What have you done with your INVESTMENT property mortgage and why?
This is another question which I encourage clients to ask or their Mortgage Broker or their banker.
An open and questioning mind may lead one to mortgage products which result in savings of thousands, sometimes tens of thousands. Deeper explanations of how various mortgage products actually work over time are rarely offered up front. Important topics like;
- How are pre-payment penalties calculated? (***Radically different from one lender to another, and from one product to another)
- Does my payment change in a variable rate product? (***Not Always!)
- What are the short term goals with the subject property?
- What are your long term Real Estate portfolio goals?
The list goes on.
An in depth analysis of the A-Z strategy with an experienced Real Estate Investor is well worth the effort. A-B is simple, Real Estate investing is not simple. It should be boring and without heart-wrenching ups and downs, but planning requires time spent with an experienced advisor.
The question of fixed vs. variable is the first one to decide upon. Should you consider exposure to variable rate mortgages within your investment property portfolio? Perhaps yes with a complete understanding of the product and property goals.
If your principal residence mortgage is in a fixed rate, then some diversity may well be in order. Although normally we prefer to structure a variable rate product on the principle residence (with interest not being tax deductible) and a fixed rate (if deemed appropriate) on the investment property as the interest expense, although historically a bit higher in a fixed rate product, is tax deductible on the investment property. Stability of cash flow is also a consideration.
For the purpose of this example I will refer again to our own personal structure on an investment property we currently own.
As this specific property increased our personal mortgage exposure marginally, as well as completing in the fall of 2010 – a time when Prime rate appeared likely to have topped out for some time, combined with the fact that the property was viewed as a potential ‘flip’ inside of five years, we chose a variable rate product.
Being viewed as a flip, mortgage principal pay-down was not a key focus, in any event we have benefited greatly from the stability of Prime over the past 3.5 years with significant principal reduction a happy bonus. We have also enjoyed positive cash-flow which was the main motivator for the variable as our choice. Sounds odd perhaps? Variable rate = stable cash flow.
A key factor in our choice of variable mortgage product was tied directly to two key lender policies;
1. A Fixed Payment (Variable rate) mortgage. Which is exactly what it sounds like. No matter the rate movement, the payment remains constant for the 60 months term as initial set. This gave us great assurance of positive cash-flow the 5 year term.
The rate may move with Prime Rate fluctuations as determined by the Bank of Canada at any of its eight preset meetings per year. However when (and if) the rate were to rise the payment itself remains static. The composition of the payment shifts, with a bit less principal, and a bit more interest being the result of any ticks upward. Typically these occur in 0.25% increments.
2. The option to convert to a fixed rate of a 3 year term or longer at any point with no fee, penalty, or any other hurdles to clear. We have no plans to lock in, but it is nice to have flexible options.
The majority of lenders require a fixed rate term equivalent to the remaining term of the mortgage. Limiting one to a 5 year option within the first year typically. Personally I am not a fan of 5 year fixed rate product. The 3yr and 4yr as options right out of the gate is very appealing.
This mortgage was placed with a mainstream Chartered Bank at an ‘A’ rate of Prime -.75% at the time. (2.25% net at the time of this writing).
With this lender, we also had the added bonus of being able to register the property and mortgage in the name of our Holding Corporation which for long term ‘buy & hold’ Real Estate investors is well worth considering. In our case there was an additional layer of complexity (another blog post entirely) with the transaction making Hold Co registration the right choice for us at the time.
I will write about investment property #2 and our decision to place that one in a fixed rate product next month.