January 5, 2008

Zero Down (100% Financing): A Dream or a Curse

by: Dave Peniuk

On the surface, zero down (100% Financing) of 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!

• 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.

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;

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".

Reader 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:

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