Benefits of Owning Real Estate

Any financial advisor will tell you that owning your home free and clear when you retire is an integral part of a solid financial plan.  Both the equity that you’ve built up as well as eliminating most of your housing payment can be the difference between a rewarding retirement and struggling to maintain your standard of living or not being able to retire at all.  On average real estate will increase in value to match inflation so it’s a very stable place to invest your money.  It’s also a very necessary and tangible asset for which there will be no end of demand.  People will not someday decide that they don’t need a place to live or it’s not fashionable to own a home.  In the worst economies there is still much trading of real estate and if bought well it can always produce very good returns.

As an investment there are several benefits to real estate that other investments can’t match.  One is its stability:  it’s a tangible asset that can’t lose all its value like a stock can and there is always demand for it.  The other major benefit is that it’s highly leveragable.  You can own real estate for as little as 5% down (sometimes less) and receive the capital gains of the entire property value.  If you put $15,000 down on a $300,000 house and the market goes up by an average 5% per year then you’re making $15,000 return; a 100% rate of return!  You won’t get that from your RRSP’s.

The fact is that real estate has made more millionaires than all other industries combined.  You have to pay for housing anyway so why not pay yourself instead of your landlord.  And your senior years will be filled with the security required to have a comfortable retirement spent travelling and golfing instead of repeating “Welcome to Wal-Mart!”

How to double your retirement income for free

I am a great believer in taking care of myself.  I don't trust the government and I don't trust any company that I've worked for to look out for my interests above their own particularly after I've left their employ.  Owning free and clear title to your home at retirement is the difference between struggling in your twilight years and being secure.  Likewise, owning a second home in retirement is the difference between being secure and being free.  I don't know about you but tending the garden and shuffleboard for 30 years is not my idea of going out in style.  I want to travel and be creative and learn something that doesn't relate to my future economic status.  I want retirement to be the best years of my life not just an acceptable end to it.

By purchasing just one additional home and having your tenants pay off the mortgage would not only be a good investment for the equity it would add to your balance sheet but more importantly it would allow for an extra income of $1500 - 2000 per month in today's dollars.  One great thing about real estate is that its an inflation hedge.  Lets assume that you were retiring today and you are an average Canadian earning $2834 each month from CPP, Old Age Security, a private pension, and RRSPs; certainly enough if you're debt free.  Make that $4,500 per month and you're going on a Mediterranean Cruise!

But let's take the worst case scenario and assume the government is finally going to deal with the  fact that it's pension plans are drastically underfunded and they've left it until the ratio of working vs. retired people is way out of whack.  Now your government pensions have been cut in half (plus your taxes have gone up), and your RRSPs and defined contribution pension from work have been devastated by the massive collapse of the major economies of the world and they have been cut to one third of their expected value.  Now try living on $1130 per month.  And this is the result of proper financial planning; if you've got some debt left over you can forget about retiring all together.  In this scenario one rental property would more than double your income and it would not depend on the government to make wise decisions or your company to survive an economic crisis.  And don't think that because you work for the government and you have a defined benefit pension that you're untouchable.  Just ask those that spent a lifetime working for the state of Florida how secure their pensions are if the state government declares bankruptcy as is expected?

There are so many wonderful places to invest our money in this world even when it's in financial turmoil but we need to take a close look at how we define "secure" investments.  More millionaires have been made in real estate than all other industries combined!  It's a tangible asset which meets a basic need of . . . well . . . everyone.  In my books you can't beat that for security.

With some basic education in property management and the right property selection being a landlord can be a relatively hassle free task.  Of course this begs the question:  What if I bought two?

What your bank won't tell you about Collateral Mortgages

The term Collateral Damage wasn't coined with mortgages in mind but it could have been.  Collateral mortgages are becoming a trend with some lenders (mostly big banks) in an effort to restrict their clients ability to go to other institutions for their lending needs. A collateral mortgage is very similar to a traditional mortgage except that it allows 125% of the appraised value to be registered on title.  The benefit touted by the banks is that when the property has appreciated then you will be able to access more of your equity without the legal expenses involved in re-registering the mortgage.  The down side is that you are now limited to one institution which may not offer what you want or need. Say for instance that you fall on hard times and require a second mortgage, or a Line of Credit?  Won't happen unless your bank has the product and rate you're looking for. What about transferring your mortgage to another company at renewal?  Very unlikely. Even TD which offers collateral mortgages won't accept them from another lender so whatever rate they offer you is what you're going to get unless you want to break the whole mortgage and pay the legal fees again.

Are collateral mortgages bad?  No.  They are what they are, but you should know what the consequences are before you sign one.  Ask your mortgage professional about it.

Cleaning up your Credit may be easier than you think

Managing your credit history and beacon score is one of the easiest ways to help yourself when it comes to financing the home of your dreams but it does take some forethought.  There are several components to your credit report that mortgage companies look at when deciding whether or not to loan you money. 

The first is your beacon score which is a complex calculation based on all the other data in your report and can range from 300 – 900.  When it comes to mortgages a score of 680 or higher will make you eligible for most programs from both lenders and insurers (ie:  CMHC).  With a score of 600 – 679 you will still be able to get a mortgage but you may be excluded from some programs like the free down payment program or CMHC’s flexdown which enables you to borrow your down payment.  Once you get below 600 then you have dropped below CMHC’s high ratio guidelines and will therefore require at least a 20% down payment and you will pay a higher interest rate.

The next item on your report will be your inquiries.  This shows every time a credit grantor has done a credit check on you.  A handful of these each year is acceptable particularly if you are opening the account that you’ve applied for.  Every time you apply for credit and there is no corresponding account opened it will lower your beacon score.  A very common problem is comparison shopping, especially for vehicles.  When you are shopping for a product where the retailer also provides the financing, be assertive with the sales staff and tell them not to check your credit until you’re ready to take care of the financing and only do it once.

Your credit report will also include any collections or judgements you may have.  These can really kill your chances with a lender and will need to be paid in full before anyone grants you additional credit.  If you ever have the misfortune of dealing with a collection agency, communicate with them promptly.  If you pay it immediately, they may not report it to Equifax or TransUnion.  This is also where bankruptcies or court judgements will show up.  One bankruptcy will stay on your credit for six years after discharge and most lenders will consider you after two years if you have made an effort to rebuild your credit.  If you declare bankruptcy a second time they both stay on your record for 14 years each and no credit grantor will consider you for a mortgage.  It is worth noting that if you are clearing up collections or judgements, making a settlement is not as good as paying the debt in full as lenders are looking at whether or not they will get all their money back if they lend to you.

The last part consists of your trade lines which is all of your open or closed accounts for the last six years.  It is worth noting that mortgages and utilities such as cell phone accounts do not report to the bureau; although some will if you miss a payment.  Each trade line shows the lender name; the date you opened the account; the date it was last reported; your credit limit; the type of loan (ie: revolving or instalment); the number of payments that were late by 30, 60, or 90 days; a rating such as R1 (revolving account in good standing) or I9 (an instalment loan that has been sent to collections; and finally whether or not the account has been closed and by whom. 

There is a lot of information here for prospective credit grantors to judge your history of repaying debts.  CMHC requires you to maintain two open lines of credit with at least 12 months history to qualify for a high ratio mortgage.  Keeping three revolving accounts with a good history will maximize your beacon score.  Other factors can include who the lenders are – RBC or Visa have stricter criteria than Citifinancial and therefore look better on your report.  Also, high balances on your revolving accounts will bring down your score particularly if they are over your limit.

If you have any questions about managing your credit or would like to do a credit review in order to avoid any problems with your future financing needs, please call me and I would be happy to review your particular situation and create a strategy to best serve your borrowing needs.

For more information about the services I offer please visit my website at www.trevormacmillan.ca.

I always have time for you and your referrals!

Mortgage Basics 101

Can I qualify to purchase a home?

In order to qualify for a mortgage you will need three things:  a down payment, stable income, and reasonably good credit.  How much you qualify for is dependant on your debt service ratios – ie:  how much of your income goes to paying off debt (expenses are not included, only debt payments such as credit cards).

How much down payment will I need?

You can put as little as five percent down under most circumstances.  If you put down less than 20% you are required to have mortgage insurance through CMHC or another insurer.  This premium can be added onto the mortgage so you don’t have a big lump sum payment at closing.  Down payments must come from your own resources and cannot be borrowed (unless secured against real estate or investments).  You can use your RRSPs and gifted down payments are acceptable as well.

If your credit score is above 680 CMHC will allow you to borrow the down payment but the payments on that loan will be included in your debt ratios.  If your credit is over 620 you may be eligible for a Cash Back mortgage where the lender will pay your down payment for you in exchange for a higher interest rate.

Keep in mind that you will also need to show the ability to pay 1.5% for closing costs as well.

If I’ve had problems with my credit can I still get a mortgage?

Lenders will look at two things regarding your credit.  One is your beacon score (preferably 620+).  The second is your payment history.  If the challenged credit is a few years old your beacon score can come up quite quickly.  The main things that affect your credit score are how timely your payments are made, the number of accounts reporting (not too many or too few, you’ll need a min. of two), how many credit enquiries you’ve had in a period of time (5 or 6 per year is ok; be careful when you’re car shopping), collections or judgments (very bad), balances over your credit limit, and the amount of time since any indiscretions.

If you do have any collections or judgments they will need to be paid off before applying.  Lenders will look at whether or not debts have been paid and how many late payments there have been.  Two years of good credit history is enough to qualify for the best rates.  If not, you may end up with a higher rate or a bigger down payment requirement.  A bankruptcy is workable once discharged and will stay on your credit for 6 years.  Two bankruptcies is a no go and they stay on your bureau for 14 years each.  A third and they stay on record for life.

What kind of income is acceptable?

Salaried is the easiest because it’s predictable.  This includes hourly if you have guaranteed hours.  If you have casual employment, commissions, tips, or are in business for yourself then you will be required to show two years worth of income records (Notice of Assessments, tax returns, books, etc.).  Overtime can be taken into consideration by averaging the last two years income.  If you have full-time, permanent employment then you just need to be past your probationary period.

What is a Conventional Mortgage?

The amount of the mortgage, as a percentage of the value of the property, is called the Loan-to-Value ratio (LTV).  A conventional mortgage is a loan that does not exceed 80% of the value of the home (80% is the LTV).  A high ratio mortgage has a Loan-to-Value of more than 80% thus requiring mortgage insurance.

What is mortgage insurance?

Mortgage insurance is default insurance in favour of the lender.  It is required for high ratio mortgages.  It is provided by the Canada Mortgage and Housing Corporation (CMHC), Genworth, or AIG.  This is not to be confused with mortgage life insurance which is term life insurance to pay off your mortgage in the event something happens to you.

Another type of insurance is title insurance which can be purchased by your lawyer.  This covers you against unknown title defects.  Title defects are anything that affects your clear ownership of the property you intend to purchase.  Examples are a builder’s lien that you didn’t know about, a fence that’s not on the property line, or a building that was erected over a utility that requires it to be torn down.  Title insurance will cover all of these including legal fees and only costs you about $150 dollars for the lifetime of your home.

Should I get a fixed or a variable rate?

This really depends on your appetite for risk and change.  A variable rate will usually outperform a fixed rate but the payments can change frequently and there is always the chance that rates could go up significantly causing a drastic rise in your payment.  A fixed rate is stable and secure.  You know exactly what you’ve got for the term of the mortgage.

What terms and amortization periods are available?

Terms range from six months to ten years or more for fixed rates; the longer the term -  the higher the interest rate.  Variable rates are only available for 1, 3 or 5 years.  Open mortgages (loans with no pre-payment penalties) are available in six or twelve month terms. 

Amortization periods (the length of time required to pay off the entire amount) stretch up to 40 years for conventional loans or 35 years for high ratio mortgages (30 as of March 18, 2011).

Can I make extra payments to my mortgage if I want to?

This is something you need to plan for as every company is different.  Most mortgages come with some pre-payment privileges such as increasing the amount of your payment or making lump sum payments but there are vast differences in the restrictions that apply.  If this is important to you, talk to your Mortgage Professional about this before you apply.  Some lenders will even allow you to make extra payments so you can skip some later; handy for long term travelers or temporary decreases in income. 

To pay off your mortgage completely before the end of your term will involve a payout penalty (unless it’s an open mortgage) which is usually three month’s interest.  If current rates have dropped you may have to pay an Interest Rate Differential (IRD) instead which can be extremely expensive.  This is another thing that you should discuss with your Mortgage Professional before applying.

I hope this has adequately answered some of the most common questions.  As always, I appreciate comments or questions you may have.  You may contact me anytime at (780) 996-2655 or at tmacmillan@dominionlending.ca.  Please visit my website for more information about mortgages and leasing at www.trevormacmillan.ca.