Invest money

If you look at the most stressful events in a person’s life, buying a home is on the top ten list. After all, it’s a big decision – both emotionally and financially. Many home buyers go through an anxious period after they’ve arranged for their mortgage and get ready to move into their new home. Knowing you’ll get a pocketful of cash would sure help, wouldn’t it?

That’s a big part of the attraction of cash-back mortgages. A plump cheque is a psychological boost to home buyers who have just made one of the biggest financial commitments of their lives. As mortgage brokers, we like to work with our clients to ensure that they look beyond the temporary “feel good” of the cash, and weigh their options wisely.

Remember that the cash-back option comes with a trade-off: if you choose not to take the cash back, you can get a lower interest rate. Over time, you could see substantial savings in interest payments.

So, start with the most important question: What will the cash be used for? Is this purchase a priority, and is it worth the difference in the rate? Perhaps you have a plan to take advantage of the cash-back to purchase the household appliances for your new home. The extra $3,000 for new kitchen or laundry appliances may be an urgent immediate need and a higher priority overall than the lower interest rate for your mortgage term.

But here is the second question to discuss with your mortgage broker: What will be the impact of the rate difference over time? You’ll need real-life figures to work out the details for your personal situation, but let’s look at an example*:

Let’s say that your cash-back option pays 1% of the mortgage amount on a two-year deal, 3% on five years, and 5% cash back on a ten-year closed mortgage. And let’s assume that you’re looking at borrowing $100,000 for a 5-year term, amortized over 25 years. Not long ago, you might be looking at the difference between cash back and a rate of 6.60%, or a discounted interest rate of 5.29%.

So what’s the bottom line? Your cash-back option would give you $3,000 up-front, but over your 5-year term, you would pay a little over $6,300 more in interest costs than you would have with the discounted rate. The exact cost of the cash-back option in this example is $3,330.44 – paid out over 5 years.

Is that a good deal? It depends. Did you get the much-needed appliances for your home… or use the funds to manage a high-priority expense? Then you probably got good value from the option. If – five years later – you can’t remember where the money went, then perhaps you didn’t make the best trade-off.

My current position November 19, 2008:

• .BABZ BA FEB 2009 40 Call – cost : $5.70
• CVI – cost : $3.60
• .KOBI KO FEB 2009 45 Call – cost : $4.20
• MECA – cost : $2.10

I bought all stocks and option hoping the price will go up.

For example, suppose XYZ stock is trading at $40 and I think the fair value is $45. So the stock is not priced correctly and I want to buy it. But current price is not selling at deep discount. So I then sell a put with a strike price of $37. This would give me some money from selling option. If I had to buy the stock at $37, I would be happy because I think the fair value is $45. So I’m actually buying on discount.

Stock LEAPS are long-term stock options. The term is an acronym for Long-term Equity Anticipation Securities. LEAPS typically become available for trading in July, and have a 2.5-year lifespan. If the LEAPS has only six months or so before expiration, it is no longer called a LEAP, but merely an option. All LEAPS expire on the third Friday of January. Because of this, you can take avoid tax. If you have a profit when selling a LEAP, your tax is not due for another 15 months. You can also avoid the tax by exercising your option.

All LEAPS, like any option, go down in value over time (assuming the stock price remains unchanged). Since there are fewer months remaining until the expiration date, the option is worth less. But LEAP has smaller monthly decay than short-term option. In the last month of an option’s, the decay is usually three times (or more) the monthly decay of a LEAP (at the same strike price). An at-the-money or out-of-the-money option will plunge to zero value in the expiration month, while the LEAP will hardly move. When buying a LEAP, plan on holding it for a long time, probably until expiration. While you can always sell your LEAP at any time, it is expensive because of the big gap between the bid and asked price.