Buying Real Estate without a Down Payment
Recently a friend of mine started a new career as a realtor. She e-mailed me asking for my opinion with respect to purchasers buying with little or no down payment. After I finished my e-mail, I thought it might be worth sharing a few of the highlights on this blog.
There are options available for buyers who can’t produce a large down payment. Several institutional lenders offer Cash-Back mortgage options, however these require the potential borrower to evidence their ability to finance a 5% down payment from their own resources, plus cover any closing costs (which average 1.5% of the actual). Also, lenders will be looking for borrowers with strong credit history, debt serviceability, and job stability, to offset the risk of the smaller down payment. Mortgage insurance may be required, and the insurer can request an appraisal to confirm the accuracy of the market value of the property, which will add a few days to the approval process. (It is also worth noting that institutional lenders will generally lend to the LOWER of the appraised value or the purchase price.)
Another option – and one I’m a fan of – is the RRSP home buyers withdrawal plan. For buyers looking to fund a down payment, this is quite simply one of the best options available to them. If parents will be involved in funding the purchase, it might be prudent to consider participating in matching contributions to their child’s RRSP. This can make the actual process of the gift less painful when the time comes for the actual purchase. The ability to withdraw from these tax-sheltered RRSP funds will be an asset in making a mortgage deal work, and should be a cornerstone of any first-time buyers planning process. (An RRSP which has been systematically accumulating over a period of time can influence a lender’s view of your credit risk and ability, demonstrating good established saving habits.)
If a borrower decides to apply for conventional financing (for a maximum of 80% loan-to-value on a purchase) with the intent of adding secondary vendor take back financing, the lender will require a minimum of 10 – 15% real equity from the borrower. (Historically, default rates are lower when a borrower’s equity is real money saved from individual resources.) During the approval process, the lender will include this anticipated second mortgage in the calculation of both the borrower’s ‘Shelter Costs’ and Gross Debt Service Ratio.
The bottom line is that there are some creative institutional lenders who offer specialized mortgage products for borrowers who don’t have large down payments. However, the interest rates on these products are higher than market on a prime plus basis, there is normally a small fee to the lender, and the restrictions are greater. Lenders with these products are looking for borrowers who – due to lower credit scores and debt serviceability – don’t fall within the bounds of conventional borrowing, but will likely do so by the time their proposed mortgage matures. It should be of no surprise that these products are priced to make additional profit for the lender to compensate for the potentially higher default rate and increased administrative costs.
A note about vendor take back mortgages: because the lender in this situation is, in fact, the seller, it is important to note that they assume a high level of risk. A great deal of care must be taken to fully disclose the risk – I’m not saying that every borrower is bad, but things can and sometimes do go wrong. Clients need to be made aware of these potential risks. There is risk for the buyer, too. There are no guarantees when it comes to refinancing, and neither are they assured that the vendor will still hold the interest in their property – it may have been sold off to fund a Mediterranean cruise, and there are no guarantees that the new mortgagee will be cooperative.
We love it when one size fits all, but I find that when it comes to mortgages, every deal is different. There’s my $0.02 worth, hope it helps.
Kind Regards,
Paul E. Croy
A Perfect Investment
Many people spend a great deal of their time and energy looking for ‘The Perfect Investment’. Over the past three decades, I have repeatedly had clients actively seek an investment that will produce a steady double digit return risk-free. This ideal investment – high reward for no risk – has become the elusive ‘Holy Grail’ for most investors.
Too many investors, following the latest hot investment tips without doing proper research, end up disappointed, disillusioned, and potentially demoralized when confronted with their losses. Even smart investors are too easily motivated by greed and don’t use common sense when confronted with a ‘get rich quick’ investment scheme that sounds too good to be true.
The simple truth is that every investment carries risk. Even not investing carries risk – inflation can decrease the value of your ‘nest egg’ and reduce the purchasing power of your money! The first step, and the key to successful investment, is fully understanding the risk you are exposed to and using management tools such as portfolio diversification to reduce your overall investment risk.
The next step to becoming a successful investor is to stop listening to others for financial advice. You know the kind: the advice offered at social gatherings and in break rooms, from people who, quite frankly, really don’t understand what they are talking about. Have your own investment rules and stick to them. These are rules and guidelines you establish to stop you from making rushed emotional investments which almost always end in a loss.
Cultivating investment mentors – successful long term investors whose opinions you trust – is the final and, in my opinion, most important step in the process of becoming a successful investor. If you ask these mentors for investment recommendations, be prepared to really listen, as these sources should have no ulterior motive. Your best mentors will often be close friends and family members. In some cases, they may offer you the name of a trusted Financial Advisor, or share what I call ‘established investment truths.’ These truths are the rules of investing that they have successfully used over the years. A few of these successful investors might even recommend that a portion of your diversified investment portfolio be invested in shares of a first mortgage MIC such as First Accredit Mortgage Corp. They might even say that it’s as close to a perfect investment as they have found.
Paul E. Croy
Your Asset Mix and Retirement Goals
Money Managers will often refer to risk as being the level of uncertainty about the returns expected from an investment. In most cases risk can simply be defined as the amount of volatility compared to a projected market return. You might also define risk as the amount of money you think you could lose and still sleep through the night.
In my opinion, being able to understand what you are invested in, and why, is very important when considering taking financial risks. A good test is to ask, “Could I explain to a 12 year old in less than a minute why I hold a particular asset in my investment portfolio?” It should be that simple.
Some years ago two researchers, Martin Leibowitz and Terence Langetieg of Salomon Brothers Inc., issued a report to the pension fund industry called, “Shortfall Risks and the Asset Allocation Decision”. In this report they used widely accepted historical return data compiled by the firm Ibotson Associates. The report found that there was a 36% chance that stocks would underperform bonds in any five year period. They also found that there was a 24% chance that stocks will underperform bonds in any 20 year period. Of course, that also means that there was a 76% chance that stocks would outperform bonds in any 20 year period.
As many Canadians are now starting to look at retirement, over the coming years it will become prudent to rebalance RRSP investment portfolios to decrease future investment risk. Using standard return and risk assumptions and a five year time horizon, Leibowitz and Langetieg concluded that an asset allocation of 30% stock and 70% bonds would result in a higher probability that an investor would meet their goals.
When constructing a fixed income bond portfolio the Money Manager will consider interest rates, maturities, redemption options and the credit rating of the bond issuer. The Managers would normally structure the portfolio with a mix of government, provincial, municipal and corporate bonds. In order for an Investor to reduce investment risk they might consider replacing the corporate bonds in the fixed income/bond portion of their investment portfolio with quality Canadian first mortgages. In addition to increasing the interest yield on your portfolio, an investment in first mortgages can offer substantially increased security when compared to corporate bonds as an asset class.
First Accredit Mortgage Corp., a Mortgage Investment Corporation (MIC) managed by Great Pacific Mortgage & Investment Ltd., invests exclusively in first mortgages. Since 2002, this MIC has offered both large and small investors easy access to investment in Canadian first mortgages while producing an annual historic yield in the range of 7.95% to 10.95%.
Paul E. Croy
“Much Ado About Nothing”
It’s been over a year of media focus on the potential end of historically low levels of Canadian interest rates. This week, it might be appropriate to quote the words of Mr. William Shakespeare, much ado about nothing, as the Bank of Canada recently decided to increase the Bank Rate by only 0.25%.
This increase was probably the single most anticipated and talked about increase ever witnessed in Canadian history. Many people originally anticipated a full half percentage increase, but recently almost every financial analyst expected the 0.25% increase that raised the prime rate at most Canadian banks to 2.5%.
Had Mark Carney, the Governor of the Bank of Canada, failed to raise rates this would have caused more of a concern as financial markets want certainty and predictability. After months and months of dealing with mortgage client’s concerns, this increase simply became a non-event. It was also very interesting to note that some mortgage lenders actually decreased their five-year mortgage rates shortly after the Bank of Canada rate announcement. Financial Institutions need to have certainty established in the long term trend of market interest rates before they can become truly competitive in their mortgage rate pricing.
In contrast to Mr. Shakespeare’s play, Much Ado About Nothing, which is a comedy, the Bank of Canada’s decision on interest rates is very serious business that effects a great cross section of our society. From small home based businesses to the construction industry and manufacturing firms, all feel the effects of the Bank’s Canadian Interest Rate Policy. Along with the value of our Canadian dollar, our Canadian family standard of living is affected too. The Bank of Canada is very aware of this fact as they attempt to balance the need to fight inflation while at the same time trying to grow our economy.
The bottom line looking forward is that we are going to see a slow and gradual increase in interest rates and this should not be a surprise to anyone. For clients still on floating rate mortgages, this may be a good opportunity to consider increasing your mortgage payment thereby accelerating your repayment and decreasing the amortization on your mortgage. This would also prepare you for slightly higher interest rates in the future while at the same time taking advantage of our still very low mortgage interest rates.
Paul E. Croy
Reducing Portfolio Investment Risk
Investing in a Mortgage Investment Corporation (MIC) can be a good way of adding mortgages as an asset class to your current investment portfolio. Shares of a professionally managed MIC can offer investors access to diversification in the mortgage market that may not normally be available to them. Diversification is very important when seeking to lower portfolio investment risk.
In the mortgage industry, a client who elects to directly invest in a mortgage is commonly referred to as a ‘Private Investor’. A direct investment in the Canadian mortgage market requires, in addition to your money, your ongoing investment of personal time to administrate and manage the mortgage. For Private Investors it can sometimes be very difficult to find quality lending opportunities. Perhaps even more importantly, it can be difficult to truly understand the risks involved when faced with mortgage underwriting decisions. Understanding investment risk and pricing the risk correctly is key to successful mortgage investment. Sometimes the best decision is the mortgage you don’t invest in.
Another risk facing a Private Mortgage Investor is the loss of interest income during the period when a mortgage is paid out and the funds are sitting in cash waiting to be reinvested. By investing in shares of a MIC, this reinvestment risk can be reduced because your funds are always working.
Great Pacific Mortgage & Investments Ltd. offers investors the choice of three professionally managed Mortgage Investment Corporations which can help to add investment diversification to both large and small portfolios.
Paul Croy
A Shoe Short Story
My wife truly loves a good pair of shoes. Over the years she has built a fine collection of well over 100 shoes; I’m sure that there are much larger collections hidden away in other people’s home closets! The interesting point is that as much as she may love the look of shoes, her daily choice selection is normally based on comfort.
For most people, getting into a mortgage is much easier than getting out of it if they find that they have made the wrong choice. Making the wrong choice can be a source of stress with potentially large financial and emotional costs to be paid. The mortgage you select should be comfortable and flexible, fitting with your lifestyle expectations. It is very important that your mortgage leaves some financial room for you to still be able to enjoy the things in life that are important to you. Feeling ‘mortgage poor’ can be somewhat like being forced to walk a long distance in the wrong pair of shoes.
It is important to spend time up front looking at the economic realities of your cash flow prior signing your mortgage documents.
What I would recommend for many clients is to try living within a budget based on the proposed mortgage payment prior to committing to it.
Paul Croy
Interest Rates on the Rise?
The Bank of Canada has signaled that they do not expect to hold present interest rate levels past the end of June…..
See the March 11, 2010, Business Week article, Canada January New Home Prices Rise 0.4%, Seventh Straight Gain
We are presently enjoying the lowest interest rates seen since the Korean War, and the only thing we can absolutely count on is that rates will inevitably rise. The ‘experts’ cannot seem to agree on when or by how much, but the varied opinions range upwards to an increase of 2.0% – 2.5% by the end of 2011.
I believe that now is the time to become pro-active and ensure that you take advantage of the present interest rate environment. Do you wish to explore the possibility of ‘renegotiating’ an existing mortgage? Would you like to ‘lock-in’ an interest rate for an upcoming purchase? Does your mortgage ‘mature’ in the next few months? Fixed rate vs. variable rate?
Our mortgage professionals are your best source for mortgage advice and can explain all your available options.
Walt Neufeld
What term mortgage should I choose?
Historically, the shortest term mortgage (ie. 6 month terms for 25 years) has been the least expensive route when financing your home.
Floating has been less expensive than fixed mortgages as institutions do not have to build in a hedge to offset interest fluctuations.
Longer terms provide stability against interest fate fluctuations as well as not having to deal with the paperwork and the stress of numerous renewals.
Here are some questions that you should consider:
1) Are you able to tolerate interest rate fluctuations and do you have the temperament to not worry about them?
2) What do you think interest rates are going to do?
3) What are your personal plans? Do you have a growing family and need more space? Are the kids leaving home and you want a smaller place? Is there a chance you can be transferred? (ie. I think I will be transferred in 3 years so I want a 3 year mortgage.)
My advice is to take a mortgage that fits your needs. Talk to your banker, accountant, lawyer, mortgage broker, etc. There is wisdom in much counsel.
Rory Campbell
Video: What is the risk of investing in Mortgage Investment Corporations?
A discussion on the risk of investing in Mortgage Investment Corporation (MIC) Funds at Great Pacific Mortgage & Investments. – Rory Campbell and Walt Neufeld
