Zero Down (100% Financing):A Dream or a Curseby: Dave Peniuk
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:
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:
Now, there are two advantages to using the CMHC program:
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
"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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On 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.
Reader Mail:
Find an Article by Julie Broad in the September 2010 Issue of Canadian Real Estate Magazine
|
Burnaby, BC, Canada
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