Last week on 6/1/2011, I requested quotes from two brokers and two banks to refinance my 30-year fixed jumbo-conforming mortgage. The criteria for my refinance is that it has to be no-point and is either no-cost or has very low-fee.

Broker H

I have worked with broker H for previous refinances before. She quoted me a rate of 4.375% with a 0.375% fee.

Broker A

This broker was recommended to me from a co-worker. She told me the rate was 4.375% with no-point and no-fee at that particular instance, but the rate was valid only on that day and it was already too late to prepare the documents to lock in to that rate. She requires an upfront $25 for the credit report and another $50 to submit the loan (which will be reimbursed at closing).

Bank of America

I received a quote of 4.75% for a no-cost no-fee loan. My current loan is 4.625%, so this option is a no-no.

First Internet Bank of Indiana (FirstIB)

Based on many good reviews, including that from TheFinanceBuff, I have been watching the online rate quote from FirstIB. The online rate quote on this particular day was 4.375% with ~$1200 fee.

What I did

I decided to wait for a better rate from the brokers, and at the same time, to submit the application with FirstIB and wait for the right moment to strike.

FirstIB does not charge a fee to submit the online application, so it was a relatively easy decision, with the only “cost” being a hit on my credit report.

I submitted the online application with FirstIB’s Gary (who has received many good reviews). I received a call back from Gary about 3 hours later. He told me the rate had improved after my application was submitted, and the new rate was 4.375% with a $5000 credit. This credit can be used to pay for the closing costs (estimated to be $3000), with the remainder going into the impound account to pay for future property taxes and insurance.

Since this mortgage rate and fee scenario met all my criteria, I locked the rate with Gary on the spot. Gary told me that he expects the refinance to close in 25 days.

I am keeping my fingers crossed and will post the timeline once my refinance with FirstIB is completed.

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http://www.tdameritrade.com/upto500

and runs through 7/15/2011. The fine print is as follows

Offer valid for one new Individual, Joint or IRA TD Ameritrade account opened by 07/15/11 and funded within 30 days of account opening with $2,000 or more. To receive $100 bonus, account must be funded with $25,000-$99,999 within 30 days of initial minimum funding. To receive $250 bonus, account must be funded with $100,000-$249,999 within 30 days of initial minimum funding. To receive $500 bonus, account must be funded with $250,000 or more within 30 days of initial minimum funding. If you open a new TD Ameritrade retirement account, cash awards are valid within your IRA only and non-transferable to another existing TD Ameritrade account. Please consult a legal or tax advisor for the most recent change to the U.S. tax code and for rollover eligibility rules. Offer is not transferable and not valid with internal transfers, Amerivest-related accounts, TD Ameritrade Institutional accounts, current TD Ameritrade accounts or with other offers. Qualified commission-free Internet equity or option orders must execute within 60 days of meeting minimum funding requirements. Contract, exercise, and assignment fees still apply. Limit one offer per account type. Account must remain open with minimum required funding for 12 months or TD Ameritrade may charge the account for the cost of the cash awarded to the account. TD Ameritrade reserves the right to restrict or revoke this offer at any time. This is not an offer or solicitation in any jurisdiction where we are not authorized to do business. Please allow 3-5 business days for any cash deposits to post to account.

Taxes related to TD Ameritrade offers are your responsibility. Retail values totaling $600 or more during the calendar year will be included in your consolidated Form 1099.

Since I already have an existing account with TD Ameritrade, I wanted to check if I can qualify. This is the reply to my inquiry

Yes, you can use that promotion if you open another account.  Please let us know if you need further assistance.  We really appreciate your business.

I opened a new account online. The account application and the credit of bonus went through very smoothly and quickly. The following is the timeline:

• 5/30/11 (Memorial Day) : Submitted application online.
• 5/31/11 : Faxed in signature form and asset transfer request in the morning. Later that day, received an acknowledgment that the asset transfer request was received.
• 6/3/11 : Assets were transferred into the account. The new account was credited with the new account bonus as well as 100 free trades.

From start to receiving the bonus, it took 4 business days. Now I just need to keep the assets there for the next 365 days.

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Market and limit trades

If you have traded stocks before, you would easily understand how the currency exchange system works in CF. Similar to a brokerage account, you can place “limit” orders or “market” orders. When you place a market order, you are exchanging your currency at the current best rate. With a limit order, you can specify the rate you want to  get, and then wait for someone else on the opposite side of the trade to accept your offer. As with stock trades, limit orders will not be matched if there is no corresponding seller.

There is no fee to place an order on the CF system, and you can make as many changes you want as long as the order has not been matched.

Cost of exchange using CurrencyFair

The cost of exchanging money using CF comes in two parts. The first part is the commission. Here is how CF explains their commission in the FAQ:

What is CurrencyFair’s commission?

Well, this rather depends on which currencies are being exchanged but whatever you’re converting; the commission is incorporated into the rate. So it’s transparent. You can see how much it’s costing.

This means that CF places a markup to the foreign rates shown on the webpage.

The second fee comes from the transfer fees charged for transferring money out from CF. CF’s funds transfer fees are as follows:

The standard fee is for a transfer made using the equivalent of ACH in the U.S., and a priority transfer is made using wire.

Placing a trade

A trade to exchange USD3000 to SGD was placed at the rate of 1 USD = 1.27 SGD. The following USD to SGD exchange quote screen appears. The current best market exchange rate is 1 USD to 1.2591 SGD.

At the same time, the offer to sell USD 3000 appears in the SGD to USD quote screen. Notice that it is shown as an offer to buy 3810 SGD at the rate of 1 SGD = 0.7874 USD. If we examine this offer, we can find out the commission that CF is charging.

Taking the reciprocal of 0.7874, we get 1.27000254, which rounds to 1.2700. This is in fact the same as the exchange rate requested, suggesting that CF is in fact not charging any exchange fee. I don’t know if this is because of a temporary fee waiver or if it is a bug or if this is the CF’s intention all along. In any case, I am happy with this finding.

I compare this rate with the rate being offered by DBS bank at that time (shown below). DBS was selling USD at 1.275 SGD and buying USD at 1.259, a spread of 1.27%. The market rates available on CF are 1.2737/1.2591, a spread of 1.16%. So the rates on CF are even more competitive than DBS bank.

The exchange

I left the limit order of 1.27 for the day (3/7/2011) but it was not filled. In the night, I reduced it to 1.2626 and it got matched in the early hours of 3/8/2011. For comparison, here’s the spot exchange rate according to Yahoo finance:

After the currency exchange, I submitted a request to have the money transferred to a SGD bank account. CF charged a fee of SGD5. The money hit the bank in two business days.

My exchange results

Assuming a spot exchange rate of 1.267 when the exchange happened, I received an exchange rate that is within 0.35% of the spot rate. The transfer cost is SGD5.

If I had gone through the traditional route, it would have cost USD25 to send an international wire, a 0.63% fee for the spread, and another SGD10 for the recipient to receive the wire. So quite a bit of money was saved using CF.

Caveats and risks

The amount of currency available depends on the number of users, and is not unlimited like with a bank. But if you are exchanging at most several thousand of USD at a time, it should not be a problem.

There could be concerns of money being held by CF in case of fraud or company failure (read this link). Being overseas, it could be inconvenient or costly to get it resolved. This risk can be mitigated somewhat by exchanging as soon as CF receives the money and then transferring the money out immediately after the exchange.

Trading spreads depend on the relative demand of the currencies being exchanged. A better or poorer rate could result.

Keywords: Experience, Review of Currency Fair, CurrencyFair.

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From the various online feedback I read, they sound like a legitimate setup and so I decided to try them out.

Initial questions

Before opening the account, I sent CF an email to ask some basic questions. Some of the answers can actually be found in their FAQ, but I wanted to confirm them (in case they are outdated), and more importantly, I wanted to see if CF responds to questions in a timely manner.

I received a well-researched initial reply from an associate director in about one business day (considering the different timezones). Subsequent questions to the same person were replied within an hour when CF was opened for business. Great. CF did well.

Account setup

With the initial questions out of the way, I went ahead and register for an account. CF requires the following information — name, address, date of birth. (Note to U.S. users: being in Ireland, CF does not require the social security number). To verify identity, CF asks for a copy of the passport or photo ID and two proofs of address (phone bill, utility bill etc). These can be uploaded online to their website. After I uploaded the requested information, my account was verified and active the next day.

Getting money to CF

At CF, before any foreign exchange can be done, money must first be transferred into one of CF’s bank account. CF’s USD bank account is Bank of America (BOA). I explored a few ways to get money to CF’s BOA account:

1. Wire the money (fees): Wiring the money to BOA would be fast, but it will also require me to visit my credit union and a domestic wire fee of $20. Scratched that.
2. Use BOA’s internal transfer (free): BOA’s online banking supports intra-bank person-to-person transfer. I don’t have an existing BOA account so I considered opening a BOA account for this purpose. I chatted online with BOA’s rep to make sure that I can transfer money to CF. The rep told me I can transfer to any BOA account. I rephrased my question and asked if that includes a “Business account”; the rep then replied that I should call a number to verify. I did not call the number since I could get wrong information again; instead I asked a friend who has a BOA account to try to add CF into the transfer list. BOA’s online system responded that online transfers to business account cannot be added, just as I suspected. I am really glad I checked first; otherwise I would be stuck with an useless BOA account for the next few months.
3. Use an ACH push (free): Many banks now support ACH pushes to other financial firms but these typically require account verifications (e.g. two small trial deposits). They also require the sender to be the owner of both accounts. Nevertheless, there are two institutions which I know of that support ACH pushes without these requirements. The two are ING Direct (Orange checking account, OCA for short) and USAA. Since I already have the OCA, I decided to try that. I found that OCA’s transfers are typically processed on the second business day. After adding one business day for the timezone differences, my money arrives at CF in three business days.

Great. I have managed to get money to CF without any fees. Now I am ready to check out CF’s foreign exchange system.

(continue to Part 2)

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Notes: Benchmark is changed to 75% Vanguard LifeStrategy Moderate Growth fund and 25% Vanguard Growth Fund (previous weighting was 50/50). This produces the equity/bond ratio of 65/35.

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Notes: Portfolio shift to 8% Timber REITs and 8% MLPs completed. Also, fixed income increased to 35%.

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I spoke to customer service when the rates were first revised and they agreed to grandfather me to the more-friendly rate schedule. This more-friendly rate schedule is still available at their sister brokerage Investrade.com.  The current rate is as follows:

Anyway, I started taking advantage of their low margin rates but in the first quarter, I was hit with a substitute dividend payment in an ETF I was holding in that account. This is the definition of a substitute payment from Fidelity:

Substitute Payments
Substitute payments are payments received in lieu of dividends, interest, or other payments. They may be generated, for example, where a security has been lent to a third party (such as a broker) over a dividend record date. When an investor has a debit balance in a margin account, securities in the account are often eligible to be lent. If the shares are lent over a record date, the investor should receive a substitute payment equal to the amount of the dividend. Although the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) introduced lower federal tax rates for qualified dividend income, substitute payments are not taxed as qualified dividends but are instead taxed as ordinary income. Substitute payments in lieu of dividends and tax exempt interest are reportable in Box 8 of Form 1099-MISC.

So basically, with a substitute dividend payment, you get taxed at the full income tax rate instead of the preferential (15% for most tax payers) qualified dividend tax rate (if the dividend was originally qualified).

The negative consequence of this could be huge. For an ETF like VEA, I could get a year-end dividend in the range of a few thousand dollars. If it gets disqualified, my additional taxes could run into several hundred dollars.

There are a few ways to avoid this

1. Move the assets to a brokerage that “gross-up” the dividends to compensate for the additional taxes you have to pay. I only know of two brokerages that have this voluntary program — Fidelity and TD Ameritrade. As far as I know, VBS (Vanguard) and WellsTrade do not offer this. eOption also does not offer this. Edit: Schwab also offers this voluntary “gross-up” program.
2. Move the assets to the cash position. Some brokerages let you specify the “account type ” of each asset, whether it is “cash” or “margin”. eOption offers this and I moved the assets that potentially produce qualified dividends to “cash”. I left the non-dividend producing assets in “margin”. I don’t believe VBS lets you do this though; all the assets in each account must be the same “type” in VBS.
3. Do not keep a debit balance. If we read Fidelity’s definition carefully, it says that if “an investor has a debit balance in a margin account, securities in the account are often eligible to be lent”. So technically if there is no margin balance, no shares should be loaned out. Personally, I do not regard this method as a fail-safe method. When you sign on the dotted line for a margin account, you are already giving permission to the broker to lend out your shares. It could be possible that the broker will refrain, as far as possible, from lending out your shares in this scenario, but I think there is no guarantee that this would never happen.

Note: FWIW, my experience is that method 3 seems to be true. Until the eOption experience, I have never received a substitute payment with the many margin accounts I have had over the years. The reason could be simply because I have never kept a margin balance except at eOption.

Reference

[1] http://www.fool.com/personal-finance/taxes/2003/12/05/dividend-tax-breaks-at-risk.aspx

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Comments: Portfolio outperforms the benchmark by almost 2%, primarily due to Precious Metal equity and the MLP allocation. At first I thought this was a mistake until I did a rough verification with the following performance information (for June 2010):

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Comment: My portfolio caught up with the benchmark due to the heavy dose of PrecMetal equity, which outperform significantly in the month.

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The following is a list of items to reduce income:

• If you have kids, and you want to help to pay for their college, plan to have more of it funded by 529 accounts. If you have to sell investments or draw down from tax-deferred accounts, that increases your MAGI.
• Pay off mortgage if possible to eliminate income requirement. Again, same thing as college funding, if you have to sell investments or draw down from tax-deferred accounts, that increases your MAGI. Without a mortgage, you have less need to realize capital gains or draw down from tax-deferred accounts.
• Derive income for ongoing expenses from tax exempt bonds (tax exempt income does not figure into MAGI).
• Use a short term tax exempt fund to hold non-immediate cash needs instead of a high yield savings account. Perhaps top up the checking account once or twice a month. This reduces the amount of interest payments reported in MAGI.
• Shift equity investments into lower yield equivalents, while still keeping the general composition of the portfolio reasonably unchanged. One potential candidate would be to invest in US LargeCap Growth instead of US LargeCap Blend. Does not work for US SmallCap (US SmallCap Growth has a poor historical record).
• Invest in rental property and use rental income to fund ongoing expenses (rental income is typically offset by property depreciation).
• Look into MLP investments that shield income for as long as the investment is not sold (you can control when to sell if necessary).
• Delay signing up social security.

Even though it looks like I could potentially benefit from the healthcare reform if I retire early, I don’t agree with the changes. They simply penalize people who are successful and are a disincentive to work. This can’t be good for the economy. But that is another story.

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Comments: Rebalanced into INT EAFE. Moved 1% allocation from US SmallCap to US Timber.

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Comments: PrecMetal equity fell about 12% in January. This contributed to a fall of about 0.5% to the portfolio. International equities, EAFE & EM, both also fell more than domestic stocks. These explained the under performance of the portfolio with respect to the benchmark (-3.23% versus -2.26%).

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When I examine the bill closer recently, I find lots of fluff and taxes in the bill. Of the $15.01 bill, $7.28 is the cost of the “measured” service (I do not pay any additional toll charges) and $7.73 is the cost of taxes and all the other fluff, including

• federal subscriber line charge,
• rate surcharge,
• state regulatory fee,
• federal universal service fee,
• CA high cost fund surcharge-A,
• CA high cost fund-B,
• CA advanced service fund,
• California teleconnectFund surcharge,
• CA relay service and communications devices fund,
• local government fee,
• 9-1-1 emergency system,
• federal fees and tax, and
• local fees and tax.

That’s right, 51.5% of my payment went towards paying taxes and junk fees; only 48.5% is the actual payment for the service. Except for the 9-1-1 fee of $0.04, I consider the rest junk fees. Something is wrong here.

I have identified my land line replacement and I am now testing out the service. The replacement is essentially a VOIP (voice-over-IP/internet) service. Once I am happy with it, I would port my existing number over and rid myself of these junk fees!

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