Zero Down Financing – Dream or Curse?


100% FinancingOn the surface, zero down (100% Financing) on an investment property seems like a fantastic idea. With no money down, it seems you can’t go wrong. But, that is not necessarily true.

Recently CMHC (Canadian Mortgage and Housing Corporation), who insures non-conventional mortgages (less than 20% down payment mortgages) in Canada, introduced the 100% financing for investment properties. This same product has been in existence for a couple of years for primary residence purchases but now, if you want to get into real estate investing (and your credit is great and you can qualify for the 100% financing), you no longer need a stack of cash to jump in! The challenge is obtaining rent that’s high enough to cover the mortgage and the 7.25% insurance premium they hit you with! Here’s an example: 

  • $300,000 purchase price (100% financed) 
  • 7.25% CMHC insurance fee ($21,750)
  • Total mortgage of $321,750
  • Amortized over 25 years at a 5.99% interest rate =
  • $2,056.67 monthly payment!

So, right off the bat you have negative equity of $21,750. If you wish to sell that property after 5 years, your mortgage balance will be $289,008. The property will have had to appreciate at least 15% over those years just to get a little bit of money out of it (remember there’s sales commissions, legal fees, property purchase taxes, etc. that will also come out of the sale price).

The next challenge is getting the $3,000 in rent each month that you would need to carry this property. Remember, it’s not just about covering the mortgage. You also have:

  • Insurance fees (approx. 5% of rent); 
  • Management fees (approx. 5% of rent);
  • Maintenance fees (5% to 10% or more);
  • Water, hydro, other utilities (2% to 5% of rent);
  • Strata or condo fees, if applicable (10% or more);
  • Vacancy coverage (2% to 5%), etc.

From our experience, if you keep your mortgage payment at a maximum of 65% of your rental income, you should be pretty close to having neutral or even positive income. In this example, that means you want to earn approx. $3,200 in rent to cover everything. Not very likely unless you are running a rooming house and if you’ve read about my two properties in Niagara Falls, you know how fun and lucrative rooming houses have been for me. 

Now, there are two advantages to using the CMHC program:

  1. No money down – you don’t need lots of cash to begin investing; and
  2. Potential for a GREAT return on investment (ROI) if the market is on the upswing;

So, it’s not the worst thing to use, but be very aware of what it will “cost” you in terms of potential negative monthly cashflow and negative equity. 

Now, what about other forms of 100% financing? Well, there are creative ways of obtaining 100% financing such as Vendor Take Back’s (the Seller holds the mortgage on the property); Obtaining a conventional mortgage (80% loan to value) thru a bank or lender and then obtaining a 2nd mortgage from either the Vendor or a private lender and registering it after you purchase the property (you must still have the 20% down payment upon closing); or using your line of credit for the 20% down payment. So, this is not to say that 100% financing doesn’t work or isn’t useful, it’s just quite costly to do it. Costly because not only your monthly debt (mortgage/line of credit) servicing is higher, but usually a 2nd mortgage or line of credit interest rate is substantially higher than a 1st mortgage rate.

I have done 100% financing once and 98% financing another time, and the only reason I was able to was because both sellers were very motivated to sell. Why were they so motivated? Because their properties were beat up and in bad areas. The rent vs. financing was strong in both cases, so I bought. I wouldn’t do it again. As the saying goes, “You get what you pay for”.

November 2008 Update – The 100% Financed, Zero Down Mortgage Has Been Taken Away in Canada

reader mailReader Mail:

“I agree with some of (the) article but remember how it (financing rental properties) was, 10% down and a 4.25% fee, my duplexes run about 200K thus the 7.25% is a 3% variance from old way. So since I usually try to amortize investment properties over 20 yrs and the 3% extra represents 6K (actually $6,850), another way to consider this is, you can keep your 20K in your pocket today at a cost of approx $300. per year ($6,000 divided by 20 years). Now if your investment planner can’t make you more than $300 off that 20K you need to find a new one. Even when I’m being extremely cautious I average 6-8% (CI seg funds are a favorite) so using 7% as average you have approx $1,100 ($20,000 times 7% less the $300) extra per year by going 0% down.”

From Dave:

Thanks for your great email Corey! It’s a pretty in-depth comment but I am going to give it a try.
Let’s look at the real numbers of 10% down vs. 0% down using mortgage insurance:
10% down
$200,000 price
$20,000 down
$180,000 mortgage
4.25% insurance fee = $7,650
$187,650 total borrowed
20 year amortization (using your example)
5.5% interest rate
$1,284 monthly payment
$120,572 total interest paid over 20 years @ 5.5% rate
0% down
$200,000 price
$0 down
$200,000 mortgage
7.25% insurance fee = $14,500
$214,500 total borrowed
20 year amortization (using your example)
5.5% interest rate
$1,468 monthly payment
$137,825 total interest paid over 20 years @ 5.5% rate
Difference in monthly payment: $184
Total difference in payments over 20 years: $44,160 
Difference in total interest paid: $17,253
He mentions keeping the $20,000 and investing it in seg funds with an average return of 7% (this would assume net return, after deducting management fees, usually 2-2.5% – so a 9%+ gross return).  This would produce approximately $1,400 annually in interest earnings. However, it is costing you $2,208 per year more in mortgage payments, so you’re now negative $808.**I’m also ignoring income tax here to try and keep this simpler.**
I don’t know of many properties that cost $200,000 yet bring in approximately $2,300 per month in rent. You would need approx. $2,300 to cover mortgage and expenses (mortgage payment of $1,468, plus roughly 35% of your rental income to go towards expenses). I am sure there are some properties out there that have this kind of return, but they are likely much higher risk. Buying an already high risk property using a high risk financing strategy is a very bad scenario, even in an upward market.
Finally, if the above wasn’t bad enough, you have negative equity in your property for at least the first 2.5 years of owning it.  If you buy that property today at 100% financing, there is a good chance it may even take longer to get into the positive again (due to the current state of the economy and housing market).  And that was the whole point of our article, 100% financing is a very risky scenario (and difficult too in terms of servicing the extra debt with higher payments). When you buy with 100% financing you are starting out $10,000, $15,000 or even $20,000 in the hole (the negative equity I refer to above).
One final final note, 100% insured financing for primary residence and rental properties has been abolished by the government by Oct.15th. Thus, some of this response doesn’t really matter come fall! But, I wanted to explain, again how 100% financing will cost you.
Thank you for the great e-mail. It really made me give my calculator a work out.
published January 5, 2008
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