Canadian Rental Properties
New to Real Estate · Northwestern Ontario · Member since 2019 · 5 posts · 0 votes
Looking for Canadian rental property mortgage advice.
How long do Canadian investors set their mortgages?
In the US it’s most beneficial to choose a 30 year fixed.
Here in Canada you can have a 30yr mortgage, but you must renew every X number of years (usually every 4-5 years if you want a low interest rate).
Unfortunately anything above a 15 year fixed seems a bit risky, especially with the threat of a possible economic crisis upon us.
I would hate to have several 25-30 year mortgages at 3.4%, and in 5 years being forced to renew at 8%+ for the remainder.
It seems to me, it would be the safest plan to pay off one mortgage at a time as soon as possible, then invest into another property to avoid getting caught in foreclosures.
However, doing it this way eliminates the power of leverage... how do Canadians do this while reducing risk?
But say you have 5 mortgages set for 25 years @4%, then our economy crashes, and then your interest rate go up to 8% at your next renewal?
Aren’t you worried that you won’t be able to keep up with the interest increase since you can’t just increase your rent?
Sara:
We bought our last "residential" property in 2017. As part of diligence, I modelled the property as though our financing rate would be 6%. After purchase we financed at 2.6%, which has since risen to around 3, however I know the property (without any improvement in rent) will survive at 6%, so there are no cashflow concerns.
If you believe interest rates are going to rise, then you should plan accordingly. Say you are acquiring a property at $238K with 20% down; your financing principal would be 190,400. Amortized over 25yrs at 4%, your default monthly mortgage payment would be $1005.00. If you believe rates are going to raise to 6%, then model your property at that rate: which would yield a monthly payment of ~$1230.00.
If the deal cash-flows with a monthly payment of $1230, then you know you will be fine with a 2% rate increase. To hedge against this (and lower your overall interest paid) you could set your payment to $570.00 bi-weekly ['cause everyone knows an accelerated bi-weekly payment is an easy way to shave 5-years of your amortization] even though the interest rate is at 4%. The extra principal paid down each month will shave years off your effective amortization and thousands off your cost of borrowing. If you are using a variable -rate product, then any adjustment in interest rate will be absorbed within your current payment ... and the extra still goes to principal pre-payment.
Slightly off topic - but the future of interest rates is an interesting question, there seems to be pressure upward but our (Canada and US) governments will be in a truly terrible position if they actually climb much higher , so what will happen?:
Looking for Canadian rental property mortgage advice.
How long do Canadian investors set their mortgages?
In the US it’s most beneficial to choose a 30 year fixed.
Here in Canada you can have a 30yr mortgage, but you must renew every X number of years (usually every 4-5 years if you want a low interest rate).
Unfortunately anything above a 15 year fixed seems a bit risky, especially with the threat of a possible economic crisis upon us.
I would hate to have several 25-30 year mortgages at 3.4%, and in 5 years being forced to renew at 8%+ for the remainder.
It seems to me, it would be the safest plan to pay off one mortgage at a time as soon as possible, then invest into another property to avoid getting caught in foreclosures.
However, doing it this way eliminates the power of leverage... how do Canadians do this while reducing risk?
Sarah:
It appears you are confusing, or at least intermingling, the amortization of the financing (the note) with the term of the mortgage.
In the U.S.A. the two are commonly coupled, but that is an almost uniquely U.S.A. phenomenon.
Residential real estate financing in Canada is typically amortized over 25-years. 30yr amortization is a possibility (but not always). Even with a longer amortization, the borrow must still qualify for the principal amount subject to a 25-yr amortization.
In Canada, residential mortgages have terms ranging from six months to ten years with 5-year and 3-year terms being most commonly subscribed. When placing a mortgage, the borrow will have a choices between fixed-rate and variable rate financing (either open or closed) which come with different conditions w/r to prepayment and early retirement and different interest rates.
Regardless of the financing chosen, the borrower must qualify as if 5-year fixed rate financing at the higher of the BoC posted rate or the lender's rate +2% was being used.
The shorter mortgage terms cut both ways - in times of rising rate they may seem more risky than the 30yr terms enjoyed south of the border (though they are normally at a relatively lower rate). When rates are falling, they are advantageous. With a though understanding of how mortgages work in Canada, you'll find that, while different than south of the 49th, they are not really more risky (Canada has a far lower incident rate of mortgage arrears and defaults than in the U.S.A.)
Our personal preference is to use 3-yr or 5-yr term variable rate financing {most of these have a cap or a right of conversion if the interest rates rise above a certain point). These are typically 1-1.5% less than an equivalent term fixed-rate financing - either you pay the lender to hedge interest rates (fixed-rate product) or you hedge them yourself (use a variable rate, but set your payments as though you were using a fixed-rate products).
If you search the forums, there are longer, more compete treatise on Canadian mortgages and strategies to which I and others have contributed in the past - I'm just never able to find them when I need to reference them (@Mindy Jensen - where's my virtual cork-board ;-) )
Slightly off topic - but the future of interest rates is an interesting question, there seems to be pressure upward but our (Canada and US) governments will be in a truly terrible position if they actually climb much higher , so what will happen?:
Chris:
While interest rates have started to rise in the past year, they are till far below the historically average range of 7 - 9% ... and minute compared to when I placed my first mortgage at almost 16% ;-)
Thanks Roy! I appreciate your input. :)
@Sarah Robertson Roy already answer the how the mortgages work here. As for length of the loan (amortization period), go for the longest possible. The payments will be lower and you can always make extra payments as you go thereby saving interest.
As for fixed or variable rate, some have a preference depending on what they think will happen to mortgage rates over time. I have a fixed rate (so it stays at 3.5%-or whatever it was) for 5 years (my term). After 5 years, I set up another term with a different interest rate.
Uninsurable mortgages carry a 30 year amortization i.e. uninsurable mortgages are for properties over $1MM purchase price. If the purchase price is less than $1mm, the amortization is 25 years, however, some lenders will offer you a 30 year for a premium rate, a plus 10 or 20 bps.
But say you have 5 mortgages set for 25 years @4%, then our economy crashes, and then your interest rate go up to 8% at your next renewal?
Aren’t you worried that you won’t be able to keep up with the interest increase since you can’t just increase your rent?
I'm not worried. I have enough money should the interest rate go up plus I've already been making extra payments. Worst case you can always sell your rental.
Now with the stress test in Canada, they make sure that you are able to still make payments should the rates go up. I knew when I got them that the rates would be higher at renewal as there was no where for the rates to go but up. They've been so low for so long, that people forget what 'normal' interest rates are.
"Aren’t you worried"
This is the way it works and is a accepted risk of going into business. If you tend to approach life from the perspective that the sky is going to fall you will never accomplish anything in life. One must take risks to succeed. Investors should not be losing sleep worrying about what might happened 5 years down the road. If that is your biggest fear then you operate as a ultra conservative investor and buy everything with cash. Buying with cash is like playing T ball, no one strikes out. Similar skill set.
But say you have 5 mortgages set for 25 years @4%, then our economy crashes, and then your interest rate go up to 8% at your next renewal?
Aren’t you worried that you won’t be able to keep up with the interest increase since you can’t just increase your rent?
Sara:
We bought our last "residential" property in 2017. As part of diligence, I modelled the property as though our financing rate would be 6%. After purchase we financed at 2.6%, which has since risen to around 3, however I know the property (without any improvement in rent) will survive at 6%, so there are no cashflow concerns.
If you believe interest rates are going to rise, then you should plan accordingly. Say you are acquiring a property at $238K with 20% down; your financing principal would be 190,400. Amortized over 25yrs at 4%, your default monthly mortgage payment would be $1005.00. If you believe rates are going to raise to 6%, then model your property at that rate: which would yield a monthly payment of ~$1230.00.
If the deal cash-flows with a monthly payment of $1230, then you know you will be fine with a 2% rate increase. To hedge against this (and lower your overall interest paid) you could set your payment to $570.00 bi-weekly ['cause everyone knows an accelerated bi-weekly payment is an easy way to shave 5-years of your amortization] even though the interest rate is at 4%. The extra principal paid down each month will shave years off your effective amortization and thousands off your cost of borrowing. If you are using a variable -rate product, then any adjustment in interest rate will be absorbed within your current payment ... and the extra still goes to principal pre-payment.
Thank you everyone!