Managing Your Money

Financial literacy has nothing to do with how well you score on tests of your knowledge.

You may be asked to define the Rule of 72 (the number of years it takes your money to double at a given interest rate) or the factors that go into calculating your creditworthiness. The problem with such tests is that they're based on facts – and facts change.

A legitimate tax avoidance strategy today can be viewed as tax evasion next year. Soon, you're getting demands from the Canada Revenue Agency for thousands of dollars in back taxes. You can score 100 per cent on a financial literacy survey and still lose money because you put your trust in bad people, companies or investments.

Trust is easily won in Canada.

Take the recent news about Montreal adviser Earl Jones, who's alleged to have spent millions of dollars that his clients gave him to manage.

In photos, the 67-year-old with the full head of white hair looks trustworthy. Clients felt they were in good hands and didn't bother to call the Quebec financial regulator to see if Jones was registered and covered by a compensation fund (which he wasn't). I'm not blaming the victims here. I'm blaming a system that allows financial advisers to operate outside of a mandatory regulatory regime.

Canadians have a sense of entitlement. There's a feeling that government rules are in place to keep us safe from fraud and wrongdoing. If you believe there's a fund to protect you in an insolvency, you'll probably let your guard down and get complacent. You won't take time to check the credentials of those to whom you entrust your savings.

Here's a way to boost financial literacy. Let's make Canadians more suspicious. Let's work on changing attitudes, not teaching more stuff. Let's encourage everyone to ask about the downside risks and the worst possible scenario. Let's develop a checklist of questions to ask – and tick off as answered – before people sign any paperwork or agree to any large purchases.

Questions such as:

What if I get sick or I can't work anymore? Can I get my money back early without a penalty?

What if the company goes under? What if the principals go to jail?

What if the stock market goes down and stays down for a few years?

What if interest rates go down to zero?

What's the worst possible loss I can have on my investment?

You may have to counteract your own optimistic tendencies about returns that look too good to be true. An investment yielding double-digit rates carries more risk than one yielding 2 to 3 per cent.

It won't be guaranteed, for sure, and it won't be a loan.

About 2,800 people in British Columbia fell victim to the Eron Mortgage fraud in the 1990s.

A study by Simon Fraser University professor Neil Boyd found more than a third of Eron investors thought they were providing a loan with a guaranteed rate of return.

Those who saw themselves as lenders lost almost twice as much as those who viewed themselves as investors – an average of about $76,000, in contrast to an average of $43,000.

Decisions to invest often take place without a strong base of knowledge and, most important, without a critical analysis.

"It will ultimately be a well-informed and skeptical investor who is least likely to be victimized by the fraudulent dishonesty" of men such as those behind Eron Mortgage, Boyd concluded.

Next week, do financial literacy and accounting go together?

Rearranging Your Debt

It has been nearly six months since the Lipson decision, in which the Supreme Court of Canada effectively blessed the debt-swap strategy known as the "Singleton shuffle." But a new court decision reminds us how critical it is when rearranging your debt to do so legally.

After all, in Canada, it's nearly impossible to write off your mortgage interest without some advance planning.

The Singleton shuffle, named after Vancouver lawyer John Singleton's 2001 Supreme Court victory, stands for the notion that you can rearrange your financial affairs to make the interest on investment loans tax-deductible. How you do that is by replacing non-deductible debt with tax-deductible debt.

The case decided last month involved Nina Sherle, who owned a rental property (Property A) with a mortgage on it upon which the interest was deductible. She also owned a personal residence (Property B) free and clear.

She wanted to switch properties. In other words, she wanted to live in Property A as her personal residence and rent out Property B. She stated she didn't want to change her financing strategy, which was to live in her personal residence (soon to be Property A) mortgage-free.

To accomplish this, she mortgaged Property B to pay off the loan on property A. As a result, she was now making interest payments on the new mortgage secured by Property B. She deducted this interest on her tax returns but was reassessed by the Canada Revenue Agency.

The CRA argued that for interest to be deductible, one must look to "the actual, direct use of the borrowed funds" and whether such use was for the purpose of earning income.

Since the mortgage proceeds were used to pay off the loan on Property A, which was to be a personal residence, not an income-producing property, the interest was not tax-deductible.

The judge in the case agreed. He wrote: "Why funds are borrowed is irrelevant.... It is the use of the funds that governs [the decision]. In the present case, the required link between the use of the proceeds and the income-producing property is just not there."

In a twist, the judge went on to describe what Ms. Sherle could have done to permit the interest to be deductible. While somewhat complex, it essentially involves Ms. Sherle selling Property B to a friend in return for a promissory note.

The next day, Ms. Sherle could have borrowed money from the bank to pay off the mortgage on Property A. She then could buy back Property B from her friend, financing that purchase through a mortgage on Property B.

Her friend would take the proceeds from the sale of Property B and use them to repay the promissory note. Finally, Ms. Sherle would use the proceeds from the promissory note to pay off the bank loan.

Confused yet? The end result is that only the mortgage on Property B would be outstanding. The interest should be tax-deductible since the direct use of the mortgage proceeds was It has been nearly six months since the Lipson decision, in which the Supreme Court of Canada effectively blessed the debt-swap strategy known as the "Singleton shuffle." But a new court decision reminds us how critical it is when rearranging your debt to do so legally.

After all, in Canada, it's nearly impossible to write off your mortgage interest without some advance planning.

The Singleton shuffle, named after Vancouver lawyer John Singleton's 2001 Supreme Court victory, stands for the notion that you can rearrange your financial affairs to make the interest on investment loans tax-deductible. How you do that is by replacing non-deductible debt with tax-deductible debt.

The case decided last month involved Nina Sherle, who owned a rental property (Property A) with a mortgage on it upon which the interest was deductible. She also owned a personal residence (Property B) free and clear.

She wanted to switch properties. In other words, she wanted to live in Property A as her personal residence and rent out Property B. She stated she didn't want to change her financing strategy, which was to live in her personal residence (soon to be Property A) mortgage-free.

To accomplish this, she mortgaged Property B to pay off the loan on property A. As a result, she was now making interest payments on the new mortgage secured by Property B. She deducted this interest on her tax returns but was reassessed by the Canada Revenue Agency.

The CRA argued that for interest to be deductible, one must look to "the actual, direct use of the borrowed funds" and whether such use was for the purpose of earning income.

Since the mortgage proceeds were used to pay off the loan on Property A, which was to be a personal residence, not an income-producing property, the interest was not tax-deductible.

The judge in the case agreed. He wrote: "Why funds are borrowed is irrelevant.... It is the use of the funds that governs [the decision]. In the present case, the required link between the use of the proceeds and the income-producing property is just not there."

In a twist, the judge went on to describe what Ms. Sherle could have done to permit the interest to be deductible. While somewhat complex, it essentially involves Ms. Sherle selling Property B to a friend in return for a promissory note.

The next day, Ms. Sherle could have borrowed money from the bank to pay off the mortgage on Property A. She then could buy back Property B from her friend, financing that purchase through a mortgage on Property B.

Her friend would take the proceeds from the sale of Property B and use them to repay the promissory note. Finally, Ms. Sherle would use the proceeds from the promissory note to pay off the bank loan.

Confused yet? The end result is that only the mortgage on Property B would be outstanding. The interest should be tax-deductible since the direct use of the mortgage proceeds was to buy the rental property.

Canada home resales

Sales of existing homes in Canada posted their biggest year-over-year gain in two years and rose for a sixth straight month in July, as low interest rates and an improving economy tempted buyers back.

In a first look at third-quarter sales, the Canadian Real Estate Association said on Friday that 50,270 homes changed hands in July, up 18.2 percent from the same month last year.

It was the first time that sales topped 50,000 units in July, and the number was 3.9 percent above the previous record for the month, set in 2007, the industry group said.

On a seasonally-adjusted basis, home sales rose at a slower pace in July, up 2.5 percent. Sales rose nearly 9 percent in June.

"National resale housing market activity continued on its upward trend in July, but its pace slowed from fullout sprint in months prior down to that of a 5K run," said Pascal Gauthier of TD Economics.

The report is the latest evidence that consumers are venturing back into the home market after a slump triggered by the recession. Low mortgage rates and signs that the worst of the slump is over are stimulating the market.

The association said demand is rebounding sharply in some of Canada's most expensive markets and that distorted the national average price upward. The average July resale price rose 7.6 percent from a year earlier to C$326,832 ($299,846).

"The difference in the resale housing market now, compared to the beginning of the year, is night and day, and nowhere is this more evident than in the West," said CREA president Dale Ripplinger.

Resale activity in Vancouver, British Columbia, surged 90 percent in July from a year ago, while Alberta cities Edmonton and Calgary posted a jump in sales of 28 percent and 22 percent, respectively.

New listings nationwide continued to fall, down 13 percent to 73,444 units from a year ago. Eight provinces reported higher prices, as did 18 of the 25 largest cities.

Mortgage Window

After a recent spike seen in mortgage rates, some consumers are wondering whether they've missed their chance to refinance into an ultra-low rate.

Fear not: While the conforming 30-year fixed-rate mortgage hit a daily average of 5.81% last Thursday, it averaged 5.53% on Tuesday, And it's possible that rates could continue to fall.

"Predicting interest rates is like predicting who is going to win the World Series in January," said Guy Cecala. That said, he calls the recent spike "somewhat of an aberration," and expects rates will continue to drift down.

Why the recent run-up in rates? Over the past month or two, "the economic skies have brightened somewhat," Gumbinger said in an email, and the threat of "trillion-dollar budget deficits for the foreseeable future, the potential for significant inflation, and few clues as to how the government might extricate itself from intrusions into markets" created a landscape that was not appealing to investors.

But now, rates are retreating partly because inflation doesn't seem as immediate a threat as investors feared, Cecala said. In his opinion, nothing fundamentally has changed in the economy over recent weeks to warrant the rate rise, yet he expects volatility through the remainder of the year as investors debate the economy's health.

"Realistically, I think that the rates will drift under 5% again. It may take a month, may take two months," he said.

It's also important, however, to realize that extremely low rates likely won't be around forever, said Bob Walters, chief economist of Quicken Loans, in a statement.

"Luckily, we have seen rates drop some this week, which should help many consumers breathe a little easier," Walters said. "But the fact remains, the government's plan of purchasing mortgage-backed securities cannot go on indefinitely, and when it ends, we will most certainly see a spike in rates. The hope is that the Fed can keep rates low long enough to kick-start a housing recovery. Whether that will work remains to be seen."

"Volatility is the key word in the mortgage industry these days when it comes to rates," said Kyle Kerwin, senior vice president of mortgage lending for Signature Bank of Arkansas.

Here are five tips for those shopping for a mortgage today, particularly those who need to refinance an existing loan:

1. Get started on paperwork. Once you've found the mortgage professional you'd like to work with, get started on the necessary paperwork. Rates move regularly, and if paperwork has been started your file can be processed more quickly when rates hit a low. When you start the application process, your credit score will be pulled and you'll need to submit support documentation including W-2 forms and pay stubs. You might be asked for updated documents nearer to closing.

2. Make sure your credit is in good shape. Check credit reports and fix problems as soon as possible. Even seemingly small charges can haunt a borrower: A forgotten, unpaid parking ticket, for example, can noticeably affect a credit score, she said.

3. Decide at what rate it makes sense to pull the trigger. If you have a 6% rate now, rates would have to hit 5% or lower for it to make financial sense to refinance. Talk with your mortgage professional about what's best for your particular situation.

4. Stick to your guns. Once you determine the rate you'd need to get, it's probably wise to stick to that decision. Consumers sometimes gamble that rates will go lower, and the plan can backfire if rates reverse course. A couple of weeks ago, rates were close to 4.5% in his market, "and people wanted to hold out for an extra eighth of a percent."

5. Remember, rates are still good. Yes, rates could fall and create another record low as a result of a swoon in the stock market, a collapse of a major bank or a deepening of a recession. But it isn't likely that many consumers would crave those economic shocks. "Why would anyone wish for those things again to simply get a rock-bottom, ultra low mortgage rate? If it means saving $250 per month on your mortgage but it costs you $50,000 in your 401(k), how could this be seen as any kind of benefit?" he said.

European Rates Unchanged

The Bank of England surprised markets on Thursday with a significant expansion of its program to boost the money supply and support growth, even as it and the European Central Bank kept official interest rates steady at record lows.

The move by the British central bank to boost its so-called quantitative easing program by 50 billion pounds ($84 billion) to 175 billion pounds ($295 billion) garnered the main attention in Europe, underscoring official caution about recent signs of an economic recovery.

As the ECB shied away from announcing any new measures on "enhanced credit support," the ECB's version of quantitative easing, the British pound lost almost two cents against the U.S. dollar while European government bonds rose — reversing an earlier loss — after the announcement in Britain.

The Bank of England noted recent conflicting data on the economy, saying financial conditions were "fragile" and that growth in the money supply "remains weak" as it explained its decision.

RBS economist Stephen Boyle said the bank's nine-member monetary policy committee had "decided it is better to be safe than sorry."

The British central bank turned to the quantitative easing program in March after almost running out of room to cut interest rates. Under the program, the central bank buys financial assets such as bonds from banks and pays for them by crediting the banks' account at the Bank of England, in effect creating new money.

As expected, it held rates steady at 0.5 percent on Thursday while the ECB stood pat at 1 percent. Economists expect both banks to keep interest rates at their current lows for some months.

In Prague, the Czech Republic central bank had more leeway, cutting its base rate by a quarter percentage point to a new record low of 1.25 percent.

Recent economic data in both the euro zone — a bloc of some 320 million people comprising nearly 17 percent of the world's output — and Britain have suggested early signs of an economic turnaround.

In Britain, the housing market and the key services and manufacturing industries have all shown signs of improvement in recent months. Similarly, German industrial orders recorded another strong month in June, advancing 4.5 percent and led by demand from other European countries, according to figures out Thursday.

"What I observed, in general, is that the overall mood is, right or wrong, today a little bit better than it was before, and not surprisingly because there have been a number of surveys that were a little bit better, some hard figures that were better," ECB president Jean-Claude Trichet told reporters in Frankfurt.

Trichet added that the "pace of contraction is clearly slowing down," and that the bank expects a phase of stabilization next year followed by a gradual recovery.

But concerns remain. Trichet repeatedly added that the outlook remains very uncertain.

"As far as we are concerned, and we can see, we are very prudent and cautious," he said.

The Bank of England said the recession had proved deeper than previously thought, reflecting data out last month showing that the British economy contracted by twice as much as economists had forecast in the second quarter — gross domestic product shrank by 0.8 pecent between April and June.

European Union statistics last week showed unemployment in the euro zone countries rose to a level not seen in a decade and consumer prices slipped more than expected.

"On the one hand, there is a considerable stimulus still working through from the easing in monetary and fiscal policy and the past depreciation of sterling," the rate-setting committee said in a statement accompanying its decision.

"On the other hand, the need for banks to continue repairing their balance sheets is likely to restrict the availability of credit, and past falls in asset prices and high levels of debt may weigh on spending."

Britain's banks are still suffering from their losses in the financial crisis and government officials say they are too tight with credit for businesses despite getting government bailouts.

Trichet suggested that banks needed to do more to strengthen their capital bases "and where necessary, take full advantage of government measures to support the financial sector, particularly as regards recapitalization."

The conflicting data had left economists divided ahead of Thursday's announcement about whether the Bank of England would expand its quantitative easing program.

Halting the asset buying program too early could prolong Britain's worst recession in decades, but pumping too much money into the economy raises the risk of an inflation headache down the road.

Trichet said the ECB's decision in May to buy euro60 billion ($86.4 billion) in covered bonds has been warmly received, with the bank revealing that it has so far spent euro5.1 billion through the ongoing program.

The ECB said that buying the bonds from commercial banks, considered a relatively safe way to provide lenders with more cash, had somewhat revived the covered bond markets from a near standstill in September 2008.