Category: Mortgages

Fixed Rate Mortgages Offer a Measure of Safety

Last week, I wrote about the challenges of having a variable rate mortgage when mortgage rates are increasing. This week, I’d like to discuss how fixed rate mortgages (FRM) offer a measure of safety. Depending on when your FRM is up for renewal, you have some breathing room to figure out how to handle the increased mortgage payments that are coming your way.

The generational low mortgages, i.e. rates below 3%, are pretty much gone for good. For very brief blip of time, you could get a discounted 5-year rate for 1.39% in 2021! That’s an incredibly low mortgage rate for a 5-year term, one I doubt that I will see again in my lifetime.

Even if you were able to snag a 5-year rate lower than 3% in early 2022, I can pretty much guarantee that you’ll be paying atleast 2% more when you renew in 2027. For my money, I think you should take the following steps to prepare yourself.

Gather information

First of all, start playing around with mortgage calculators. Plug in your own numbers so you can see the difference that a higher rate is going to have on your mortgage payment. It should be obvious that a higher rate on your FRM means that the payment is going to go up. The mortgage calculator’s job is to inform you of the size of that increase.

Armed with that knowledge, you can start making a plan on how to pay for your property when your mortgage costs go up. The last thing you want is to be surprised by a $500 increase in your mortgage payment, or to face a future foreclosure because you can’t pay your mortgage debt.

Build a lumpsum payment

Secondly, start saving the difference between what you’re currently paying on your FRM and what you anticipate paying at renewal. How you save the money is up to you. Here are a few suggestions:

  • Get a part-time job.
  • Bring in a roommate.
  • Cut your expenses.
  • Obtain a promotion or raise at work.
  • Start a cash-flowing side-hustle.
  • Use an insurance payout or inheritance.
  • Sell things you no longer use.
  • Take transit to save on parking fees.
  • Cook at home most days of the week.
  • Save your tax refunds and work bonuses.

Open a separate bank account for this money. Set up an automatic transfer so the money goes into the new mortgage account without any further decision-making on your part. Remove the temptation to spend this money – do not get a bank card for this account! If it’s your priority to be in a position to handle your increased mortgage payments, then you should not be touching whatever’s in this account.

This money is meant to be in place so that you can make a lumpsum payment against your mortgage at renewal time. Lumpsum payments decrease the amount of money being borrowed. Applying a lumpsum to your outstanding mortgage balance will lessen the impact of the higher interest rate’s impact on your mortgage payment. The more of the principal that you pay down, the less money you have to borrow from the bank to pay off your remaining mortgage debt.

Increase your mortgage payments

Thirdly, you can increase your mortgage payment. When I had a mortgage, my bank allowed me to increase my mortgage payment by up to 20% every year. It was a fantastic feature, and I used it religiously. Of course, my initial mortgage payment was something like $300 bi-weekly, so it wasn’t a hardship to find an extra $60 every two weeks. A friend of mine took a different path. Every two weeks, she determined whether to make a lump sum payment against her mortgage. Since her expenses were far more variable than mine, she needed that flexibility. However, the both of us managed to pay off our mortgages way earlier than the 25 years that our lenders had allotted to us.

Your mortgage payment might be over $1500-$2000-$2500, so a 20% increase will pinch a bit harder. However, if you can increase it by any percentage, then do so. The sooner you repay the principal balance owing, the lower the balance that you have to renew. A lower renewal balance results in less of an increase in your future mortgage payments.

Renew now instead of later

Finally, determine if you can lock in a mortgage renewal rate today. This step is for people whose FRMs are coming up for renewal in the next 90-days. Most lenders allow people to renew their mortgages early, usually within 90-120 days from the expiry of the mortgage term.

While it’s not a 100% guarantee, you can confidently assume that the Bank of Canada will be raising the prime interest rate again on October 26, 2022 then again on December 7, 2022. When they do, lenders will take the opportunity to increase their mortgage rates. If you lock in a renewal rate before these dates, you should definitely do so.

A Measure of Safety

I’ve always relied on fixed rate mortgages. I think they’re great for allowing borrowers to know the fixed costs of their shelter for a defined period of time. Having a fixed mortgage payment goes a very long way towards understanding where your hard-earned money must be allocated. My father once told me that, when you know the cost of your shelter, you can build the rest of your budget around it. He was right. Having a place to lay your head is a fundamental necessity so paying for it must always be top of mind.

Assuming that you do not want to sell your property or lose it to foreclosure, it would behoove you to start thinking about how much your mortgage payment is going to be upon renewal. Knowledge is power so use knowledge to your advantage. In this post, I’ve shared a few tips with you on that steps you can take to minimize the impact of increase rates that are headed our way. You will need shelter until the day you die, so please do not procrastinate. Take steps today to ensure that you can shelter yourself tomorrow.

Living Underwater is Fantastic for Fish & Bad for People!

When it comes to mortgages, you never want to be underwater. Repeat after me – living underwater is for fish, not people!

A person is underwater on their mortgage when the mortgage amount owing is higher than the value of the house. For example, if you have a $450,000 mortgage but you would only be able to sell your house for $395,000, then you are underwater on our mortgage.

This is a not a desirable situation because it means you cannot sell your house without taking the deficiency to the bank in order to pay off the bank. In the above example, the deficiency is $55,000 (=$450,000 – $395,000). The mortgage debt to the bank can only satisfied by a payment of $450,000. This is known as discharging the debt.

Unfortunately for you, potential buyers of your home are only willing to give you $395,000. In order for the bank to discharge your mortgage debt, you would need to take the $395,000 from the buyers of your home and another $55,000 from your own pocket to the bank.

Just out of curiosity, do you have an extra $55,000 lying around? No? Then you, my friend, are trapped in your house.

The Downsides of Being Trapped in a House

If you’ve got no reasons to leave the house you’re in, then living underwater on your mortgage is an academic problem. Since you’re not going anywhere, there’s no issue about having to pay any sort of deficiency to the bank. You can continue to pay your mortgage and wait for the real estate market to recover. Even if recovery takes a decade, you don’t need to care since you won’t be trying to discharge the mortgage on your house.

The situation is quite different if you want to move across the country for a new job, or your health status changes and your home is no longer suitable for you. There are any number of reasons why you might choose to move your current abode to another one. None of them change the fact that being underwater on your mortgage means you can’t sell your place without satisfying your full debt to the bank.

I ask you again, do you have enough money in your wallet to satisfy the deficiency and get the mortgage discharge you need?

Mortgage Rates are Rising

Those without a mortgage can be forgiven for not realizing that the cost of mortgages is increasing. For the rest of you, it’s imperative that you start thinking ahead. When it comes time to renew your mortgage, will your budget accommodate a 1%-2% increase in your current rate?

If the answer is “No”, or “I don’t know”, then you should be making extra payments to your mortgage. Make extra payments as often as you can. And make those payments are large as you can! This will ensure that, at renewal time, your mortgage is as small as it can be. This means that your new payment at the higher rate will be lower than it would be otherwise.

You can use an online calculator to estimate the size of your next mortgage payment. Whatever rate you’re paying now, add 2%. Assuming you’ll be renewing a mortgage of $350,000 and the anticipated 5-year rate at renewal time will be 5%, here are the mortgage payments generated by this online calculator.

  • If you’re renewing with a $350,000 balance at 5%, then your bi-weekly mortgage payment is $1,017.81 or $2,025.62 monthly.
  • If you’re renewing with a $325,000 balance at 5%, then your bi-weekly mortgage payment is $945.11 or $1890.22 each month.

How to Stop Being Underwater

There are a few ways to stop being underwater. Some are harder than others. The most effective way to cease living underwater is next to impossible – you can change market conditions so that the value of your house rises above the balance on your mortgage. See what I mean? That method is next to impossible. Manipulating market conditions likely isn’t within your particular skillset.

Your best bet is to find a way to make extra payments on your mortgage until the balance equals, or is less than, your mortgage’s balance. At that point, the trap is sprung! In other words, what you get from a potential buyer is enough to satisfy you debt to the bank.

Paying extra on your mortgage is a simple plan. Note that I said “simple”, not “easy”. Depending on your other financial obligations, it might not be easy to find the extra money to throw at your mortgage. You might take on another job or start a business. Maybe you’ll sell you no longer need or take in a roommate.

Ridding yourself of non-mortgage debt facilitates another way to make extra payments. Maybe you owe money on student loans, credit cards, vehicle loans, or other consumer loans. As you pay off other debts, re-direct that former payment to your mortgage. Think about it. You were already sending that money to a creditor, so you’ll keep doing so. Your lifestyle won’t change since you were living without that money anyway. All that will change is the name of the creditor.

However you choose to do it, the goal is to stop living underwater on your mortgage.

Will you be prepared when it’s time to renew your mortgage?

According to the various talking heads in financial media, mortgage rates are set to rise over the next two years. They’re predicting that almost everyone is going to see their mortgage payments rise on renewal. If you’re on your last mortgage term, then you have my heartfelt congratulations. You don’t have to worry about your mortgage payment going up because it will be going away. You will get to keep your current mortgage payment instead of sending it to your lender. Hooray for you! Take a chunk of it – no more than a third – and use it for day-to-day spending. The rest of it should be invested for long-term growth. Enjoy your money and the comforting feeling that comes from knowing that your disposable income has gone up, way up!

If you’re one of these lucky ducks, you need not finish this article. The increase in mortgage rates will have little to no direct impact on you.

For the rest of you, keep reading. If you’ll be renewing your mortgage at some point in the future, you’d be wise to ask yourself how your budget will accommodate an increased payment. The only pertinent question that you need to consider is the following one. Will you be ready when they do?

Fortunately for you, there are many online amortization calculators. These little beauties will tell you how much your new mortgage payment will be if your mortgage rate changes. I urge you to find one immediately! Then I want you to add 2% to whatever rate you’re currently paying, figure out how much your remaining mortgage debt will be on renewal, and determine what your new payment will be at the higher rate. The sooner you have this information, the better.

Should you be fortunate enough to have access to Excel or Numbers, then you have the ability to create your own amortization table. This spreadsheet will break down your payments into the principal and interest portions. You can then play around with the interest rates and mortgage debt to see the impact on your future payment.

Armed with this new information, you can turn your attention to your budget and figure out where the money will come from to fund the higher payment. Remember! If you don’t pay your mortgage, then your lender can take your house. No one wants this to happen to you.

If your budget can accommodate the new, higher payment without trouble, then hooray! You’ll be fine and you need not worry about the increase’s impact on your life. Your house won’t be at risk of foreclosure, and you won’t need to worry about declaring bankruptcy. You can stop reading here if you choose.

Should you be in the position that your budget will balk at the increased payment, consider the following option to prepare yourself for the inevitable.

One way to keep the same mortgage payment, even if rates go up, is to make a lump sum payment at renewal time. After all, your payment is based on both the prevailing interest rates and the remaining mortgage debt. The smaller the debt, the smaller the payment. If you can accumulate a few thousand dollars between now and renewal, then do so! You’ll have the option of making a lump sum payment at renewal time. Doing so will keep your payments from inflating more than your budget can bear.

You could even start sending extra payments to your mortgage in advance of your renewal date. Doing so chips away at the mortgage’s principal balance even sooner. Every dollar of principal that is repaid is a dollar on which your lender can no longer charge you interest. Prepayments are a fantastic method of ensuring that your increased mortgage payment isn’t as high as it could be. Revisit the terms of your mortgage contract and see what options are available to you for making prepayments.

Be prepared for the day when your mortgage lender asks you for more money. Mortgage terms in Canada are rarely set for 25 years. You’d be wise to assume that mortgage rates will continue to increase. If they don’t, then you’ll have done yourself absolutely no harm by being prepared.

My Money Mistake – Investing vs. Paying Off a Mortgage

One of the eternal questions that’s raised in the personal finance world is whether one should be investing or paying of a mortgage. I made my choice 15 years ago. In hindsight, my choice could qualify as a mistake but, if so, it’s not the worst one I’ve ever made. As I’ve said before, personal finance is personal and it should be about what makes you the most comfortable when it comes to investing your hard-earned money.

I was raised to not carry debt. It’s a good lesson, and I can’t disagree with it too, too much. That said, there are nuances to debt that I did not learn nor understand until after I’d paid off my mortgage at age 34. I’m going to share my perspective of those nuances with you so that you have the information to make the best decision for your own life and goals.

Different Choices, Different Risks

Jordan and Leslie are both 30 years old when they finally buy their first house. They both have 25-year amortizations, and they both have an extra $1500 per month that can be used for investing or paying down the mortgage.

Jordan decides to pay off his home early. His extra $18,000 per year goes into making extra mortgage payments. He’s in line to pay off his home in 15 years when tragedy strikes. At year 14 of the amortization, Jordan loses his source of income and cannot make his mortgage payments. Within six months, he loses his house to the bank in foreclosure. After years of making mortgage payments, Jordan is left without a house and without an investment portfolio. He has to start over from scratch – find another job, build another down payment, start making mortgage payments all over again, figure out how he’s going to pay for his retirement.

Leslie makes a different choice because she knows that time lost can never be regained. Investments need to be made early so that they have the maximize time to grown. Leslie decides to pay minimum monthly requirement on her mortgage, which commits her to the full 25 year amortization. Leslie invests her extra $1500 per month by fully funding her TFSA and RRSP every single year. Once those two registered plans are maximized, she invests the remaining money in a non-registered investment plan through a brokerage. In short, Leslie chooses to invest $18,000 per year. As with Jordan, Leslie loses her employment income at year 14 of her mortgage.

Leslie’s not worried about losing her house. Why not? Her investments have grown quite nicely over 14 years. She has money in the bank. Her dividends and capital gains are enough to provide her with cash flow to pay the mortgage. They’re not yet enough to replace her entire former income, but they’re enough to keep her afloat until such time as she finds another job.

Even if Jordan and Leslie hadn’t lost their jobs, Leslie would still have been wealthier than Jordan at the 25-year mark. Why?

Leslie’s investments would have had 25 years to grow while Jordan would have only had 10 years of growth. Even if he starts investing his entire former mortgage payments the day after his mortgage is paid off, Jordan’s investments will not grow as large as Leslie’s. Her investments have had an extra 15 years to grow, assuming the same rate of return for both portfolios. Both Jordan and Leslie would have a paid-off homes at the 25 years mark, but Leslie would also have a much bigger cash cushion than Jordan.

Hindsight is 20/20.

Now, don’t get me wrong. The logic of this example was lost on me when I took out a mortgage on my home. As a matter of fact, I don’t even think I saw the options presented this way until after I’d paid off my home. If I’d seen it sooner, I would have atleast thought about it while paying off my biggest debt.

With the benefit of hindsight, I now realize that I should have followed Leslie’s lead. It’s been nearly 25 years since I took out my first mortgage. Had I kept that mortgage and invested my money instead, I’d be that much closer to financial independence. Instead, I chose to become debt-free in my early 30s and have been diligently investing in the stock market for the past 15+ years.

My parents taught me to stay out of debt, and I heeded their advice. Was I wrong to do so? Not really… Yet, if I had learned about more about investing and the compounding of time, I would have made a better-informed decision. I might have better appreciated what it meant to lose those early years of compound growth as I worked very hard to pay off my home in 5 years.

Since you’re best-placed to know your own life goals & dreams, you will make your own choice. Investing vs. paying off a mortgage is a major financial decision. The consequences of the choice won’t be known until long after you make it.

My hope is that you make an informed decision. While you can’t know the future, you can influence it by making wise choices and planning accordingly.

There’s nothing wrong with changing course, if necessary.

If you’re currently making extra payments but you’re doubting that choice, then know this. It is perfectly okay to change your mind. When you know better, you do better. Maybe you stop the extra payments for a few months while you stuff your RRSP and your TFSA. Perhaps you decide to alternate – one month the extra money goes to your mortgage and the next month it goes to your investments. You have to do what makes you most comfortable. And if you decide to keep paying off your mortgage, then do so with the full knowledge of what that might mean for your future.

We no longer live in a world where the majority of people have pensions. For the majority, saving for retirement is up to each individual person. Lifetime employment with the same employer is no longer the standard. Committing to decades of mortgage payments without the security of gainful employment is risky. In Canada, houses are ridiculously expensive so mortgages are often several hundred thousand dollars. I understand why getting rid of such a large debt is a huge priority for people. At the same time, getting out of debt shouldn’t diminish the responsibility you have to funding the Care & Feeding of Senior You Account.

When I think about my own choice through the lens of maximizing my wealth, I feel that I made a mistake and that I should have kept my mortgage for as long as possible in order to invest. Yet when I consider the fact that employment is not guaranteed and funding retirement is on the shoulders of the employees, I think I was wise to eliminate my mortgage as fast as possible.

Will I have the absolute maximum amount for my retirement? No, but I’ll still have enough and that’s what matters most.

Lock it down!

Quick! Do you have a variable rate mortgage? Has your lender given you the opportunity to lock in your next mortgage rate today since it’s up for renewal in the next 90-120 days?

If the answer to either question is yes, then I’m going to suggest that you seriously consider locking down a fixed-rate mortgage as soon as possible. Mortgage rates are going up. The higher the rate, the more interest you’ll pay to the bank. Why pay more if you don’t have to? If you have the opportunity to renew your mortgage at a low interest rate, then lock it down as soon as possible!

It’s fairly complex. I am certainly no expert but my understanding is this. The 5-year mortgage rates are going up because central banks are expected to raise the bond rates. They’re raising those rates in order to fight inflation. The bond market controls long-term interest rates. That’s the entirety of my understanding of how the whole thing works. You’re encouraged to learn more about this if you’re interested.

The long and the short of it is that the very low 5-year mortgage rates that we see today will soon be gone. Some people are predicting that mortgage rates will double in the next 18 months. You should play around with an amortization calculator. Doing so will give you a good idea of what your mortgage payment when mortgage rates are twice what they are now.

This is not a good time for procrastination. Lock it down! Call your lender and figure out how to secure a fixed interest rate while fixed rates are still very, very low.

Once you’ve locked into a fixed rate, consider making extra payments towards your mortgage. When your mortgage renews in 5 years, the rate is going to be higher. As we all know, higher mortgage rates mean higher mortgage payments. Throwing extra payments at your mortgage while paying a lower rate over the next five years will lessen the impact of renewing at a higher rate. If your budget won’t allow for extra payments, then start a sinking fund. Every time you have some extra cash, squirrel it away. When renewal time rolls around, you’ll have a chunk of cash to throw at the principal. Making lump sum payments is another way to minimize the increase in mortgage payments when you go to renew your mortgage in the future.

Of course, if your mortgage is scheduled to be paid off in the next 5 years, then you need not worry too, too much. You won’t be on the of ones renewing into a higher interest rate environment.

If you have a line of credit, pay it off! Your monthly payment on your LOC is made up of interest and principle. As the interest rates go up, the portion of your payment devoted to interest will also go up. The result is that it takes you longer to pay off the principle. In other words, you’re paying more interest on your line of credit as interest rates go up.

For the record, I’m a huge fan of 5 year rates, so my suggestion in this article applies to the 5-year fixed rate. I only ever had 5 year amortizations when I had a mortgage. To me, it was easy enough to plan life in 5 year increments. Some people like the idea of having a 10 year fixed rate. Others want to lock in a rate for 3 years. You’ll have to pick the timeframe that best suits your life and your goals.

Beware the HELOC!!!

HELOC is an acronym that stands for home equity line of credit. It is a way for homeowners to access the equity in their homes without actually selling the home. Banks love these kinds of loans because they are secured by the property. For this reason, HELOCs are risky – they put your shelter at risk. This is hardly ever a wise move from the personal finance perspective!

In short, if a homeowner doesn’t repay the HELOC, the bank has the right to foreclose on the home in order to recoup its money.

Another way to think of a HELOC is to view it as a line of credit that is tied to your house. An unsecured line of credit carries a higher borrowing rate, since the bank doesn’t have any recourse if you don’t make your LOC payments as required. Banks presume that most people do not want to lose their house and that they’ll do whatever they have to in order to avoid that unfortunate outcome. As a result, the risk of delinquency is also presumed to be lower than lending borrowers money through an unsecured line of credit. Since the HELOC has a lower risk, the bank charges a lower rate of interest.

Those who’ve been reading my blog for a while now already know that I hate debt. Payments to creditors prevent most people from investing for their futures. Debt forces people to put today’s income towards paying for past purchases.

I especially despise the HELOC. Like all loan products, banks benefit from them more than the consumer. If you have a HELOC, you have to make payments on the loan each month. And if you miss enough payments, then you’re considered delinquent on your debt and the bank can take your house away from you. This is why I personally believe that HELOCs are risky.

Remember! A HELOC is a charge registered against your mortgage. When you take out a HELOC, you’re putting your home up as collateral.

If you really must take out a line of credit, then I would urge you to get an unsecured line of credit. This kind of LOC is not tied to your house. If you fail to pay it, you certainly damage your credit rating… but no one is going to take away your home. It might take 7 years to repair your credit, but so what? It’s better that you repair it from the comfort of your own abode, than suffer the double-whammy of repairing your credit and also losing your home through foreclosure.

Another reason I very much dislike the HELOC is that it is a loan that can be called at any time. A HELOC is a demand loan. That means your bank can demand that you repay it whenever they want.

Let’s say you take out $45,000 of debt via a HELOC against your $375,000 house to do… whatever. (Equity withdrawn via a HELOC can be spent however the homeowner sees fit.) You agree to repay the HELCO at a rate of $750 per month. You’re making your payment as agreed, and getting on with the business of living your life. For reasons they need not declare, your bank gets twitchy and demands that you pay off your outstanding HELOC balance. And if you don’t, they’ll proceed with foreclosure proceedings to get their money bank. You’re suddenly in the position of losing your $375,000 house over a $45,000 debt…Not good!

How are you going to repay the debt? If you’d had the money in the first place, you wouldn’t have borrowed from the bank, right?

I’d suggest that you think long and hard before you take out a HELOC against your home. Make sure you understand what you’re risking before you sign on the dotted line. And if you already have a HELOC, then I suggest that you pay it off as soon as you can.

Life is stressful enough. The risk of your home possibly being the subject of a foreclosure is one added stress that you should work very hard to avoid.

Owning vs. Renting…decisions, decisions!

In the interests of complete transparency, I’m going to say that I am a homeowner. I’ve owned my current home since 2004, and I bought my first home in 2001. I only ever rented for a few years – maybe 2? – before I got my very first mortgage and jumped on the property ladder.

Things have changed drastically in the past 20 years… Damn! I hate typing that out, but facts are facts. Twenty years ago, I was able to buy my first place for $74,000. Fortunately, I bought just before prices in my province went crazy.

I’ve listened to both sides of the own vs. rent debate, and both sides make good points. Personally, I still prefer to own. Why?

When I’m old, I want to have the option of selling my home to pay my bills. Renters do not have that option.

I’ve spent years reading Garth Turner’s advice at the Greater Fool. He strongly advocates that people who own sell today, if not yesterday, so that they can take advantage of the incredibly high housing prices that we are currently seeing in various parts of Canada. He exhorts them to invest their tax-free capital gains, to create a cash flow that will pay for their living expenses, and to become happy, carefree renters. Mr. Turner has written numerous blog posts about the costs of home ownership, and how people routinely discount the costs of maintenance, repairs, taxes, land transfer fees, and all other expenses that come with owning a home. Paying the mortgage is least of a homeowner’s concern. There are so many other ways that a house becomes a financial albatross!

Mr. Turner advocates for becoming a renter, allowing the landlord to subsidize your housing expenses, and investing the difference between rental payments and mortgage payments. I will admit that this perspective is compelling. Having owned my home for years, I am known to refer to it as a money pit. There’s always something that needs to be paid. Renting and living off my investment portfolio does have a seductive ring to it.

…Until I start thinking about whether my portfolio is big enough to handle 20 to 30 years of rent increases. I don’t want to be 75 years old and facing yet another rental increase that means I’ll have to move to a smaller, less desirable location. I know the stock market has returned 10%-12% on average over very long periods of time. That’s all fine and good. Yet, we know that this is an average. Some years, the stock market drops.

If I have a $200 per month rental increase in a year where my portfolio has taken a hit, then don’t I have to liquidate some of my principal to pay my rent? And doesn’t that mean that I’m cannibalizing my portfolio’s capital right when I shouldn’t be touching it? Once the money has been withdrawn to pay rent, it’s no longer able to recover and grow. Selling during a downturn means I’d be decreasing the size of my portfolio at the worst possible time in order to keep a roof over my head.

That is precisely what I should not be doing in my dotage. Remember, the ideal scenario is that my portfolio will always churn off enough capital gains and dividends to cover my living costs.

But what if it doesn’t? What if my portfolio isn’t big enough to churn off sufficient funds to pay for my living expenses once I’ve stopped working? Then what happens? Who comes to my rescue as my portfolio dwindles over the years?

With a house, I believe that I have a few more options. Once it’s paid for, there’s no longer any risk that the bank will foreclose on it. Whew! It’ll still cost me in upkeep and repairs. Those are just a fact of life. However, my house lets me participate in house-hacking if necessary. I can take in a roommate. I can rent my house to someone who needs the space while I live somewhere else. If I needed to, I could sell it and use the money to pay for my long-term care. Or I can die in my own home, secure in the knowledge that no one ever forced me to leave a place where I wanted to live.

I’ve yet to see the pro-renting advocates address the fact that not everyone is able to build a portfolio that is large enough to cover ever increasing rents, and the other costs of living. Mr. Turner’s suggested course of action works wonderfully for people who bought in Vancouver 25 years ago and are now sitting on millions in equity. I’m not as easily persuaded that it works for people who don’t already have a boatload of equity to invest in the stock market. It’s true that a house cannot be sold one doorknob at a time to pay for one’s bills. However, it can be sold all at once and hopefully the money lasts as long as needed.

Life has taught me that there is no one right answer for every situation. If you can build a portfolio large enough to sustain you, then I see no problem with renting. It’s the situation where a large portfolio isn’t in the renter’s future that troubles me. In those circumstances, it’s very difficult for me to believe that renting is better. If the portfolio isn’t sufficiently large to cover life’s expenses, and there’s no home to sell, then what is the renter to do to find additional money?

I will think on it some more. Stay tuned.

Housing Prices & Interest Rates

When I was a kid, one of the things I learned from my mother was that interest rates are inversely correlated to housing prices. If interest rates are going down, then housing prices are going up.

Over the last 12 months, I’ve seen this lesson play out in real life. By the time this blog post goes live, we will have passed the one-year anniversary of the COVID-19 pandemic. Yet, there are cities in this country where the housing market is red-hot. People are tripping over themselves to buy homes and they’re “winning” bidding wars to do so.

Five-year mortgage rates in my corner of the world had been on offer for as low as 1.84% up until just recently. At the time of writing this article, they’re slowly creeping up but a few can still be found at just around 2%. The Talking Heads in the media are predicting that 5-year rates will increase steadily over the next year. They say that this will be due to the economy fully re-opening as everyone gets their vaccine.

Who am I to argue with the Talking Heads?

The corollary to my mother’s great insight is that house prices drop as interest rates rise. This is due to the fact that fewer people can afford house payments when the cost of borrowing increases. Fewer people buying is a fancy way of saying lower demand. Less demand for something forces sellers to drop prices in order to sell their goods. In the housing market, rising interest rates are very strongly linked to decreasing housing prices.

For the past 10 years or so, the interest rates for mortgages have been less than 4%. I can tell you that my very first mortgage – taken out nearly 20 years ago – was for 6.5%. That seems astronomically high by today’s standards! When I was teenager and working part time as a grocery store cashier, I worked with folks who were thrilled to get a mortgage at 8%. The super-low mortgage rates of the past decade have been normalized, and I worry that people forget that rates can also move in the other direction.

Two Minds

I’m of two minds when it comes to housing. Buying a house was a very smart move for me. I was fortunate enough to buy what I needed at a price that was less than 3 times my gross income. The mortgage payments were less than 30% of my take-home pay. I could afford the repairs and maintenance that come with a house. Taxes and insurance weren’t an onerous burden on top of these other costs. The monthly nut associated with my shelter did not inhibit my ability to invest for retirement, travel, and have a bit of fun with my family and friends.

In short, buying a house was a good move for me… 20 years ago.

Today, twenty years later, I’m not so sure that buying a house would be a good financial move for me. For starters, I would have to choose between servicing the monthly nut of homeownership and every other financial goal. My mortgage, property taxes, insurance, repairs & maintenance would render me house-poor for a very long time. There wouldn’t be room in my budget for things like retirement savings, travel, entertainment, vehicle replacement, or those little luxuries that make like easier. My financial life would revolve entirely around paying for my housing, and there would be no room for my other money priorities.

I used to think that renting was a bad idea. However, my perspective has become more nuanced. If renting allows one to have a balanced life, then I think it might be a good idea. Of course, that balance has to include maxing out all retirement savings and building an investing portfolio. Those investments need to be big enough to pay for rental accommodations when the paycheques stop arriving. Whether you own a house or rent your space, you need to pay for shelter one way or another.

Cheap rates aren’t here to stay.

Today’s very low 5-year mortgage rates will go up. Securing a mortgage at 1.84% is wonderful, but that rate is likely only going to be locked in for 5 years. (And only for those who were lucky enough to grab it!) At renewal, the rate might be 3.5% or higher. Can your crystal ball predict the future perfectly? Will your budget be able to survive the mortgage payment increase that will come with a higher mortgage rate? Are you positive that you’ll still have the same income that you have now?

Even if your job’s salary stays the same, will your other expenses do the same? I’ve noticed that the cost of my streaming service goes up every 18 months or so. The price of food hasn’t gone down, ever. Taxes seem to only ever move in one direction. The list goes on. Life gets more expensive every year, yet salaries and wages don’t always go up in tandem with the increased expenses of every day life.

So even if you were only of the lucky ones to grab a super-cheap mortgage rate for a five-year portion of your mortgage, I strongly urge you to calculate how much your mortgage payment will increase when you renew. It’s not too, too crazy to believe that the bond market will push the five year rate up by 50 basis points each year for the next five years. Add 2.5% to your current rate and see what your new payment will be. Can you handle it?

Alternatives

Your first option is to pick rich parents. It’s been my observation that some parents with an excess of money are willing to help their offspring purchase a home. Financially speaking, it’s wonderful to have that kind of help to get onto the property ladder.

Not all of us can pick our parents, so that means being a little more creative.

If I were starting out today, I’d be looking at becoming a landlord. Either I’d try to buy a house with a rental suite or I would have roommates. There would have to be someone else around to contribute to the mortgage payments. If my salary paid for the minimum monthly mortgage payment, then the tenant’s rent would be what I would use for the extra payments to principle.

Would it be ideal? No. Would it have to last forever? Also, no.

A third alternative would be waiting to buy. Like I said earlier, house prices will come down as mortgage rates go up. Figure out how much of a mortgage you can afford. This number will be different than what the bank says you can afford. After all, you’re the one who’ll be responsible for the payments so look at your budget and be realistic.

Once you know how much mortgage you can comfortably carry, open an account at EQ Bank and start salting that mortgage payment away. This benefits you two ways. First, you’ll get used to having a mortgage payment since you’ll have to make that payment once you’ve signed the mortgage documents. Second, this money will help you make as large a down payment as possible.

I’m not trying to dissuade you from buying a house. Truly, I’m not. I just want you to think long and hard about the financial commitment that owning your own home will entail.

In a world without pensions, I am not persuaded that it’s a good idea for a person to spend 25-30 years paying off a mortgage without the ability to save for retirement. A mortgage debt that leads to an extended hand-to-mouth lifestyle is rarely a good thing. It limits options and inhibits one’s ability to pursue their true dreams, goals, and desires.

Money-Making Magic – Real Estate Investing

It’s taken me a few years but I finally understand how to create money from real estate re-financing. It’s another aspect the money-making magic of properly investing your money.

Right off the top, I want to tell you that I have never done this. In other words, my understanding of the process is only theoretical and it is not based on my own experience. I have never bought a property, renovated it, and then re-financed it to extract my investment.

Secondly, I want to be explicitly clear that I am not telling, instructing, advising, recommending, or otherwise encouraging you to do this with your money. It’s just a theory that I have finally understood so I want to share it with the world via this blog.

I’m a fan of the podcast Millionaires Unveiled. In episode 145, the hosts were talking to a guest who had made significant money in real estate. The guest used the same BRRRR method espoused by Brandon Turner at Bigger Pockets. You may also want to check out Graham Stephan on his YouTube channel, where he goes through a detailed example of how to profitably invest in real estate.

A Simple Example…as I understand things!

Purchase Price – $80,000. Renovations – $20,000. Total Investment – $100,000. After Repair Value – $150,000. Re-Finance & Cash Out @ 85% of ARV – $127,500. Free Money to Investor – $27,500.

So let’s un-pack this.

In this example, the investor bought a property for $80,000 in cash, meaning that there was no mortgage debt to the bank. (This example also works if the investor invests a 20% down payment – $16,000 – and gets a mortgage for the remaining $64,000. Either way, she’s still buying an investment property for $80,000.)

Renovations of $20,000 were made to the property. At this point, the investment in the rental property is $100,000 = $80,000 + $20,000.

The money-making magic starts when the investor goes to the bank to get financing on the property. (If the investor had had a mortgage, then she would’ve “re-financed” the property.) In the example above, the bank appraises the property at $150,000, which is $50,000 more than the investor’s total investment. The bank agrees to finance 85% of the ARV, which puts $127,500 back into the investor’s hands. As we all know, $150,000 x 85% is equal to $127,500.

(And if the investor started with a mortgage, she would go to a second bank to re-finance the property. She would then pay off the mortgage of $64,000 at the first bank, and be in the same position as if she had paid the full $80,000 up front. $127,500 – $16,000 – $64,000 – $20,000 = $27,500.)

Since there is now a mortgage on the property, equivalent to $127,500, the investor uses the rent from that property to pay back the mortgage. If everything goes perfectly, the rent will also cover other costs such as insurance, property taxes, and repairs.

In this example, the investor has earned $27,500 in free money through the money-making magic of real estate investing. Remember, she invested $100,000 of her own money ($80,000 + $20,000) and is walking away with $127,500 after financing her property. There are three things to take-away from this example.

  • The investor now owns an investment property while also recouping her entire $100,000 investment. In other words, she has none of her own money in the property.
  • If everything goes right, someone else is paying the mortgage and costs of this property with a little something leftover for cashflow to the investor.
  • Finally, the $27,500 is tax-free money. This is money that was derived from a higher appraised value. She’s removed some of the equity from the property and put it in her own pocket.

If you decide to start real estate investing, get proper accounting and tax advice from professionals you’ve paid to do work on your behalf. Do NOT take accounting and investing advice from blogs on the internet.

Lots of Things Have to Go Right for This to Work

The rewards are bountiful when things go right. In our example, the investor had the money to invest. The appraised value after the renovations was high. The bank was willing to finance 85% of the property value. There was a pool of available renters who could afford to pay a rental amount that covered the mortgage payment and associated costs of the investment property. The market rental price was high enough to cover the mortgage payment and the aforementioned associated costs.

Let’s say the bank had only wanted to finance 65% of the ARV. Our investor would have only been able to pull out $95,700 (= $150,000 x 65%). She would not have pulled out her entire $100,000 and the increase-in-equity-through-the-power-of-smart-renovations amount of $27,500.

Or let’s say that the real estate market had dropped between the date of the purchase and the date of the new appraisal. The bank tells our investor that the appraised value had come back at only $115,000, instead of $150,000. Even at the 85% ARV financing, the bank would only give the investor $97,750 (= $115,000 x 85%) to put towards the purchase of her next investment.

Another area where the plan could’ve gone haywire is the renovation costs. If our investor had budgeted $20,000 for renovations but wound up paying $50,000 for renovations, then her investment amount in the property would be $130,000 (= $80,000 + $50,000) instead of only $100,000. If the re-appraised value remained $150,000 and she could finance the property at 85%, she still would not be extracting her full investment of $130,000 because the bank would only be giving her $127,500.

Finally, there’s always the possibility that the renter stops paying the rent and the investor is forced to pay for the property. Every dollar out of the investor’s pocket is a decrease in the return from the investment property. The money-making magic has suddenly been turned into a money-sucking curse.

Research, research, research!

Like I said at the beginning, I finally understand the theory behind the money-making magic of real estate. It’s taken me years and many, many, many hours of listening to various podcasts & YouTube videos, but I finally get it. Now that I do understand it, I personally think it’s disingenuous to use click-bait language like “buying real estate with none of your own money.”

Obviously, at some point, you will need money to invest in real estate. It’s more accurate to say that there isn’t always a need for your own money to stay locked inside your investment properties… Okay, I get it – my language isn’t nearly as catchy and it would never qualify as click-bait.

However, that doesn’t change the fact that I generally know what the pundits mean when they use the click-bait language. I’m not a real estate investment expert. I haven’t put this theory into practice, and I’m not certain that I ever will. What I am certain of is that I finally understand – in a very rudimentary way – how a person can own real estate without keeping their money in an investment property. If the stars are aligned just right and nothing goes awry, real estate investors have the ability to own real estate without their money remaining in their investment properties.

It’s certainly not risk-free, but it does sound like it could work if everything goes right. If it’s something that you’re interested in, then I suggest that you start learning as much as you can before you start investing.

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Weekly Tip: Pay off your mortgage before you retire. It’s not good to go into retirement with debt. You will more than likely be living on a fixed income. Do what you can to ensure that creditors aren’t take a bite out of your fixed income every month. You won’t regret the fact that you’re mortgage-free when you’re retired.

House-Hacking is Worth Considering

House-hacking can be an amazing tool for building wealth.

You know how sometimes you’re on YouTube watching one thing and then a suggestion pops up on the side of the screen? And you decide to hit play instead of scrolling past it? Well, this week held one of those so I indulged my curiosity and hit play on a video that I otherwise never would have found by searching. For one reason or another, I was watching some videos about tiny houses. I started with this one because I wanted to know how anyone could spend $165,000 to build a tiny 300 sqft house.

And that’s how I discovered Robuilt. I promptly watched several more of his videos and I have to admit that a lightbulb went on after watching his video on house-hacking. I loved this particular video because this fellow goes into detail about how he financed his house-hacking project. He’s not shy about sharing how he obtained the money to build a tiny house, to renovate his basement suite, and how much rental income he’s earning from various sources. The only question I would’ve appreciated hearing him answer was how he and his spouse had initially accumulated the down payment for the purchase of their $640,000 home on writer & teacher salaries, but I guess everyone likes to maintain at least some small measure of mystery.

Anyhow, the lightbulb moment for me was when I realized – deep in the marrow of my bones – that it’s sometimes okay to go into debt if you’re borrowing money to buy real estate. I shouldn’t have been so shocked by this revelation. I’ve borrowed money to buy all of my properties. I’m very familiar with the concept of mortgages, how they work, how to repay them, etc…

Living in a Million Dollar House for Free

No. What shook me to the core was the manner in which Mr. & Mrs. Robuilt went from having a $4000/mth mortgage payment to a $0/mth mortgage payment by borrowing money. This video goes into more detail about how exactly they accomplished this feat so I encourage you to watch it.

Okay – so they bought the house and renovated the basement suite within two months. That rental of that suite netted them at least $2K – sometimes $3K – each month.

Blue Lobster, that still leaves at least a $2K/mth mortgage payment.

Yes, Numerate Reader – you’re right. Having the basement suite wasn’t enough.

The Robuilt’s decided to build a tiny house in their backyard. They’d initially budgeted $40,000 but the project ended up costing them $72,000. They didn’t take the money from the equity in their main home. Instead, they went to a private money lender to pay for this project.

Once the tiny home was built, they eventually rented it for $1800 per month. They refinanced the mortgage on their home to get rid of their PMI, bringing their mortgage payment down to $3700/mth… meaning that they were able to live in their home for free. Oh, and the value of their principal residence had gone up to over $1,000,000 because of the tiny home in the backyard.

Damn…

The Key was Getting Financing

Pay attention to the part where they went to a private money lender. (And they also relied on their credit cards, which is a very risky move because of the very high rates on credit cards. I am not recommending that you do this.)

As I watched the video, I could hear the thunderclap inside my head. You need access to money to acquire property, whether your own home or rental properties. The money can come from your own savings, from a family member, from friends, from a sou-sou, from a lifetime of collecting your loose change… it matters not. You need to get your hands on money to fund your real estate purchase.

And if you don’t have cold hard cash of your very own, then you need financing.

The Robuilt videos opened my eyes to the world of private money lenders. I don’t know all the details about how they work. Nor am I familiar with how they structure the lending terms. I don’t even know the rates or how they assess your credit. And to be clear, I don’t know why Robuilt’s didn’t go to a bank to get the money they needed to build their tiny house.

What I do know is that people who are cut off from obtaining financing are essentially cut off from the opportunity to acquire real estate. And if they’re not cut off completely, then their lack of access to money contributes to their delay in wealth-building. Maybe it takes someone an additional 7 years to be in a position to buy real estate. Whether that’s 7 years to save up a sufficient down payment, or 7 years to clean up their credit enough to qualify for a mortgage or a private money loan, it hardly matters. The result is the same – that person is unable to build wealth through real estate for 7 years.

Financing & Intergenerational Wealth

The thunderclap for me was the realization that access to financing is one of the keys to getting ahead when it comes to building wealth. If you buy rental properties, then you earn the equity while your tenants pay down the debt. If you buy your own home, then you still earn the equity while you pay down the debt. In order to earn the equity in the first place, you have to own property.

House-hacking as displayed in the Robuilt videos wouldn’t have been possible in as short a timeline as theirs without access to financing. That access allowed them to start creating wealth for themselves today. They’re also now able to build intergenerational wealth for their daughter.

It should be obvious that a lack of access to financing inhibits the creation of intergenerational wealth. In this blog post, I’ve focused on one couple who have used financing to buy & build real estate. Their reliance on financing allowed them to craft a situation where others pay for their mortgage. This results in their salaries going to other things, like accumulating another down payment to buy more property if they choose.

I’d like to point out financing can also be used to start a business. People who are more sophisticated than I am use it to invest in the stock market. For the record, there are many ways to use financing to build wealth.

People who don’t have access to financing have fewer opportunities to build wealth. It can still be done but it’s harder because those people have to accumulate the same amount of money from their own earnings. Imagine if your credit was so bad that you couldn’t get a mortgage. Or if you were legally prohibited from owning property. The only way for you to buy a property would be to save money from your paycheque then pay cash for a home.

How long would it take you to save enough money from your paycheque to buy a house? Even if you were house-hacking by living with a roommate?

Access to Financing = Access to Opportunity

The person who has to pay cash for a house doesn’t have the same opportunity to build wealth through real estate as the person who can get financing to buy property. I know that it might take the mortgage-holder a lifetime to repay the debt. After all, that’s why 25-year and 30-year mortgages exist, right?

Assuming the mortgage is paid, then the home can be passed down to the next generation. Imagine where would you be financially if you’d inherited a full-paid for home!

The person who can’t get financing for a home – yet miraculously saves enough money to buy one – can also pass their home down to the offspring. The possibility exists in theory only. It’s just such a monumentally harder endeavour to use cash to buy a home that most people never seriously consider doing it this way.

I’ve always believed that debt-free is the ultimate and best status when it comes to personal finance. This week, I’ve had cause to re-assess my position on debt. For whatever reason, these videos about house-hacking were more visceral for me than anything else I’ve read, watched, or heard. The power of financing and its ability to generate intergenerational wealth was put on full display. I have to admit that my eyes were opened to the possibilities in a way that they hadn’t been before.

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Weekly Tip: Borrow books from the library. It’s free and it’s a better use of your time than scrolling a social media site. There are books on anything that you can think of. Borrowing books is free. Libby is a magnificent app that prevents you from ever incurring a late fee because it automatically returns books to the library for you. Feed your brain – read a book.