Do you buffer your mortgage interest rate when doing projections?

Question

When doing cashflow projections on a prospective property, do you buffer your mortgage interest rate when doing projections? And if so, by how much and why?

And have I made a big mistake by not doing so for my current purchases? (Options to mitigate the risk now if rates move up?)

Roy N. · Answer

Jeff,

No origination fees on residential mortgages in Canada (it's all behind the curtain).

By setting up our deals as if we were paying the BoC posted rate - a full 2-points over what we can obtain for a variable rate mortgage - we leave ourselves ample room to set our payments as though we had a 5-year fixed-rate mortgage (normally 0.5 - 1.0 greater than the variable rate) and still have sufficient cashflow for other projects - the extra principal pay-down is our "reward" for hedging any interest rate movement ourselves rather than paying the lender for a fixed-rate note.

It is also quite easy and inexpensive to pull equity back out if it is needed (up to 80% LTV, with some lenders only 70-75%).  With a variable rate mortgage, the penalty is 3-months interest.  With the "extra principal" per payment and the bi-weekly payment frequency, after a couple of years 3-months interest is a pretty cheap penalty.

Thomas S. · Answer

I generally peg my number at least  2 points above what I am paying and calculate based on 100% financing.

Roy N. · Answer

@Darren Horrocks

If by "buffer" you mean over estimate or hedge, then yes.

We typically analyse a deal as if we were paying the Bank of Canada (BoC) 5-yr posted {fixed rate} mortgage rate (presently at 4.64) though we are currently using 5-yr term variable mortgages at rates of 2.2 - 2.7 (depending if it is residential or commercial).

Furthermore, though we always use a variable rate mortgage we will typically set our payments as though we were paying a fixed rate (normally a point higher) ... rather than pay the lender to hedge the interest rate, we do it ourselves.

Paul MacInnis · Answer

I learned this exact technique from @Roy N.!!

I have changed all of mortgages  by applying the difference between the BOC's rate and the variable residential rate (so 4.64-2.5ish) directly to the principal.   Hedges the interest and builds equity, win-win.  Only regret is how long it took me to find the info!  Thanks, Roy!

Darren Horrocks · Answer

I have started doing my projections /w 100% as well. The more and more conservative I start making my numbers, the more "deals" don't fit anymore.Is there such a thing as too much padding?

Darren Horrocks · Answer

Sorry about the late reply Roy! I fell off the face of the Earth for awhile.

So I don't use traditional "big-5" financing, b/c they can't offer me the terms I wanted.

Roy N. · Answer

@Darren Horrocks

I see they are a division of MCAP.  I was under the impression they only did owner-occpant mortgages, perhaps it's worth a further look.

Roy N. · Answer

@Darren Horrocks

If you are purchasing residential property and will be placing your mortgage with a conventional lender then they must qualify at the 5-yr fixed mortgage with a 25-yr amortization, regardless of the loan you end-up taking.

35-yr is an "odd" amortization in this country.  The Big-5 and most other banks/credit unions are offering 25-yr amortizations on residential properties these days - you  may still find a 30-year.   A few years ago they started to introduce 40-yr amortizations about the time the wheels came off the U.S.A. market  - regulators soon put paid to those.

Even on the commercial side, I've not seen anyone offering more than 30-year as of late.

So I am curious, is your 35-year amortization a private lender or a from a life-insurance pool?

Darren Horrocks · Answer

Yes, this thread was a valuable learning experience. I've already addressed building the buffer mentioned into my spreadsheet. And created an amortization schedule that has the extra BOC principal payment option built in too!

Now I just need to buy another property for proof of concept! Hahah   I hope other newbies read this, it is definitely great advice that is not voiced often.

One last question: Do I always project my cashflow analysis using 25 year AMs? Even though I have access to 35 year AMs?

Roy N. · Answer

Darren:

The time to work the 2% buffer into your analysis is before you purchase.  Now, you are in the early stages of a 5-year fixed - at 2.6%, at least you have a good rate - I would concentrate of operational efficiencies and building sufficient reserves to handle the inevitable vacancies and CAP Ex requirements.

On your next purchase, you can build-in the buffer and pay a variable mortgage at the fixed-rate payment level.

Do you buffer your mortgage interest rate when doing projections?

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