Walking through the airport gift shop recently, I saw the Toronto Life cover titled a Mortgage Slaves. It showed a picture of a family sitting on a couch, looking hopeless. The article discussed how tightened mortgage rules and less flexibility with CMHC meant that more people were looking to private mortgages in order to purchase their first home.
The article warned readers that many private lenders were predators and they should beware. What the article didn’t say was that, as a real estate investor, the lack of funding available at the banks creates a cool opportunity for you to help a family become home owners while you can make a steady return on your money.
The trick is understanding how to do it in a way that is fair to the home owners and gives you a return given the risk you take on.
Why is it harder to qualify for mortgages?
In the past 5-7 years CMHC rules have made it more difficult to quality for financing with shorter amortizations and tightened lending guidelines.
To add to that, thanks to mergers, there are far fewer financial institutions today than there were even 15 years ago.
What does this mean to a buyer? Fewer financing options has meant less people qualifying conventionally. Where relationships used to help people get financing in the past, clients are treated more like a number than ever before. Due to these changing circumstances in the lending industry, buyers need private mortgage options.
4 ways to help homeowners now while getting a great return.
As a savvy investor with access to funds, there are four great ways you can invest in mortgages and make a great return:
#1 – In Your RRSPs
Have you ever heard this before? “Well, you do have some excellent options for your investment. The first option is a daily interest account, where the current rate is 0.25 percent. Is that really an excellent option? “It is very safe!” was his reply. It also won’t even keep up with inflation … my money will be shrinking every single month if I do that! It is crucial as an investor to look for better ways to grow your money, or you simply won’t have enough in retirement.
If you have done a great job regularly contributing to your RRSPs, you will have a nice sum of money in your account With RRSPs, you must use an arms length mortgage (close relatives or your own personal mortgage are not qualified investments). This also works for other registered money, like TFSAs, RRIFs, RESPs, LIRAs, and LIFs . Investing your RRSPs in mortgages is covered in detail here.
You do not need to take your registered funds out and pay taxes to take advantage of this strategy; they are simply transferred to this new investment. A trust company and a lawyer can help you set this up to ensure your investment is protected.
#2 – Use Your Own Home Equity or Cash
Second, non registered funds, such as equity you pull from your personal residence or non-registered investments in stocks or mutual funds, can also be used. When refinancing, the banks typically mandate that you must leave 20-25% of your equity in your home. For example, if your home valued at $400,000 has a $100,000 mortgage, the bank requires that you leave 20 percent as equity, so you can borrow up to $320,000. This means you can take out $220,000 and lend it out to someone needing a mortgage.
If you are paying 2.75 to 3% on your mortgage and you can make 6% to 12% on a first or second mortgage, this is an excellent interest rate spread and potential opportunity! Using non registered funds is much simpler than using registered money, because it is a fairly quick process to refinance your home or withdraw money from regular investments. However you do not have access to the same tax deferral strategies or tax exemptions that you do when investing using RRSPs and other registered products.
How do you find people who need a mortgage? One of the best sources would be the local service professionals. Mortgage brokers, lawyers, and realtors will often have clients who do not quite qualify for a mortgage (again, due to tighter lending requirements), and would happily refer you to them so they can still get the deal done.
It can also be a good idea to connect with or get a referral from someone at a local real estate investor meeting.
As an investor you need to do your research so you understand the deal, market and borrower risks. You must know your exit strategy ahead of time- if the owner defaults will you keep the home as a rental property? Will you sell it? What are the rules in your province for handling defaulted mortgages? Next, what do you know about the person you are investing with? Is their job secure? What is their history in home ownership? Do they have financial and character references? Ask as many questions as you can. If you’re not sure what to ask, you can review the elements that Julie Broad recommends an investor put in a Deal Summary. Getting answers to these key questions will help you reduce the risks.
Finally, have your lawyer review all of the paperwork to ensure you are well-protected.
#3 – Purchase an Existing Mortgage
Third, you can purchase an existing mortgage, or use your money to pay out an existing mortgage. Some people may find themselves in the position of needing to refinance their home, but they no longer qualify. Maybe they want to consolidate debt and lower their monthly payments, for example.
If they’ve recently changed jobs or started a business, they will be unable to qualify for financing under typical bank rules. The bank wants to see income history of 2 or 3 years of self-employment before they will provide a mortgage. Someone in this situation might be willing to pay a higher interest rate for access to a private mortgage. As the new mortgage holder, you can pay out the existing mortgage to the bank, and you then become the first party listed on title with the mortgage. All of the paperwork and dealing with retrieving the mortgage payout figure, getting the funds to the bank, and checking title, should be handled by a lawyer on your behalf.
As with any financing, it is important to do your due diligence. Make sure you are comfortable with the home you are mortgaging, have 2 appraisals done to make sure the value given to the property is accurate, and check references and job history. You could have a mortgage broker help you review their financial history and credit bureau, as well as look at their debt ratios. If you have any concerns or your gut instinct tells you this is not right for you, listen! You don’t need to take advantage of every opportunity that comes your way, wait for the opportunity that provides you with a great return with the least amount of risk.
These private mortgage opportunities can come up as you networking and let people know what you are looking for. You may find yourself having to do a little education on what private financing is, so prepare to take the time to explain what type of financing you want to do, and how your friends, family and colleagues can help you find what you’re looking for. A cool example- I had an acquaintance tell me that they were paying a high interest rate on their mortgage because they had ran into some difficulties before purchasing their home, and were forced to use a high interest rate mortgage company. I was able to find an investor that paid out that company so that the investor is the new mortgagee, reducing the interest rate charged to the homeowner by 50 percent! The mortgage is 75 percent loan to value which the investor feels is a secure investment. In addition, it is providing a great return to the investor. Happy homeowner, happy investor!
#4 – A Vendor Take Back Mortgage
Fourth, you can sell your home and hold the mortgage for the buyer. Vendor Take Back mortgages, more commonly knowns as VTB’s are explained in detail in this article: https://revnyou.com/seller-financing-vtbs/.
What this means for you is that you can become the bank holding a private mortgage when you sell your home, assuming you have equity in it.
Title still changes hands – the buyer will be the owner of record. You will just become the lender (or, one of the lenders).
How does this work? You are secured on title as the mortgagee and have the same protection as the bank. If you own your home free and clear of debt, and are looking to downsize into a smaller home, or you’re going to rent you may not need the equity from your home to make your move. With a VTB you can put that equity to work for you, and help a new buyer. This is often the case for baby boomers, who are now empty nesters and are looking to travel and enjoy retirement instead of tending to a large yard and caring for a big family home. In this case people often take the proceeds from their sale and invest it- holding a private mortgage is simply another way to invest that same money. The added benefit is that you know your mortgaged property inside and out- thereby again mitigating risk.
Plenty of opportunity exists for investors looking for safe real estate backed investments without the hassles of having rental properties. In addition, it is satisfying knowing that you are able to help someone purchase a home that may not otherwise have been able to. If you would like to learn more about this topic, reach out. I provide online training and real estate investment coaching to new as well as experienced investors.
Candice Bakx-Friesen has been investing in real estate for nearly 15 years. She has a diversified portfolio including single family, multi-family, and commercial properties that have been financed through private and conventional means, and has used joint venture partners as well. Contact her at firstname.lastname@example.org or connect at www.investorsmarts.ca.
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