This last year has been the year of all things “unprecedented”. Add one more to the list: an historically low interest rate environment that has helped turbo-charge the Vancouver real estate market. But is building wealth through real estate as simple as going on a shopping spree in 2021? One of Canada’s top, investment-focused Mortgage Brokers Kyle Green joins Adam & Matt to tackle this question, breaking down today’s lending environment and the varied strategies anyone can employ – from an aspiring first-time buyer to a long-time Vancouver homeowner to a seasoned real estate investor in aggressive growth mode (Bonus Material: Kyle’s top Canadian market picks for 2021!). We are in unprecedented times, and they call for unprecedented action. Here’s your roadmap!
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Please tell us about yourself.
I’ve been a mortgage broker for 14 years and niched into working with real estate investors. Most of what we do at Green Mortgage Team is work with investors and help them grow their portfolios. We help educate people about opportunities. Being a Vancouver mortgage broker has been very interesting over the last decade. I’m also a real estate investor myself with six properties.
What should potential home buyers know about the current interest rate environment?
Low interest rates make home ownership more affordable. However, they don’t make the qualifications easier. Interest rates have dropped over the last couple of years; they peaked in late 2018/2019 at around 4% and are now under 2%, which is a big difference. But in that same period of time, the qualification rate (the stress test) has not dropped by the same amount. So these lower interest rates aren’t helping people qualify but they do help people with affordability.
So it’s not easier for people to borrow, but people who do borrow are in a better position.
Correct. In fact, when covid first hit, a lot of lenders tightened their reigns. Most of those guidelines have relaxed but people did pump the breaks. For example, pilots who are working a lot fewer hours or people who are self-employed in certain industries may have a lot harder time qualifying.
Covid has affected different industries. Hospitality workers have been hurt badly. But almost every white collar worker I know is just as busy, if not busier, than before covid and they’re saving more money.
Does the low interest rate impact costs on the month to month?
Yes. If you’re borrowing $100,000 on a 30 year amortization at 4% interest, your payment will be $475 per month. If you’re borrowing the same amount but at 2%, your payments are down to $370. So per $100,000 you borrow, is about $100 less per month with the lower interest rates.
Even on a 30 year amortization, you’re paying 50% interest and 50% principal right from that first payment. So you’re saving money each month and paying less interest. When I bought my first place in 2007, I had $0 down, a 40 year amortization and 6% interest. My very first mortgage payment was 9% principal and 91% interest. If I was to borrow now on a 25 amortization with today’s interest rates, it would be about 60% principal on the first payment.
It’s a very interesting time. Interest rates have a big impact on the market and we’ve seen that.
If someone locks in a low interest rate today, what happens with their interest rate 5 years from now?
This is one of the good things the government has done. Although interest rates have dropped, borrowing power has not increased much thanks to the stress test. So you have to qualify at that higher rate of the stress test, 4.79%.
However, I don’t think interest rates will hit 4.79% in five years. I think they’ll stay flat for a while and then start to increase. We may hit 4% in five years, maybe. So you have to look at your personal budget and see what works. The banks don’t know your spending habits. You have to look at the lowest common denominator between your budget or your borrowing power and go with that number. If interest rates start to rise, we want to see what your payments will look like, especially with a variable interest rate.
Let’s say someone takes on a fixed five year mortgage, 30 year amortization, with payments of $2000 per month right now (2% interest). At the end of the five years, let’s say interest rates go up to 4%. When they’re renewing at the end of the term, what can they expect?
You can expect payments to raise by 20-25%. There’s also the option to re-amortize your mortgage to save more. We don’t advise clients to do that unless they really need the lower payment.
How would payments change if you were making lump sum payments during your first five years at 2%?
When you’re making lump sum payments, your amortization shrinks, not your monthly payments. So it’s less interest paid over time. If you want your payments to be reduced, when your renewal comes up, you would want to re-amortize. If you’ve been making lump sum payments, you’ll see a bigger reduction in monthly payments once you re-amortize.
For example, if you were on a 25 year schedule and reduced it to 15 years with your lump sum payments, and you then re-amortize for a 30 year schedule, you’ll see a significant reduction in monthly payments.
For someone who is renting right now, what should they be thinking about in this current interest rate environment?
In general, it’s more expensive to own than rent each month in most cases. If you factor in that you’re paying down a mortgage each month and have an appreciating asset over time, your future net worth changes dramatically.
I have a rent VS own spreadsheet that I show to potential first-time homeowners. You have to compare apples to apples. In most cases, while the cost of ownership is higher on a monthly basis, if you factor out the principal reduction on your mortgage, it’s actually cheaper. The principal paydown is a forced savings account. So the net cost of ownership is cheaper and you have an appreciating asset.
What should homeowners be considering right now?
You may find that you can save money by refinancing your mortgage. If you time it right or got your mortgage at the right time or with the right lender, you could save some money.
If you’re with a major bank and took a five year fixed rate, you probably won’t save money. If you have two years left, your penalty will exceed the savings you’d get in most cases.
However, it may still make sense to refinance and lock in the lower mortgage rate for longer. If you took a five year fixed rate in late 2018/early 2019, you may want to look into the numbers as there could be some savings available to you.
What about the option of blend and extend?
Blend and extend means the lender will blend your current rate and the current market rate together and give you a new five year term. So blending the weighted averages of the interest rates and extending your term. Sometimes it makes sense but it’s not always in the clients’ favour.
A lot of lenders who were doing blend and extend actually won’t do it anymore. I believe this is because a lot of clients were doing this and seeing their penalty significantly drop. So it was a loophole for clients who wanted to get out of their mortgage terms.
So homeowners should figure out their current rate, what rates are today and what their penalties are. But we are seeing savings for some people who are refinancing, right?
Absolutely. I have clients saving five figures. You should definitely spend five minutes figuring out your numbers.
What should real estate investors be considering in this climate?
In general as a real estate investor, you make money from cash flow, mortgage paydown and appreciation. If you put 20% down on a piece of real estate, it’s difficult to find something that cash flows, especially in the Lower Mainland. So many are cash flow neutral or maybe slightly positive. So your ROI in cash flow is not significant (0-4%). You typically make most of your money on mortgage paydown and appreciation.
If you bought a property for $500,000 and put 20% down ($100,000) and the property goes up by 1%, your return on investment is based on the cash you put in. You’ve now made $5000 on your $100,000 investment. You leveraged your equity so your return is 5%, even though the property only appreciated 1%.
People often forget about mortgage paydown. A typical mortgage costs $400 per $100,000 of mortgage. And right now about half of that is going towards your principal. So even if you bought something with no cash flow and no appreciation, you could still see a 10% return on your money just by having the tenant pay down your mortgage for you.
If you add these three things up (15% from appreciation, 10% from mortgage paydown, 0-4% from cash flow), you have a 25-30% return. It sounds silly but it’s actually very reasonable. And it’s why so many people are investing in real estate.
Fixed VS variable?
You would expect now would be a great time to go fixed since rates are so low, but my recommendation when covid first hit was to go variable, so you could ride the wave down. We did this during the 2008 financial crisis and it worked for many of our clients. They could then lock into a fixed rate at any time.
Rates have started to flatten out and there’s not as much movement. I don’t expect much more downward movement or much upward movement in the next few years. The variable and fixed rates are about the same right now. So why would you go with the variable that has room to go up? Penalties.
We look at the penalties and that’s where the big shocker is. If you take a five year fixed with the bank today and break it in 2-3 years and rates haven’t changed much, the expected penalty cost will be 5-10 times more than if you had gone with a variable rate. The variable rate mortgage is capped at two months’ interest.
Here’s how they calculate your penalty for your five year fixed rate: Let’s say you got a rate of 1.79% but the posted rate was 4.79% – so you got a discount of 3%. You’re now breaking your mortgage and the new posted rate is 3.5%. So your penalty rate will be the difference between your rate (1.79%) and 0.5% (current rate of 3.5% minus your 3% discount). But 0.5% is not a rate the bank is currently offering, so the numbers are manipulated in the bank’s favour.
Some people had a smaller penalty because the discount rate at the time when they first got their mortgage was smaller. But now that discounts are so steep, it will create much larger penalties. We’re talking about the difference between a penalty of $7000 with a variable rate VS $60,000 with a fixed rate.
Which Canadian markets are you excited about for investors?
I’m excited about Mission and Chilliwack if you’re looking for detached houses that cash flow in the Lower Mainland. I like the idea of owning land that appreciates. A detached house allows you to own more land, unlike you would in a condo.
There might be some good buys in downtown condos if prices soften. There hasn’t been a lot of demand; many sellers are selling and getting out of downtown because they need more space. However, I think when covid is less of a factor and migration is opened again, there will be more demand downtown. I don’t know if I like the timing right now but if prices do drop, that’s an area I will be keeping my eyes on.
I like Vancouver Island. We’re seeing a lot of people, particularly in healthcare, moving over there. You can make the same income but your expenses are lower. Especially in areas like Sooke, we’re seeing a lot of cash flow and growth.
Kamloops is an area I’m keeping my eye on too. I have a lot of investors in Prince George too. It’s basically the capital of northern BC. There’s the university and a lot of worker activity. Covid hasn’t affected that area as heavily. Some of the two bedrooms in new builds are renting for $2000/month. Buying new in that market could be a good play.
I like markets for vacation rentals, which I think will be big moving forward. So areas like Kelowna, Penticton, Tofino, etc. But it is like running a business. You’re in hospitality, not just real estate. There’s a lot to learn if you want to do Airbnb, but it can be successful if you run it right.
I’m a little weary of Alberta and the prairies with how reliant those provinces are on oil. We’re seeing a similar effect in Toronto as we’re seeing in Vancouver with people going to suburbs in search of more space. But I’m not seeing a specific area in Ontario where everyone is buying. Some areas of the maritimes, like New Brunswick, have great cash flow. I’m not sold on capital appreciation but cash flow in multi-family in New Brunswick is an option.
You started a consulting business in 2020 and work with people across Canada. Do you have one exciting strategy that everyone is talking about? One hot tip?
My one tip that applies to the most people is about taxes. One of the easiest ways to build wealth in real estate is to make sure you’re tax efficient. For example, making lump sums on your mortgage is a great strategy. We suggest clients set up a readvanceable mortgage.
You may have heard of HELOC (home equity line of credit): when you pay down your mortgage principal, your line of credit limit will increase. This allows you to borrow against your home equity – you’re paying down your mortgage and saving money for investing. Borrowing against your equity allows you to invest again. The key is that every time you invest, the interest payments are tax deductible. Talk to your accountant to ensure this works!
So you pay down your personal mortgage, reborrow the money to buy investments, take the positive cash flow from your investments and pay down your personal mortgage again. You keep cycling through and get a snowball effect.
There are also higher level strategies, involving using rental income to pay down your personal mortgage, to accelerate this strategy.
What do you think interest rates are doing in the next 1-5 years?
I expect fixed rates to stay low for 12-24 months. Fixed rates are tied to bonds and the government is actively buying back their own bonds, which I don’t see changing anytime soon. They will then start to increase, but I wouldn’t expect more than 0.5% increase per year. So maybe 3.5% by year five.
On the variable rate side, the Bank of Canada is unlikely to move the interest rate until 2023/2024. So we have 3-4 years of enjoying a low interest rate.
One of our strategies is to go variable now and ride it out for 1-2 years. And when it looks like fixed rates are about to climb, lock in a fixed rate. You can lock into a fixed rate at any time without penalty. By locking in then, you can have that lower interest rate for the next 6-7 years, instead of five.
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