As an investor, you’re likely aware of the overwhelming variety of mortgage products that exist on the market today. Picking the wrong product can add thousands – even hundreds of thousands – of dollars to the cost of your mortgage. Doing so can also result in significant opportunity costs that will hinder the growth of your portfolio.
Chasing nothing but the lowest rate is a big mistake. While we all want favourable financing terms for our properties, the rate is often just the tip of the financing iceberg. As consumers, we only see the advertised rates; we have no way of realizing what lies underneath and the catastrophic toll it can take on our finances and investment goals.
Let’s assume that one of the lenders your investment property deal qualifies with is offering the lowest rate on the street for rental properties. Here’s what the rest of the low-rate iceberg might contain:
1. A fully closed mortgage
A fully closed mortgage is not opened for repayment unless the property is sold through a bona fide sale. You will have no opportunity to break it, even if you pay a penalty, unless the property is sold to someone who is not related to you. Investors looking for flexibility should beware.
2. Add-on insurance premiums
Some lenders will add up to 2.9% of the loan amount in insurance premiums to the mortgage, even if you are purchasing with 20% down. This added cost essentially changes your effective cost of borrowing, turning a rate that may have initially looked tantalizingly low into one that is higher than other rates on the market.
3. Prepayment limitations
Prepayment privileges allow you to pay down the mortgage faster through regular payment top-ups and lump-sum payments. Some of the mortgages that come with the lowest rates will restrict how fast you can pay down your mortgage. Fifteen per cent is a typical prepayment option, and some lenders offer 20%. When there are restrictions, that figure can drop to 10%.
4. Equity trap
Equity is a key source of capital for most investors. Some mortgage products will enable you to easily access equity over time, while others will trap the equity. Advanceable mortgage products, for example, will allow you to accumulate equity on a secured line of credit as you pay down the principal on the mortgage. The lowest-rate mortgage provider may not offer such a product. If that’s the case, the only way to take out equity from your property down the road would be to refinance.
5. Teaser offers
Teaser rate offers are designed to entice consumers to switch mortgage providers or attract new business, and they tend to create a lot of buzz. While teaser offers might initially save you money, the savings may not last forever because they are time-sensitive. For example, a teaser rate may offer a really low one-year fixed option, but once that year is up, you are bound by what is offered with that lender at that point in time.
6. The wrong lender for your portfolio
For investors looking to build a real estate portfolio, financing the property at hand has to be done with an eye toward the next set of properties you’re planning on buying. The objective is to obtain the best financing terms on as many properties as possible through proper planning and structuring of financing. A lender who is offering the lowest rate for a current deal might not be the right lender for your portfolio from a strategy standpoint. The wrong lender could limit the number of properties you can finance down the road at favourable terms or have an implication on the type of financing you can get for your next deal.
Chasing the lowest rate can result in you getting, quite literally, much more than you bargained for. Your long-term plans, the strategy you have in mind for the property you are buying (buy-and-hold, rent-to-own, flip, etc.) and your risk profile should shape the selection of the right mortgage product.
Dalia Barsoum is an award-winning mortgage broker, real estate investor and finance advisor with more than 20 years of experience in the banking sector. Barsoum won CREW’s 2017 Mortgage Broker of the Year Award and is a regular speaker and contributor on the topics of investing and financing. She is the bestselling author of Canada’s number-one financing book, Canadian Real Estate Investor Financing: 7 Secrets to Getting All the Money You Want. To schedule a complimentary consultation or to plan your equity take-out, email firstname.lastname@example.org or visit streetwisemortgages.com.
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