Mortgage Agent #M09001336 :: Mortgage Edge #10680

March 1, 2010: that’s the deadline to making your 2009 RRSP contribution. Sometimes, however, we don’t always have the money at hand to make a lump sum payment. With equity markets continuing to rally and interest rates remaining low for the next 2 quarters, it may be worth considering borrowing for the short term to shelter long term gains.

There are several ways this can be accomplished and the strategies outlined below can be used to fund either your entire contribution or only part of it:

1) Borrow the funds from your HELOC: the Bank of Canada reiterated its position last week to keep rates low until the second quarter of this year barring an unexpected rise in inflation. HELOC rates are presently between prime + .5% to 1% (2.75%  to 3.25%) depending on the institution.

Borrowing for the short term would allow you to make an immediate lump-sum contribution while taking advantage of extremely low interest rates. And what’s best, you can tax-deduct the interest on the revolving portion as long as the funds are used for investment purposes. Consult an accountant if it’s a joint HELOC account.

2) Cash-back mortgage: If you’re renewing an existing mortgage or in the process of closing on a home, you can obtain a cash-back mortgage. Lenders are not oblivious to RRSP season and with today’s promotional offers you would be able to get upwards of $6,000 on a $300,000 mortgage (5-year term) at very low rates.

3) Matrix mortgage: If you’re renewing an existing mortgage or in the process of closing on a mortgage, with this mortgage you can unleash your equity position in the property and use the HELOC to make the contribution. Both the mortgage and HELOC would be with the same institution. Again, given that interest rates would likely increase by the end of this year, I would advise borrowing from your HELOC on a short term basis. You never want to be highly leveraged when the cost of borrowing starts creeping up.

RRSP reminders:

• The maximum contribution limit for tax year 2009 is $21,000
• Unused contribution room from 1991 to 2006 can be carried forward
• Your deduction limit would be specified on your CRA NOA received last year
• Your deduction limit depends on your MTR

Two key developments are happening now that may impact your cost of borrowing in the coming months:

First, the US Federal Reserve has come out with a plan to stop purchasing mortgage-backed securities (MBS) by the end of March. Since the plan’s inception in January 2009 to alleviate pressure off of Fannie Mae and Freddie Mac’s balance sheets, stabilize sinking housing prices and keep mortgage rates low, the Fed together with the US Treasury purchased over a trillion dollars worth of MBS.

With the US economy showing signs of improvement, albeit at a subdued rate as fundamental figures demonstrate, the Federal Reserve is pushing ahead with a plan to stop the purchase of MBS in the next two months. According to the Wall Street Journal, proponents of the plan at the Fed argue that purchasing over a trillion dollars of MBS over the past year diminished enough supply from the private sector to keep mortgage rates low even after the Fed stops purchasing these securities.

Perhaps unsurprisingly, there is no shortage of opponents to the plan on Wall Street. Some fear that the Fed is withdrawing its support too soon and that such an abrupt move can cause interest rates to spike and already battered housing prices to weaken further. The interest rate on a 30-year mortgage in the US has already increased in the weeks leading to the Fed’s decision. The 30-year rate now stands at 5.20%, up from about 4.70% back in early December.

The Fed’s decision to buy MBS have also pushed down on the yield on US Treasury bonds and kept the spread between comparable T-bills and MBS at a mere 70 basis points. With the Fed stopping its purchases, the spread between both securities would undoubtedly increase, raising the prospect for a hike in mortgages rates. What is not yet known is the extent of the damage. Some argue it would be severe given the fragile state of the US economy while others side with the Fed by claiming any ill-effects will be negligible. I know that last sentence is somewhat simplistic and vague but at this time all I can say is stay tuned to see whether this story would have global ramifications.

You may be asking yourself how this would affect us in Canada. The simplest explanation is our economy is closely linked to the US economy. When the US economy was brought to its knees during the most recent financial turmoil, other national economies followed in a domino effect. Despite our conservative lending standards, we too felt the pain. While Canada’s banking sector remained strong throughout much of the ordeal, it was not immune to losses, and Canada’s overall economy did end up being dragged into a recession that forced governments into deficits.

Our own “Fed”, the Bank of Canada, have already indicated they will raise the overnight rate that prime is benchmarked to in the second quarter of this year. Last month, in fact, Canada’s big banks released their projections for where they believe rates would head. TD, for instance, stated that the overnight rate would be 3.25% by 2011. Add to that the 2 to 2.50% premium lenders add minus let’s assume the increment that my discount lenders are providing now (-.25%) and you’ve got a variable mortgage rate of around 5% within a year now, or about a 3% increase over where rates are today. And that’s with inflation under control. Should inflation spike, we’d probably be looking at much higher rates.

At this point it’s all speculation. Financial forecasting is never easy. Recall that at a time Finance Minister Jim Flaherty was saying that Canada’s books would still be in the black even though we were in the midst of the worst recession since the Great Depression. TD came out with a report shortly afterward forecasting that Canada would actually post a $14 billion deficit in 2009. Turns out that $14 billion would’ve been a bargain considering that we’re now over $50 billion in the red, and our deficit is projected to balloon to $150 billion (according to today’s Toronto Star) by 2014. So TD’s researchers got it right that we would be posting a deficit despite all the optimism floating around at the time, but their target was well short of reality. Of course, at the time we didn’t know just how much stimulus Ottawa would be providing and how much it would ultimately cost. But it goes to show that certain credibility should be given to at least some projections provided by leading institutions. And if these latest rate projections prove accurate, Canadians should look forward to more normal (higher, that is) interest rates in the coming years but much sooner than they may think.

Second point takes us to a land of beauty and serenity and perhaps most appealing to bankers, neutrality and a secure place to hide money.  A key meeting of the Bank of International Settlements took place in Basel, Switzerland over the weekend. The BIS, which maintains a rather low profile in the media, is an association of central banks where key members are essentially the central banks of the world’s richest countries: The Federal Reserve, the Bank of England, the Bank of Japan, and the ECB to name a few. Canada is represented on the Board of Directors by Mark Carney, Governor of the Bank of Canada. While the BIS holds regular meetings among members to discuss various agendas, this particular meeting saw the executives the world’s biggest banking institutions come under scrutiny for what the BIS believes is the return of excessive risk-taking by banks in the face of historically low interest rates and a resurgent stock market.

The BIS wants members to supervise banks more closely by implementing “macroprudential” policies that would measure the impact of risk-taking behavior of large financial institutions on the banking sector as a whole as opposed to the financial state of individual companies. That’s because as we saw during the most recent financial crisis, no bank was safe from toxic assets. The fact that no one knew just how many toxic assets the other party had on its balance sheet produced a domino-like liquidity crisis that led to the collapse of hundreds of banks in the US and spurred massive government bailout packages around the globe to keep markets afloat.

Why should we care? The banking system in any free market economy is tightly linked and as we have learned all too well over the past 2 years, the reckless actions of a few will have consequences that would affect millions in so many pervasive ways.