The talk this week is all about the central bank dropping interest rates to 0.25% and promising not to raise them for a year. That would effectively eliminate all the worry about converting a variable rate mortgage for quite some time. Good news for those who have been stewing about what to do, what to do.

This week has been full of question… a higher than normal number came in, and I’m happy to report I got some of the best questions – most thoughtful and proactive – I’ve had yet. Y’all are getting it and it’s showing in your thinking.

There are still a few people who are surprised by things that happen financially or are operating under misconceptions. Here are some examples of what I mean:

S wrote:

I got my tax package back from my accountant and learned that I owe a tax bill of $1700. I was floored – especially since I was expecting a refund of about $4000 due to a large RRSP contribution last year. I discovered that while I was on maternity leave for most of 2008, not enough income tax was deducted from my EI benefits and my employer’s top-up benefits (yes, I’m one of the lucky ones whose employer pays us extra while on mat leave). This happened because each entity calculated my income tax deduction as if that pay stream was my only income. I’m gobsmacked and “mourning” the loss of the cash I was expecting for a refund that was going to be put towards other goals and I feel “robbed” of the money that I will have to use to pay the tax bill. I’m upsetthat I did not know that I should have checked the tax withholding on my two streams of income (EI and employer benefits) to ensure the calculations took into account my total income. Do you know if this matter is a common mistake, or is it common knowledge? Shouldn’t the EI people warn you about this when you apply for your maternity-parental leave benefits? Can you let your maternity/parental-leave minded readers know about this potential pitfall?

S is not alone. Very often people who take second jobs or go off on maternity leave benefits do not manage their income tax withholding so that enough tax is taken. The result: they end up with an unexpected tax bill. It’s not up to the payroll department to ensure they’re taking enough tax for your specific circumstances. They need only take enough to meet the withholding tax rules.  It’s your job to make sure there’s enough tax being withheld. So heed S’s warning and make sure you don’t get hit with an unexpected tax bill.

J wrote:

I just received a pleasant little note from one of my banks (RBC) – which holds both my car loan and PLC – that the premium on the interest rate for the PLC has been hiked from prime + 2.5% to prime + 5.25%. I have been making only the minimum payment on this account in order to pay off the CCs. Was this a mistake, and should I bother to try to renegotiate the rate? Would another lender consider consolidating my PLC and CC debt at a lower rate, or is this a bad time to ask for such ‘favours’ from any lending institute?

J has bumped up against the reality of the new economic climate. I’ve been getting a lot of letters like this one: people who are desperate because their lenders are raising their interest rates (making the minimum should not create a problem as long as it was made consistently), or calling their loans. For EVER I’ve been trying to get the message out that credit is not a reliable source of money – how long have I been saying a line of credit is NOT an emergency fund? – and now that people are being faced with a different reality they’re really thrown off-kilter.

My girlfriend, Victoria, was offered a line of credit recently and when she declined she said, “You can give it, and you can take it away, no thanks.” The young lady behind the counter cocked her head and asked what Victoria meant. Victoria had to explain to “the banker” that a line of credit (like a credit card) is “callable” credit… the bank can demand repayment at any time. Apparently the young miss didn’t know that! Hmmm.

I think it is ridiculous that as the central bank’s rate has fallen, some lenders have seen this as their opportunity to make more money. With interest rates at a historical low, these aren’t the letters I should be getting. I strongly suggest that consumers – particularly those with a good credit history and sound financial foundation – find a new source of money that isn’t rapacious in it’s lending practices. Check out your local credit unions as an option. Better still, get the hell out of debt!

R wrote:

My spouse and I separated almost a year and a half ago, and the first year of separation he claimed my daughter on his income tax. We agreed that we would alternate years to claim her. Is there a better way of doing this? We have shared custody and she alternates weeks between the both of us with the exception of times when he is unable to have her because his work takes him out of town.

R and her partner have come to a solution for how to used the equivalent to spouse credit for a dependant child. And, no, there’s no “better” way.  I hope y’all know that if you are the supporting parent of a child, you can use this claim to lower your taxes. BTW, the Tax Man’s rule on this is whoever claims first gets the credit, which makes a good case for filing early.

M wrote:

9 years ago when my husband and I purchased our first home, we borrowed from my RRSP under the home buyers plan. I have been consistent with the re-payments annually however, we have been gifted $5000. My question is should I (am I even able to) put this on the home buyers plan? So that I am earning on my RRSP again. Also, I don’t know where to find out what the remainder is that I owe.

Did you know that you can pay back as much as you want whenever you want? M makes a good point about earning money on their RRSP… since you’re not paying interest on your HBP loan, your RRSP is earning no return. The sooner you can get this money back into your RRSP and invested, the better. As for how much you still owe, check the annual Home Buyers’ Plan (HBP) Statement of Account that the Tax Man sends with your notice of assessment.

Ashleigh wrote:

I have been a huge fan of the show and have taken and applied every possible piece of knowledge that you have given out. (i.e.; live on cash, cut up the credit cards, write everything down etc) I even went out and got a 2nd job just to put towards paying off the debt that both my better half and I have (approx $37,000) after buying our house last year. I have gone from ignoring the problem and making it worse to being obsessed and completely consumed by it. Everything I do I am running the numbers in my head – if I spend $10 to get my car washed then that is $10 less I have to put towards debt type of attitude. It is driving me and my better half insane because we make nearly $140,000 yr and we can’t do anything fun. I even run numbers for my next 4 weeks paycheques in my head while I am in the shower! I am wondering if this is common to go from denial to obsession and what I can do to curb it as life isn’t any fun anymore. HELP!!!

I’ve never been a proponent of all or nothing. I’m the girl who keeps trying to tell y’all that balance is the name of the game. Once you have taken care of the must dos, you can breathe easier. Plan like a pessimist so you can live like an optimist… Okay, so where’s the optimism in this letter? Ashleigh’s pendulum has swung too far in the opposite direction, and this is as unhealthy as ignoring debt and not being aware of what you’re spending. It’s an easy trap to fall into. But staying there is anathema to a healthy relationship and a happy life. So Ashleigh, make a plan, follow through, and relax. Don’t make yourself crazy. Do the details and then have some fun.

C wrote:

I am turning 31 in a couple of months and wanting to start an RRSP how much a month do I need to put into the account to have 1 million by the time I retire?

C has obviously bought into the Magic Million propaganda. Too bad. She’ll suffer frustration, she may take unhealthy risks, and she’ll wonder why she can’t make this happen. The Magic Million should not be the goal. Saving regularly and having a life too should be the goal. Perhaps the most frustrating thing about saving is setting the bar too high and then having to deal with the disappointment of not achieving the milestone set. (Equally as frustrating is comparing yourself with others and being unhappy with your outcome compared to theirs.)

I’ve written about the Myth of the Magic Million several times. It’s a myth because it was created to motivate people to put money away. But it is an arbitrary number picked for it’s marketing pizzazz. We need to get over it. The best you can do is:

• determine the amount you should be setting aside for the future (10% of your net income, or more if it doesn’t strangle your cash flow),
• set up an automatic savings plan,
• find investment options that suit YOU,
• stay the course.

Okay, while we’re on the topic of questions, I’m still getting a b’zillion requests for private consultations. Sorry, no can do. And people have taken to sending me very long questions full of all their financial information in the hope that I’ll make them a budget and a financial plan. Sorry, no can do. I’m happy to answer your questions. I love it when you send me a questions that makes me think hard! But I have neither the time or the inclination to take control of your money on your behalf. 

I could hire a staff of smart, able people who could do this for you, but it would probably cost about $3,500 to do your analysis (yes, it takes time and effort), and another $200 a month (six month minimum) to keep you on track. Hey, if there’s a demand…

I’ve been getting a bunch of letters from people recently about taking advantage of the new, lower interest rates. Here’s one from Kristina:

Today’s mortgage rates have my husband and I tempted to refinance our current mortgage. We are 17 months into a 5 fixed year term, 25-year mortgage. When we bought our house, the 5 year fixed rate was 5.75% and now it is 4.09%. This is a difference of $320 a month, an amount that would significantly accelerate the down payment of the mortgage. I have read that we can expect that the bank will want 3 months interest in penalties if we try to get out of our current mortgage. Is this always the case or are there any other options that we can explore? When does it make sense to refinance?

When you’re trying to decide what interest rate and term to use for your mortgage a whole bunch of factors come into play:

• There’s the difference between the rate for a variable mortgage and one for a fixed-term mortgage, along with
• The different terms being offered, usually anywhere from six months to 5 years (or in some cases even longer), as well as
• The choice to go with a closed mortgage or one that is open and can be repaid early.

From the lender’s perspective, the rates reflect where interest rates are headed. Usually longer-term rates are higher than shorter-term rates, but the yield curve can become inverted  if the economic gurus are predicting that rates will be coming down over the long term. And usually, variable rate mortgages are less costly than closed, fixed-rate mortgages. But those closed, fixed-rate mortgages also protect you from interest rates that head upward during your term.

If you choose to go with a closed mortgage and then watch interest rates drop, as they have over the past few months, you may feel like you’ve been cheated since your mortgage is going to cost way more than it needed to. If only… if only you had known interest rates were going to fall, you’d have gone with a variable rate… if only you had known rates were declining, you’d never have committed to such a long term at such a high rate… If only…

Quitcherbitchin people. You looked at the info at hand, made a decision and now must stick to your side of the bargain. If you try to get out, the lender will hit you with a big fat penalty – called a “lost interest compensation, or LIC” – because you’re breaking the contract.

Some people are very willing to eat the LIC, adding it into their mortgage so they can get the lower interest rate for a longer period of time. Hmmm. They argue that the longer-term savings on their mortgage is well worth paying the LIC.

If you’re determined to renegotiate your mortgage, let me introduce you to the concept of the “blend-and-extend.” With a blend-and- extend, you continue to pay the existing interest rate for the remaining term on your mortgage, but you renew early to lock in the lower rate for the remaining term.

Let’s say you have 18 months to go on your mortgage at 5%. For argument’s sake, the current 5-year rate is sitting at 4%. If you used a blend-and-extend, you’d pay 5% for the first 18 months and 4% for the remaining 3.5 years on your new 5-year term.

Most lenders offer the option to blend-and-extend. They may not know it, but they do. And you may have to convince them that this is something they can do, since the financial world is sadly under-educated in terms of how stuff works, and what their own companies offer. Hmmm.

You must be persistent. Your persistence will be rewarded with big savings. Brenda wrote me to say:

You are a peach! Dear Gail your advice has saved me $2,259.70 blending and extending mtg, and I negotiated a rate of 4.638 from 5.1 based on $214,515. locked in for 5 yrs closed. It took a lot of wear on the branch mgr, but TD came through.

So, are you going to beat yourself up for not having the foresight to predict where interest rates were going? Are you going to bitch and complain about how lenders are greedy dicks?  Are you going sit there wondering how long the lower interest rates are going to last? Or are you going to find a way to capture those lower rates right now, so there are fewer surprises in your future? Hey, hindsight is 20/20. It’s what you do with the information you have in the here-and-now the separates the whiners from the winners.

BTW: A lot of you have been indicating that you’d like an opportunity to get together and meet me in person. Saver Queen is making plans for a Potluck in the Park. There’s a forum set up under Gail Clubs (all the way at the bottom), and if you’re interested in participating, you can go there and get into the mix. I’m coming, and bringing kids with, along with a nice salad. Saver Queen has been good enough to front the costs for the park permit, and we’re all going to chip in. Go check out the forum!

Imagine that you’re selling lemonade. It’s a hot day and there’s a big demand for a long, cold glass of you’ve got. You can probably charge two bucks a glass and get away with it. Yup, thirsty people won’t think twice about shelling out for a little lemony relief. And if you’re down to your last glass or two, someone may offer a premium, coughing up an extra fifty cents to grab a glass. So, when supply is low and demand is high, prices jump. Of course, if your next-door-neighbours all decide to set up their own lemonade stands, you’re going to have to practically give it away to get it off your hands. And if the weather suddenly changes, a cold wind blowing the leaves and your customers’ thirst away, nobody is going to pay a red cent for your lemonade.

What’s true for lemonade is also true for money. When there’s more money than stuff to buy, prices go up. When there’s more stuff than money, prices go down. Inflation is the measurement of the changes in prices of all that stuff.

Enter interest rates. The lower the interest rates, the less it costs to borrow so there’s money to buy stuff.

Think of interest rates as the price of money. The central bank is in charge of deciding the cost of money overall, so it is the central bankers who set the interest rate. When central bankers raise interest rates, they make money more expensive and so the demand for it goes down. The less money available to buy stuff, the more pressure there is on prices to come down. That’s why higher interest rates lead to lower inflation.

Of course, if the central banker decides to raise interest rates to fight inflation, that means that the economy is going to slow down. After all, if nobody has the money to buy TVs, then the company that makes TVs is going to make fewer, so they’re going to lay off some TV builders, who then won’t have the money to buy food, never mind TVs. And that’s why the interest rate/inflation dance is such a precarious one.

Whenever there is news about the changes in the central bank rate, most people’s eyes glaze over. We know if rates go up, that’s no good for borrowing. But that’s about all we know.

At the turn of the new century, our central bank, the Bank of Canada, introduced a new system of eight “fixed” or pre-specified dates each year for announcing changes to the official interest rate it uses to implement monetary policy. Since the rates could no longer be changed on any day in response to an economic ill wind, this was seen as a good way of stabilizing interest rates. Central banks in Europe and the U.S. Federal Reserve also use this system. Of course, the central bankers reserved the right to make a change off schedule under extreme circumstances.

The Bank of Canada sets interest rates with the objective of keeping inflation between 1- 3%, with an optimal target of 2%. So when the inflation rate hit 3.1% last July (over July 200&), it was the biggest jump we’d seen since September 2005. Then in August, inflation jumped again by 3.5%. Ooops.

Of course, the central bank’s decision has an impact on our ability to borrow money. And while many a lender has been holding the line – not raising rates – to keep customers coming through the doors, those days are drawing to a close. Expect to see higher interest rates as lenders themselves find money is tight and they must pay more.

When rates go up, it isn’t all bad news. Only the borrowers suffer. The savers jump up and down clapping their hands because their deposits are working that much harder. While, typically, periods of high interest rates are associated with periods of high inflation, as with everything else, things will change again. If interest rates jump way up, you should consider buying investments that will hold those higher rates for as long as possible.

Start your research on various interest-based investments now. Learn about options like mortgage-backed investments (don’t laugh), the various types of bonds, and mutual funds that are based on fixed-income investments. Figure out what TIGRs and STRIPS are. Learn the language of investing — including all the stupid acronyms — so you’re ready to take advantage of what comes next.

We are leaving the age of rampant borrowing. Who knows what age we’re entering next. As with everything else in life, the changes are painful. But the opportunities are great. Get focused. Know what you want. Get educated. Take advantage of what the future holds. Become an OWAP…. an Optimist With A Plan!