over $1,000 in interest charges. This will really accelerate my debt paydown.

Obviously, transferring a substantial balance to a credit card is not without risks:

• By opening a new credit account and running it up to 100% utilization, I'll be hurting my credit score. However, I don't plan to apply for any new credit within the next couple of years, so I'm willing to take this temporary hit.


• If I miss a payment (or pay late) during the 15-month promotional period, then the interest rate will jump up to 19.99%. I'm not clear on whether this will be retroactive to the time I first transferred the balance, but either way, it's something to avoid. I need to keep a close eye on my payment schedule.


• Similar to the point above, I need to make sure that I pay off the card balance (or at least transfer it back to my line of credit) before the promotional period ends. I'll be setting lots of automatic reminders to make sure I stay on top of this.


• If I use the card at all for purchases, then those purchases will immediately start to revolve at a 17.9% interest rate, and will continue to do so for as long as there is a balance on the card (because payments are always applied to lowest-rate balances first). This doesn't affect me, as I will never use this card (or, in fact, even carry it in my wallet) for anything other than the initial balance transfer. However, it's an important point to recognize, as it's what MBNA is hoping I'll do.

These are the primary risks, as I see them. By recognizing them, and planning to mitigate them, I think the benefit of faster debt reduction still makes this plan worthwhile.

Have I missed anything? Has anyone else taken this approach, or used this card?

He's here! Quick, drop the rate!

Well, as of yesterday, my Emergency Fund is held at HSBC Direct.

As of today, HSBC's savings APR has dropped from 4.25% to 4.00%.

I'm trying to tell myself that 4.00% is still a good rate. It's 25 basis points above ING (who can't be far behind with a rate drop of their own), and my decision to move was based as much on HSBC's impressive access methods as on their rate, so I still think it was a good move.

I just wish the rate had stayed higher.

Maybe even for a whole week.

Credit card arbitrage comes to Canada

Million Dollar Journey has a couple of great posts on credit card arbitrage:

• Credit Card Arbitrage I - What is it?


• Credit Card Arbitrage II - An Analysis

Now, credit card arbitrage is one of the most discussed topics in the PF blogosphere, but the Canadian focus of these posts is a great resource for anyone looking to apply this principle here in the Great White North. For those of us here in Canada, the hardest part of this arbitrage process is finding 0% balance transfer offers. This article lists a couple of offers, and also includes some sample scenarios to illustrate the actual benefit of a successful arbitrage.

Anyone living in Canada and looking at credit card arbitrage as a potential alternative income stream should definitely read these posts.

Canadian High-Interest Savings - Redux

One of my first posts was a brief run-down of a few Canadian high-interest savings accounts and their rates and features. I referred to an old review I'd found of the big players in the high-yield savings arena.

Today I found the CANOE Money summary of Canadian interest rates. These lists should prove useful:

Savings Account Rates
Credit Card Rates

Their list shows that ICICI Bank has the best rate (4.50%) of all the Canadian players, and after taking a tour of their website, it looks like they're a strong option. In fact, the review I posted previously has been updated to reflect that ICICI is probably the best choice for anything but a full chequing account replacement.

Another option I've found is Canadian Tire Financial Services, which offers an everyday 3.80% rate, with a 90-day teaser of 4.50%. Their everyday rate beats ING Direct, and they give a $10 gift card as a welcome gift.

I think I'll be trying out Canadian Tire and ICICI. I'll let you know how it goes, and whether I make any changes as a result.

Demystifying Mortgage Rates

I'm a die-hard "numbers guy". I've always loved using spreadsheets to lay out and track various scenarios, typically related to personal finance. I like to know exactly what the numbers in my life mean to me. This doesn't mean that I'm particularly good at acting on what the numbers tell me (refer to my total debts in previous posts for proof of this), but it does mean that I'm always "tinkering" with the data in my life.

One thing that has always fascinated me is the tracking of loan payments over time. I had the basic exposure to simple and compound interest calculations in high school, but these calculations almost always focused on a starting principal that remained constant over time. For example, "Sam has $1,000 that earns interest at a rate of 4.0%, compounded monthly. How much money does he have after two years?" The answer to this is very simple ($1,000 x (1 + 0.04) ^ 24 = $2,563.30), because the interest is the only source of change over time. However, when periodic payments, either toward an investment or against a debt, are brought into the picture, the answer gets more complicated, and is harder to express as a single formula (there are, in fact, "simple" formulas that take these payments into account, but their form is not exactly intuitive to the average person).

For every loan I've ever had, I've created a spreadsheet that details, over time, how much interest is accruing from one payment to the next, and how much principal remains over time. These are usually pretty accurate, but when I set up a spreadsheet for my mortgage, I found that my interest calculations were consistently higher than the actual interest charged, resulting in a longer calculated amortization. It turns out that this is due to the way mortgage rates are reported in Canada.

Canadian lenders post mortgage rates that are "compounded semi-annually, not in advance". Well, that clears it all up, doesn't it? It turns out this is actually very simple, but we need to sort out the jargon.

The "compounded semi-annually" part means that the rate is posted assuming that interest will be calculated every six months. The "not in advance" part means that interest is charged after it accrues, so you don't start out your mortgage owing six months' worth of interest. That is, if you have a $100,000 mortgage with a posted rate of 7.0%, then after the first six months, you would see an interest charge of $3,500 ($100,000 x 0.07 / 2). Note that this is actually equivalent to an annual rate of 7.1225% ((1 + 0.07 / 2) ^ 2 - 1), as opposed to the posted 7.0% rate.

In the real world, however, no one pays their mortgage semi-annually; most mortgagees make monthly payments. In the example above, this means that the rate of 7.1225% needs to be converted to monthly compounding, so each month, we would expect an interest charge of 0.575% ((1 + 0.071225) ^ (1 / 12) - 1). Multiplying this rate over twelve months gives us a true effective annual rate of 6.90%. Using this calculated rate, mortgage interest works out to within a few cents of what is actually charged by the lender.

The calculations here may seem a bit confusing, but here is a summary:

R = Annual rate posted by lender

r = Effective annual rate charged by lender

r = 12 x (((1 + R / 2) ^ 2) ^ (1 / 12) - 1)

Note that this formula is based on semi-annual calculation of interest. In the United States, interest is calculated monthly, so we would end up with the following:

R = Annual rate posted by lender

r = Effective annual rate charged by lender

r = 12 x (((1 + R / 12) ^ 12) ^ (1 / 12) - 1)

r = 12 x (1 + R / 12 - 1) = R

Therefore, in the US, the posted annual rate is actually the same as the effective rate.

I was quite shocked the first time I worked this out, because I could not figure out why lenders would advertise mortgage rates above what they actually end up charging. It turns out that financial institutions are required by law to express their interest rates this way, so that consumers are able to compare "apples to apples", since all lenders are advertising their rates on the "semi-annually, not in advance" scale.

So now you know.

Canadian High-Interest Savings

It's impossible to read a personal finance blog without seeing myriad references to high-interest online savings accounts. ING and HSBC are probably the most commonly cited, and since most of these blogs are based in the US, they refer to these banks' 4.50% and 5.05% APY (respectively). This can get a little frustrating to us Canucks, as we simply don't have access to the same rates that are available south of the border. I thought I'd do a quick write-up of the deals that are to be had in Canadian online banking.

ING Direct

ING currently offers Canadians an everyday APR of 3.50% (calculated daily, this is equivalent to a 3.56% APY), with no minimum balance. They currently have a promotion rate of 4.25% on new balances until August 31, so it's a good time to try them out. If you e-mail me for a referral, you'll also receive a $13 bonus when you deposit at least $100 into your new account (a nice complement to the incentive rate).

HSBC Direct

HSBC also offers 3.50% APR, with no minimum balance. They currently have a signing bonus of $50 for new customers, but this is only for accounts opened by Monday. With an HSBC account, you can use any HSBC or BMO bank machine for free.

PC Financial

PC Financial offers a 4.0% APR (equivalent to a 4.08% APY) if you maintain a balance over $1,000, but only 1.0% if the balance is $1,000 or less. With a PC account, you can use either PC or CIBC bank machines for free.

Other Options

I found an article from last fall that goes through the various Canadian options in detail. The author seems to recommend PC Financial overall, but ICICI receives positive mention as well. Check it out...