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Real Estate Investing – Why you should always consider a readvancable collateral charge mortgage

Home owners can use certain mortgage products to access their equity without triggering legal fees or penalties. Here we explore how this can work for you and covers the disadvantages you may face.

Collateral Charge Mortgages

What is a collateral charge?

 The lender has your lawyer register more debt on title than you actually owe. It is important to understand this does not increase your actual debt or harm future qualifying for a mortgage.

What are the benefits of a collateral charge mortgage?

A collateral charge allows the lender is able to increase the loan size without changing the charge on your property’s title. The benefit to you is the ability to increase your home equity line of credit (HELOC) limit beyond the original amount without breaking the mortgage or paying legal fees.

What are the disadvantages of these types of mortgages?

When your mortgage comes for renewal it is slightly more expensive to change lenders (typically around $400).

** It is also important to note that most lenders retain 85-90% of their renewal business. Scotiabank retains well over 90% of its mortgage renewals. The reason for this is typically because lenders have very little cost to renew your mortgage and require minimal paperwork (usually just signing renewal papers). You generally do not need to requalify to renew your mortgage. For a new lender to acquire a renewal they must fully underwrite the mortgage file, collecting all of your personal documents (Thing income, property, and asset documents). This difference allows the renewing lender to offer far more aggressive rates which we help our clients obtain.

The second disadvantage of these products is a lender’s ability to claim unsecured debts against your home. An example would be taking a large unsecured loan for a sole proprietor business with the same bank and defaulting on it.

The simplest way to avoid this is obtaining large unsecured loans with other lenders that do not have a collateral charge on your home.

We are always here to help our clients navigate this planning.

Readvancable Mortgage Products and how they can help home owners and real estate investors

What is a readvancable Mortgage?

A readvancable mortgage works as your mortgage is paid down by you or your tenant. Every payment reduces the debt you owe on your mortgage and becomes available on your home equity line of credit (HELOC). You are able to access the paid down funds through your HELOC. Some lenders have this adjustment happen automatically while others require you to go into a branch and request the HELOC increase. Other lenders have the HELOC increase in relative real time and others have delays. We specialize working with clients to find the correct overall product to maximize these benefits and avoid any drawbacks.

What are the benefits and uses of a readvanable mortgage?

Readvancable mortgage products offer greater financial flexibility as you have access to cheap funds with quick notice. These funds can be used for repairs, renovations, down payments for investment properties, investments as well as personal needs and vacations (not suggested). Having access to these funds can allow you to grow a real estate portfolio or investment portfolio far quicker than by simply saving. Borrowed funds used for investment purposes are generally tax deductible** as well. This can significantly improve the performance of your investment, increase your return on investment and minimize your cost of borrowing.

What are some disadvantages with readvancable mortgage products?

One disadvantage can be limiting your lending options based on the product you are looking for. In our experience, this can result in paying roughly 0.1% more than restricted or simpler mortgage products. For the vast majority of clients the benefits outweigh the drawbacks.

 Some lenders debt service the limit of HELOC’s and having access to these funds can reduce your total borrowing power. If this is a barrier our solution to this is having the lender only increase your HELOC limit at your request as well as the ability to close the HELOC if needed.

** Always speak to an accountant about tax matters.

How can these mortgage products befenefit real estate investors?

These products can be combined on investment properties to drastically accelerate portfolio growth and minimize mortgage penalties and legal fees.

Increased ability to acquire down payment for future investments properties faster.

The combination of these products allows the investor to access principle paydown as well as the appreciation of the property. This can allow investors to have a higher degree of control with their real estate portfolio growth.

Avoid penalties and minimize costs to maximize return on investment.

Not only can the investor increase the total lending limit beyond the original loan, they can do so without triggering mortgage penalties or legal fees. As a real estate investor myself I always prefer to minimize unnecessary or avoidable costs to boost my return on investment while reducing my overall risk.

Reduce accounting costs and easier book keeping.

The ability to have up to three mortgage and three home equity line of credit components as a minimum (some lenders allow for more). This allows you to keep your tax-deductible and non tax-deductible debt separate on your residence as well as separating funds borrowed for different investments. This can make filing your taxes easier and can reduce your accounting fees. We always suggest working with an experienced accountant who understands real estate investing. If you are looking for someone exception send me an email – Keaton@KBMortgages.ca and I can help you find the right accountant.

Ability to pay off the debt on your primary residence significantly faster with the Smith Manoeuvre.

We are Smith Maneouvre Certified Professionals and work directly under Robinson Smith to help Canadians implement the strategy alongside other Smith Manoeuvre Certified Professionals like accountants and financial planners. To learn more about how to reduce the cost of your mortgage and to create wealth for retirement click here. Let us know if you need any type of professional, we are here to help however we can. Our goal is to help you improve your retirement, pay off your mortgage faster and to minimize the total cost of your mortgages. We achieve this by maximizing tax deductibility and positioning you to keep your equity working for you.

If you would like to connect for a call to chat  – you can reach me here.

Learn how to reduce the total cost of your mortgage by 15% and how investors can avoid a qualify issues.

Here are two podcasts we have been guests on about the strategy.

The Real Estate Investor Dad Podcast

The Explore FI Canada Podcast

Thanks for reading and I hope you have an amazing day!

 

To lock in your variable mortgage or stay fixed

 

It’s a question many people are debating right now. As a mortgage broker I get asked about this daily.

I am personally buying a home right now, I actually get the keys May 12th! I cannot tell you what the right decision is for yourself but I will share why I am sticking with a variable.
 

Should I lock in to a fixed rate mortgage?

 
If I lock into a fixed rate today I will be guaranteeing roughly another 8
increases overnight. This is because fixed rates are roughly 2% higher
than variable rates currently. On top of this locking into a fixed rate
increases prepayment penalties by almost 800%.
 

The numbers behind the fixed vs variable debate

Here is some quick math on the average interest rate over 5 years (broken into 8 sections per year as the Bank of Canada increases rates). I have marked the increases in orange.

 

This scenario assumes 8 further rate increases over 2 years and then rates stabilize. (The average cost/rate over 5 years is in yellow)
 
See the 8 increase scenario (8 orange boxes) (sorry you have to click the image to see the full picture)
If rates increase beyond the 8 increases in 2 years variable would likely cost more. The risk of this could be reduced by paying down extra principle on your payments.
 
See the 10 increase scenario (10 orange boxes) (sorry you have to click the image to see the full picture)
 
These numbers can be altered by changing when rates increase, this is not a prediction but rather an illustration of how increases may alter your average interest rate.
 
Key take away – in both these scenarios (8 increases and 10 increases) the variable rate barely costs more than the fixed-rate option. If rates increase more gradually, increase and then retreat or fail to rise this sharply the variable option is the clear winner. You will need to ask yourself if you expect rates to rise beyond these scenarios.
 
It was this breakdown that led to me deciding to stay variable (after much consideration). I personally believe variable is still the safer route for many Canadian due to the lower prepayment penalties and lower interest costs upfront (prepay your mortgage during this time if you can but do not exceed your prepayment limits). I have also attached the
spreadsheet I used for this math if you want to run your own rate vs your lock-in options.
 
 
A final word on fixed vs variable – Unless you are going to pay off your mortgage in the next 5 years a fixed rate only DELAYS your exposure to rising rates. Let’s say you have a mortgage you will pay off over the next 25 years. Imagine rates gradually rise over the next 25 years.
 

John Fixed and Jane Variable – A tale of two borrowers

I want you to imagine two neighbors, John Fixed and Jane Variable. John and Jane both bought identical houses for the same price on the same day.
 
John Fixed takes a fixed-rate mortgage at 4.14%
 
Jane Variable takes a variable rate mortgage at 2.6%.
 
Let’s assume that rates increase based on our second scenario (10 increases over 5 years).
 
In the first 5 years, John and Jane have a very similar interest costs.
Jane averages 4.21% and John averages 4.14% (because he had a five-year fixed).
 
5 years after they bought their home they both renew. John adjusts from
4.15% to market rates of 6.6% (5-year fixed) and Jane adjusts from 5.6%
to a similar variable product.
 
And the cycle repeats… every 5 years John Fixed takes a new fixed mortgage and Jane Variable rides the rates up and down. If rates rise gradually John Fixed only delays the change, every 5 years he has drastic swings in his rates. When rates drop from time to time Jane Variable benefits from this.
 
Meanwhile John Fixed watches with envy, he even goes to his bank asking about refinancing but gives up in frustration when he realizes his penalties are 900% larger than Janes.
 

When does a five year fixed rate make sense?

 
The only scenario John Fixed comes out ahead is if his renewal lands on a temporary low point in the market (talk about leaving things to chance), or if rates spike very aggressively for a short period of time and fall back. Sometimes lowest cost and flexibility is not the main priority but rather payment stability the priority. In this situation a fixed rate can make sense. An alternative to this would be a “variable” rate mortgage where the interest rate adjusts but your payments stay the same.
 

 Why do I often suggest Variable Rate mortgages?

 
The moral of the story – historically variable products have outperformed fixed rate products. I do not expect this to change. One study by Dr. Moshe Milevsky showed that “variable rate-mortgages saved borrowers money 88.6% of the time.” when compared to fixed rate mortgages.
 
Over 25 years you will have an average interest cost, a variable mortgage will adjust often, up and down, whereas with a fixed-rate mortgage you will have a new rate set for years 1,5,10,15,20, and 25.
 
To avoid massive penalties, avoid potential rate shock on my renewal, and hopefully have a lower interest cost in the long run I am staying variable. You will need to decide for your own family but I hope this helps.

Here we cover how to reduce your risk to rising interest rates and to reduce your total interest cost by over 15%.

 

Find out more

As mortgage broker’s we are on your team. Our job is to understand your needs, plans and wants in order to understand your mortgage needs. We then look at a number of lenders to find the best products and solutions for you.

During our time in the industry we have learned a number of tips and tricks to help you save money and to pay of your mortgage faster.

If you have any questions or would like a customized mortgage plan let us know!

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