Dear Ross, I am bullish on the long term prospects of Canadian real estate – especially in the Greater Toronto Area, where I live. I am already a homeowner, and our mortgage balance is only $102,000. Now we want to buy a second property, rent it out, and watch our equity grow over the years, just as our home has. We see this could be a great supplement to our retirement nest egg. What are your thoughts about this? What kind of property do you suggest? And what about the mortgage?
I think this is an excellent idea. Some media personalities are suggesting you wait on the sidelines in the hope prices go lower, but it’s very hard to be a market timer. And it’s not as if they give you a guarantee if they are wrong! If your intended holding period is long enough, say at least fifteen years, you should be fine.
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You need to know your own financial and risk/reward profile:
Several clients over the years have bought fixer uppers and flipped them. Others have bought houses which they have then torn down, and built something majestic on that same lot. I don’t think this is for you. You want to be careful you don’t evolve into a property speculator, rather than a real estate investor. Stick to rental properties in good areas with excellent, sustainable tenancy prospects.
(1) How much could you comfortably spend each month towards the investment? Some people prefer properties which can cover most, if not all, of their monthly outlays. This is Nirvana – you build equity without dipping into your own pocket! But that’s not the only way to skin the cat.
(2) Consider your overall financial picture. Does it make sense to invest in a two million dollar property when your own home is only worth, say $700,000? This seems rather imbalanced to me.
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(3) How solid are your personal finances that you could withstand a decline in prices? Especially since this could affect the value of both your investment and your home.
Align yourself with a trusted realtor who really understands your market, and is experienced and comfortable with investment properties. Together, you should research homes and neighborhoods, to decide what you are targeting.
You have to take emotion out of the buying process. This will not be your home. It is an investment and you have to be clinical in your selection.
What kind of mortgage should you select?
Arguably the biggest thing driving Canadian real estate values over the past ten years has been our incredibly low interest rates. A $500,000 mortgage does not look so sexy if you are renewing at 6 or 7%, does it?
Therefore you should consider at least a five, maybe even a ten year fixed rate mortgage. A ten year mortgage at 3.69% is a wonderful thing for someone investing in a rental property. Lock in your mortgage payment for ten years, and you don’t have to be concerned about the fall-out of a big rate blip anytime soon.
Before you go nuts, sit down with your mortgage specialist, open your kimono, and disclose all your personal finances. You want to be sure you will actually qualify for a mortgage on a second home, and for how much.
What about the down payment?
You can tap into your current home’s equity and use some of it for your down payment. If you already have a Home Equity Line of Credit facility, it’s as simple as writing a check.
If you don’t, you can easily arrange one (usually up to 65% of the value of your home) or you can refinance your home, increase your mortgage, and use the equity takeout for your investment property.
Money borrowed to invest is often tax deductible; do mention you are doing this to whoever prepares your income tax returns.
Related article: Tax deductible mortgages
The bottom line is you have a good idea here. But don’t be lazy. Do your homework, and use the services of your expert advisers in real estate, mortgages, and income taxes.
Most apartment leases have a provision for sub leasing – so if you are truly ready to assume home ownership, there are ways you can exit your existing obligation nicely and legally