Hugo Dos Reis – VINE Group
With the warmer spring weather comes a much more active real estate market and we’ve seen a significant increase in consumer confidence for 2019 than we did this time last year. We’ve also recognized that there still seems to be a large disconnect between clients financing expectations on what they believe they can qualify for and what they end up with. With the introduction of the Stress Test in 2018 and a few other financing rule changes, any expectations you’ve had for financing prior to 2018 should be completely updated.
These days it’s very 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 will end up costing them much more than they planned for.
Our practice has always been proper planning, surrounding yourself with a strong team, and focusing on the long-term picture. Everyone should be having a conversation with a financing professional to understand their profile and all their mortgage options before making any purchases. A lack of proper planning or review could cost you thousands in the current lending environment.
To help make some immediate changes to your current profile and portfolio, we’ve put together four action steps that should be able to significantly improve your ability to qualify for financing on your next application.
1. Create a Mortgage Binder
In the real estate world, time is money and having an organized system where you can access all your critical data is the key to success. We refer to this tool as a “mortgage binder”, but essentially the idea is to have either a physical or digital location where all your information is stored and easily accessed. With tax season fully underway most clients will have already put together many of these documents, but ensuring that it remains organized will save you valuable time and money.
The information lenders will typically require includes, but is not limited to, the following:
- Updated income documents (Pay stubs, letters of employment, original employment offers, copies of current employment contracts, full T1 Generals and T4s for the last 2-3 years, notice of assessments for the last 2-3 years, and financial statements for the last 2-3 years).
- Updated business documents (Articles of incorporation, business license, financial statements for the last 2-3 years, business tax returns for the last 2-3 years, access to last 6-12 month bank statements to confirm business deposits, and copies of any invoices from client contracts).
- Current property tax bills for all properties to confirm the annual amount due.
- Current mortgage statements for all properties that can confirm the property address, mortgage balance and current mortgage payment. If you have a HELOC (Home Equity Line of Credit), multiple mortgages or LOCs (Lines of Credit) on a property, you’ll need to keep these all together.
- Current lease agreements. If leases have expired, you’ll need to have a paper trail of the month-to-month agreement or a tenant acknowledgement agreement, along with access to the last 3-month bank statements to confirm rental income is being received.
- 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 not only stay organized but also 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. We recommend that clients complete an annual financing review that includes a credit score evaluation. However, everyone should monitor their credit score annually to understand where you stand and to allow time to address issues that could come up. There are plenty of credit monitoring programs available or even a simple chat with your financing partner.
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, so if you’re looking to access more lending you’ll want to manage these two variables. 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 in mind cash-flow and overall portfolio expenses. If you’ve decided to be aggressive with your mortgage payments to pay the balance down quickly, you may have put yourself in a position where future financing becomes restricted due to your higher mortgage payments. The solution to this is to see if a refinance is even required by completing a review with your financing partner but if needed, consider stretching your amortization to the maximum (30 years) allowed if available.
On a $400,000 mortgage you could have payments in the lower range of $1,700/month by stretching the amortization to 30 years. However, 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 $250/month or about $50,000 in more financing.
If you’ve decided that you absolutely need to pay down your mortgage, there is another solution: prepayments. In the same example above, we would advise the client to keep the mortgage as low as possible (or at $1,700/month), but to prepay the difference of $250/month. 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.
Before any refinancing, a proper conversation with your financing partner is strongly encouraged to ensure this strategy makes sense as there could be fees or penalties involved with making changes to your mortgage.
When reviewing a mortgage application, lenders will complete a credit check and review all your personal credit balances. These would include: car loans, student, and other loans with fixed payments, unsecured lines of credit, credit cards, leases, etc. Depending on the credit type, the lenders will take a specific balance per month and include it on your mortgage application.
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 normally require an interest only payment, a much higher monthly expense is being considered for lending purposes. For fixed installments such as those on a car loan, lenders will simply take the actual ongoing monthly payment.
For the example above, this client has $1,250/month in credit expenses.
If a client was looking to purchase a new property, their borrowing capacity would be reduced by about $225,000 because of these monthly expenses.
If we were able to consolidate and refinance these balances into a mortgage, we’d be able to reduce the monthly amount to $335/month and the reduced lending capacity would only be an estimated $50,000. Quite a large difference and could make all the difference.
4. Converting existing HELOCs into mortgages
Home Equity Lines of Credit (also known as HELOCs) are excellent tools for investors. They provide an interest only payment to keep cash flow in check and at a reasonable interest rate. Most investors will use their HELOC to finance rental properties. What many people don’t know is that on a mortgage application a HELOC with a balance can make it challenging for future lending. 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 5.34%) and amortize payments over 25 years. This is similar to the new Stress Test rules that were introduced in 2018.
On a $250,000 HELOC balance you would normally have interest-only payments of approximately $825/month. On a mortgage application, we would treat this balance as a mortgage with a rate of 5.34%, amortized over 25 years, with a monthly payment of $1,503. This is a difference of $678/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. In the above example we could ask the lender to take the $250,000 and convert it to a 5-year variable rate. Assuming a rate of 2.85% over 30-year amortization, the payment would actually be $1,032/month. This is lower than the $1,503 stress test payment that the lenders are using to qualify you and increases your borrowing capacity by about $75,000.
Financing these days hasn’t been easy, but knowing how to stay ahead of the curve by being informed is the real secret to continuing to be a successful real estate investor.