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Four Steps Homeowners Can Take Right Now to Improve Their Next Mortgage
The real estate market in Canada is fiercely competitive – all the more reason for you to be prepared with accurate expectations of how the financing part of homeownership will work for you.
These days, it’s common to have a conversation with a client who just made an offer on a property without a formal financing pre-positioning review. Clients are then surprised when they don’t qualify under traditional rules, and their alternatives end up costing much more than they had planned.
To help make some immediate changes to your current profile and portfolio, I have put together four action steps to significantly improve your ability to qualify for financing on your next application.
1) Create a Mortgage Binder
Having an organized system with immediate access to all your critical data is the key to success in the real estate world. This is where a mortgage binder comes in. It can be physical or digital, and it keeps all your data in one place.The information lenders will typically require include, but is not limited to, the following:
· Updated income documents
· Updated business documents
· Current property tax bills for all properties to confirm the annual amount due
· Current mortgage statements for all properties confirming the property address, mortgage balance and current mortgage payment.
· Current lease agreements
· Updated investment or savings statements. These could include RRSPs, TFSA, non-registered savings etc.
· Rental spreadsheet with all your property details. As your portfolio grows, having a rental spreadsheet will allow you to stay organized and have a current snapshot of your holdings to allow for a high-level conversation when needed.
· Real estate partners’ contact details. These should include mortgage broker, accountant, lawyer, real estate agent, insurance broker and property manager.
· Copy of your credit score
2) Refinancing Back to a Longer 25-30 Year Amortization
When it comes to residential mortgage lending, it always comes down to income versus expenses. Lenders require a certain level of expenses versus income to allow continued access to funds. While we all want to pay down our mortgages as quickly as possible, you should always keep cash flow and overall portfolio expenses in mind.
Suppose you’ve decided to be aggressive with your mortgage payments to pay the balance down quickly. In that case, you may have put yourself in a position where future financing becomes restricted due to your higher mortgage payments. Consider stretching your amortization to the maximum allowed, which is typically 30 years (if available).
On a $400,000 mortgage, you could have payments in the lower range of $1,685/month by stretching the amortization back to 30 years. If you’ve decided that you’re comfortable paying $900 bi-weekly, your actual monthly expense on a mortgage application is $1,950 ($900 x 26 = $23,400/12). The difference in this example is $265/month or about $50,000 in more financing.
If you’ve decided that you need to pay down your mortgage, prepayments are another solution. In the same example above, we would advise the client to keep the mortgage as low as possible (or at $1,685/month) and prepay the $265/month difference. This strategy ensures that they are still paying down the mortgage aggressively and keeps their mortgage payment much lower for a mortgage application because the prepayment is not reported on the credit bureau.
When reviewing a mortgage application, lenders will complete a credit check and review your personal credit balances. These would include car loans, student, auto and other loans with fixed payments, unsecured lines of credit, credit cards, leases, etc. The lenders will take a specific balance per month and include it on your mortgage application, depending on the credit type.
Let’s look at a scenario:
For revolving balances such as the ones on credit cards or unsecured lines of credit, most lenders will take 3% of the balance and use this as a monthly credit payment. Even though most of these accounts usually require an interest-only payment, a much higher monthly expense is considered for lending purposes. For fixed instalments such as those on a car loan, lenders will take the ongoing monthly payment.
For the example above, this client has $1,250/month in credit expenses. If a client were looking to purchase a new property, their borrowing capacity would be reduced by about $225,000 due to these monthly expenses.
If we were able to consolidate and refinance these balances into a mortgage, we would reduce the monthly amount to $335/month, and the reduced lending capacity would only be an estimated $50,000. Quite a difference!
4) Converting existing HELOCs into mortgages
HELOCs or Home Equity Lines of Credits are excellent tools for investors. They provide an interest-only payment to keep cash flow in check and a reasonable interest rate. Most investors will use their HELOC to finance rental properties. Many people don’t know that a HELOC with a balance can make it challenging for future lending on a mortgage application. The main reason for this is that lenders will treat the HELOC balance as a mortgage and calculate a monthly expense payment using the current Bank of Canada 5-year posted rate (currently 5.25 %) and amortize costs over 25 years, similar to the stress test rules.
On a $250,000 HELOC balance, you would typically have interest-only payments of approximately $650/month. On a mortgage application, we would treat this balance as a mortgage with a rate of 5.25 % amortized over 25 years for a monthly payment of $1,490. This is a difference of $840/month or $120,000 in reduced lending.
One easy fix is to ask your lender to take the balance portion of the HELOC and convert it to a mortgage (not all lenders offer this). We could ask the lender to take $250,000 and convert it to a 5-year variable rate in the above example. Assuming a rate of 2% over 30-year amortization, the monthly payment would be $923.01/month. This is a lower payment than the $1,490 stress test payment that the lenders use to qualify you and increase your borrowing capacity by about $75,000.
Financing hasn’t gotten easier but staying strategically ahead of the curve by being informed is the real secret to becoming a successful real estate investor!
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