A colleauge of mine passed on an article to me from the Washington post from Monday Decmber 8th, that indicated that more than HALF (!) of mortgages that were “modified” in a bid to keep them out of foreclosure went back into delinquency within 6 months.

HALF!!! Talk about some gruesome underwriting!

John Dugan, Comptroller of the Currency, said it was unclear why so many of the borrowers, freshly helped, ran into trouble so quickly. This is making people wonder how policy-makers really should be approaching this problem as clearly just modifying the terms isn’t enough.

Personally, I think the fact the mortgages were set up in the first place is brutal and that no amount of “modifying” of the terms can avoid the fact that the borrower owes the money (and often against a property not worth what they paid for it). At the end of the day someone has to “pay the piper” and it shouldn’t always be the taxpayer.

The figures from Dugan point to 36% of “modified” mortgages being delinquent after 3 months, and 53% being delinquent after 6 months. How bad was the underwriting???!!!

It looks to me that the only way out of this mess it THROUGH IT, just like every other challenge, and if that means foreclosures, I think that we have to accept that and move forward.

Opinions?

I read an article on housing starts and how they had falled dramatically in the past year despite some prior resiliance to the world financial crisis. I found this article by David Friend in THE CANADIAN PRESS and felt it did a good job of explaining some findings. Enjoy!

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Finance Housing starts tumble in last month to lowest levels since late 2001, CMHC says

David Friend, THE CANADIAN PRESS
December 08, 2008

TORONTO – Construction of new homes in Canada slowed last month to levels not seen since late 2001, driven by a drop in condominium construction and a tougher environment for borrowers, according to a national housing agency.

Several bank economists noted that new-home construction has been lower this year compared with 2007, because pentup demand has been largely satisfied, but the pace of decline sped up in November because of changes in the credit markets.

And the decline is expected to continue throughout next year, Canada Mortgage and Housing Corp. said. CMHC reported Monday the seasonally adjusted annual rate of housing starts fell to 172,000, down 19 per cent from 211,800 in October. That was far below private-sector economist expectations of about 200,000, and the biggest percentage decline since last December.

November marked a significant deterioration in CMHC’s outlook for 2009 as both market value and consumer confidence crumbled to their lowest levels in recent memory. But the November numbers “remain consistent with our forecast, which calls for more moderate activity of 212,000 units this year and 178,000 units next year,” commented CMHC economist Bob Dugan.

The latest full-year adjusted numbers were below expectations for 2009. However, the CMHC noted that the agency still has to account for December results, which they expect will boost the overall full-year results closer to their 212,000 estimate. Dugan noted home construction bulged early in the decade because of pent-up demand, but “over the last few years, this excess demand gradually decreased and our forecast for 2008 and 2009 reflects this new reality, with housing starts more aligned with long-run demographic demand.”

The rate of urban starts dropped 21.6 per cent month-over-month to 144,800 in November, with declines in all parts of the country as volatile multiple starts tumbled 29.1 per cent to 81,700 while single-family starts eased 9.0 per cent to 63,100.

“After showing a great deal of resilience over the past year, the Canadian housing market is cooling,” said Dina Cover, an economist at TD Bank. “With our expectation that homeowners will be facing tight credit conditions and a softening job market over the next two to three quarters, the rapid rate of growth in housing starts seen since early in the decade – which was simply not sustainable – is likely to continue to unwind.”

A correction in the Western Canadian housing market has been playing out since the start of the year, said Marc Pinsonneault, senior economist at National Bank. “The pentup demand that was accumulating in the ’90s has been satisfied, so we viewed a lower advertisement

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Another article out of THE CANADIAN PRESS with another institution (a BANK? Who would have thought?) seeking a bailout package. This recent article has left this mortgage broker wondering when his own personal bailout will be mentioned in the news.

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Bank of Montreal calls for $16 billion stimulus package
THE CANADIAN PRESS
December 11, 2008

OTTAWA – The federal government should move decisively on a fiscal stimulus package of as much as $16 billion next year to arrest the economy’s slide into recession, the Bank of Montreal says.

In a four-page note, deputy chief economist Douglas Porter argues that a $16 billion stimulus in the Jan. 27 federal budget is appropriate and that after 12 years of budgetary surpluses, Ottawa can well afford to spend to boost growth and put more money into ordinary Canadians’ pockets.

Porter offers a number of suggestions on how Ottawa can spend the money beyond the already expected construction projects on roads, bridges and sewer works to improve the country’s infrastructure.

These include cuts to payroll taxes, the GST and spending vouchers that would give Canadians government cheques on the condition they spend rather than save. As well, Porter says Ottawa should think of a one-time financial transfer to the provinces, which could put the money more directly to use.

Porter’s recommendations partly coincide with a ranking of options open to Finance Minister Jim Flaherty for his upcoming budget issued by IHS Global Insight economist Dale Orr. Orr and Porter agree that the key criteria for choosing the best form of fiscal stimulus is that measures should be tailored to impact the economy as quickly as possible, be targeted and be temporary so they can be withdrawn once the economy recovers.

Orr places small infrastructure projects at the top of the list, followed by a temporary cut to the GST, followed by cuts to personal income taxes.

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A colleague of mine passed this article on to me, and in light of my recent post surrounding a ABCP  Bailout, I felt it was a good idea to offer the other side of the argument AGAINST the bailout.

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Government help for ABCP would open floodgates to other industries: observers
THE CANADIAN PRESS
December 11, 2008

TORONTO – A professor at the Rotman business school says a government bailout for holders of asset-backed commercial paper, or ABCP, would open the floodgates to other industries seeking financial assistance.

Laurence Booth, a banking expert at Rotman, suggests that bailing out the group trying to salvage $32 billion of ABCP would make it hard for federal leaders to deny the auto industry, energy producers and other sectors of the economy looking for either loans or tax breaks.

Booth says that the government shouldn’t become involved in a market that was handled by mostly extremely sophisticated investors who he thinks should have known what was going on. Financial Department officials met Wednesday with the committee that’s been trying for more than a year to salvage the frozen ABCP market, which seized up in August 2007.

Reports say that Ottawa might be asked to backstop between $5 billion and $10 billion of the troubled paper if economic conditions don’t improve. Asset-backed commercial paper was supposed to be a low-risk, short-term investment that would mature within a year.

But worries developed in August 2007 that some of the paper was tied to dodgy U.S. home loans, in addition to bundles of higher-quality mortgages, car loans, credit card receivables and other assets.

The paper is held mostly by pensions

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We are already seeing some of this action in the United States, where other beleaugered producers and manufacturers have stepped up asking for financial assistance from the government sparking the question: is what’s good for the goose, really good for the gander?

Another article that I found that talks about the seriousness of the price declines hitting our market.

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THE CANADIAN PRESS
December 15, 2008

OTTAWA – House prices across Canada tumbled almost 10 per cent from a year earlier in November and the number of sales slumped even faster, the Canadian Real Estate Association reported Monday.

The association estimates the drop translates into $2.8 billion less in spin-off consumer spending.

CREA said 27,743 homes were sold last month, a drop of 12.3 per cent from October, and the weakest monthly activity since January 2001. The volume of sales dropped in 85 per cent of Canadian markets in November compared to October.

The association said the 9.8 per cent year-over-year decline in average house prices nationally “reflects further declines in both activity and price in British Columbia, Alberta and Ontario.”

It said declines were steepest in higher-priced markets such as Vancouver, Victoria, Calgary, Edmonton and Toronto.

“The housing market reflects the economic reality in Canada,” CREA president Calvin Lindberg stated.

The association tallied $7.9 billion in November sales, down 11.7 per cent from the previous month and the lowest total since January 2004.

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In a prior article, I explained that mortgages in Canada will have their rates quoted on a SEMI-ANNUAL compounding basis. Most other countries quote the rate on a monthly basis, and despite being in the industry, I have trouble wrapping my own head around what this semi-annual business means, and after discussing this with accountants, financial planners, and other brokers, it became clear that a write-up of how it works versus the more common monthly and annual compounding would be instructive.

This is a technical article that will go through the nuts and bolts of interest calculation. While it is not exactly fun stuff, it will serve to clarify the difference between the three most common forms of interest and the effect that each has on what you ACTUALLY pay on your mortgage. Ultimately, the rate on a mortgage is not as important as the dollars and cents that you have to pay.

All examples below will follow the same structure and will have the following assumptions:

1. Principle amount borrowed is $100,000
2. Interest rate used will be 10% (annually, monthly, and semi-annually)
3. No Payments will be made (so we can isolate the effect of the interest and its compounding)
4. All money is borrowed on January 1st and repaid on December 31st for ease of comparison
5. All numbers rounded to the nearest 1 dollar for ease of reading and presentation

ANNUAL COMPOUNDING

This is the most common form of interest in the consumer eyes, but in reality is not that common in the mortgage world. This form of compounding is the lowest overall EFFECTIVE rate (the rate you are really paying), and therefore it is the way that banks pay YOU such as on a term deposit or GIC.

Taking the numbers from above, here is how the interest would accrue and compound on an annual basis.

January $100,000 Outstanding
February $100,000 Outstanding
March $100,000 Outstanding
April $100,000 Outstanding
May $100,000 Outstanding
June $100,000 Outstanding
July $100,000 Outstanding
August $100,000 Outstanding
September $100,000 Outstanding
October $100,000 Outstanding
November $100,000 Outstanding
December $100,000 Outstanding + $10,000 Annual Interest Accrued and Compounded

Total $110,000

Interest Accrued is $10,000

This type of interest is typically called SIMPLE interest as it is a relatively easy concept to understand and calculate.
MONTHLY COMPOUNDING

The next most common form of compounding is the monthly compounding which is used on nearly all consumer loans, credit cards, student loans, retail cards, car loans, lease payments, and just about every other form of credit. It is relatively easy to wrap the mind around, but we will work through the numbers anyways to show how it is actually a higher rate of interest than the previous semi-annual compounding.

Taking the numbers from above, here is how the interest would accrue and compound.

January $100,000 Outstanding +$833 of monthly compounded interest
February $100,833 Outstanding +$840 of monthly compounded interest
March $101,673 Outstanding +$847 of monthly compounded interest
April $102,520 Outstanding +$854 of monthly compounded interest
May $103,374 Outstanding +$861 of monthly compounded interest
June $104,235 Outstanding +$869 of monthly compounded interest
July $105,104 Outstanding +$876 of monthly compounded interest
August $105,980 Outstanding +$883 of monthly compounded interest
September $106,863 Outstanding +$890 of monthly compounded interest
October $107,753 Outstanding +$898 of monthly compounded interest
November $108,651 Outstanding +$905 of monthly compounded interest
December $109,556 Outstanding + $913 of monthly compounded interest

Total $110,469

Interest Accrued is $10,469

As you can see from the two examples above, the monthly compounding results in $469 more interest paid than the annual compounding despite having the SAME QUOTED RATE of 10%!!! This is JUST the result of more frequent compounding. By compounding, I am referring to the banks calculating the interest, adding it to the principle, and then recalculating next months interest based on the new higher amount. In other words, the interest ON the interest. The more frequent the compounding (monthly vs annually) the higher amount you will ultimately pay in dollars and cents.

SEMI-ANNUAL COMPOUNDING

So if monthly compounding works out to being a higher amount of interest paid than annually compounding, semi-annual compounding (once every 6 months) should work out to be higher than annual compounding, but lower than monthly compounding.

Let us see if the math works out that way.

January $100,000 Outstanding
February $100,000 Outstanding
March $100,000 Outstanding
April $100,000 Outstanding
May $100,000 Outstanding
June $100,000 Outstanding + $5,000 semi-annual interest accrued and compounded
July $105,000 Outstanding
August $105,000 Outstanding
September $105,000 Outstanding
October $105,000 Outstanding
November $105,000 Outstanding
December $105,000 Outstanding + $5,250 Interest Accrued and Compounded

Total $110,250

Interest Accrued is $10,250

In summary, the amount of interest paid under each type of compounding is as follows:

$10,000 Annual Compounding
$10,250 Semi-Annual Compounding
$10,469 Monthly Compounding

…and if we take it a step further…

$10,516 Daily Compounding

The bottom line is that the more frequent the compounding periods, the more interest you will actually pay despite the fact that it still just says 10%.

If you really want to make yourself crazy, go look at your term deposits or GICs and then look at your credit cards… you will find that your term deposits (when the bank pays YOU) the interest is calculated annually in most cases, and that your credit cards (when you pay the BANK) are compounded monthly (or maybe even daily!!!). Just one more way that the bank always wins…

UPDATE

A reader of my blog recently pointed out that while I have done a good job explaining WHY the various interest rates work out to more or less interest, I did not answer the question of how the bank actually charges the interest and when does it compound if the compounding is “semi-annual” yet the payments occur monthly?

The answer: the bank only receives the 10% semi-annual amount, but the calculate interest on a daily basis at a rate that would be equal to 10% semi-annually. For example the documents would read “10% semi-annual interest not in advance”, they would actually be charging  a DAILY interest rate of 9.759337323%

This looks like a horrible long decimal, and it is, but if you do the calculations, the above DAILY rate will equate out to 10% semi-annually. In this fashion, the bank can DISCLOSE a rate of 10% semi-annual, but accrue it on a daily basis at 9.759337323%  and then collect payments in any way you want: weekly, bi-weekly, monthly, etc…

Bottom line: the bank only gets their 10% semi-annually, but they charge a daily amount that works out to equal the 10% semi-annual amount.

Clear as mud? If you have any questions, you can always give me a call at 604-657-6775 7 days a week, 365 days a year.

For the past 16 months the “commercial paper” market has been in turmoil. I read an article last week that talked about ABCP securities, and the damned article failed to actually define what ABCP means.

ABCP = Asset Backed Commercial Paper

Normally, “Commercial Paper” refers to money market securities issued by large banks and corporations. It usually has a short maturity, and is used by large institutions to raise short term cash. The “paper” trades and usually provides a guaranteed return on investment which, while small, is useful for cash management.

So what does the “Asset Backed” part mean? Normally Commercial Paper is just backed by the corporations credit worthiness. Asset Backed Commercial Paper (ABCP) means that the corporation has pledged some asset as security for the debt beyond just their own credit worthiness. Often large institutions will exchange their trade receivables or mortgages (assets to them) for cash. Traditionally, banks devised ABCP conduits as a device to put their current asset credits off their balance sheets and yet provide liquidity support to their treasury.

In plain english: they are securities backed by mortgages, which are backed by property. On the surface, they look very secure.

In reality, the ABCP is only as safe as the mortgage that backs it. The mortgage is only as safe as the borrower or property. When banks fund mortgages, they show up as an asset on their balance sheet. (The debt to the bank is an asset to the bank the same way a term deposit is an asset to you and me). If the bank that issued the mortgage, did so without doing proper credit checks, income verification, or property evaluation, then the mortgage doesn’t really mean that much. However, when banks package up their mortgages to sell them off and raise cash (they do this ALL the time – some banks ONLY do this as their entire business model) they don’t have to disclose which mortgages are “good” (subject to normal guidelines of credit worthiness) and which are “bad” and the truth is that even they don’t often know. When the mortgages are sold off, they are sold off in large blocks (usually $10,000,000 “tranches” or chunks – although the size varies widely).

To the investor that purchases a block of mortgages, they don’t really know the quality of the mortgages. When the lenders in the US and Canada were issuing sub-prime mortgages, they often had teasers, and other front end softening of the payments that made the blocks of mortgages look far better than they really were. When the mortgages started going bad (defaults and foreclosures) the lenders often had to replace the “bad” mortgages with “good” mortgages. This left the lender with even more “bad” mortgages on the books and with rising delinquency and continuing foreclosures, the lenders were forced into bankruptcy leaving the investor who purchased the ABCP “holding the bag” with no further security except a bunch of “Bad” mortgages on their books and no recourse to sue as the originating lender was now out of business.

This resulted in ABCP becoming essentially worthless, and lenders became unable to raise capital after funding mortgages, and this forced many sub prime lenders out of the market (I would suggest 95% of them are gone as of this article).

RELIEF!

However, the 16 month long debacle surrounding the ABCP market appears to be ending as the federal government as well as Ontario, Quebec, and Alberta have agreed to support the $32 Billion dollar ABCP market through a large taxpayer guarantee.

Federal Finance Minister, Jim Flaherty, made the announcement on friday that Ontario and Quebec would be supporting the guarnatee, and Alberta later made the same pledge to do their part. The whole purpose of this move, in Flaherty’s words, was “achieve a stable and effective restructuring  agreement” which “will protect financial stability  and the health of Canada’s financial markets.”

Personally, as a broker that deals with many lenders who sell into the ABCP market, I am glad to see that this guarantee has occurred as it means that more lenders will have access to more money and this will result in more competition for mortgages and funding.

The market for ABCP based on packages of mortgages and debt completely dried up in August of 2007 when investors suddenly feared that the packages of debtg may contain American Sub Prime mortgages and other risky assets. While this often wasn’t the case, the fear spread across the globe and investors pulled their cash sending the value of the securities tumbling: hence several of the banks in Canada having large write-downs this year.

With the government backing the ABCP market, hopefully we’ll see some loosening of the financial markets, and general easing of rates and regulations surrounding debt.

Not a day goes by that I don’t get a call from someone from my website or blog asking about my rates and then when I meet with them, they drop the bomb on me that they are talking about commercial real estate. I have to hit the brakes hard in this situation as commercial real estate financing and residential real estate financing are two totally different animals.

First off, why? The rules regarding the protection for homeowners are very different than the laws that protect business owners. Also, the lender’s rights are substantially different in a commercial transaction that in a residential transaction. If the commercial property happens to be a farm, that makes it ever MORE difficult for the lenders.

Secondly, when lenders “securitize” or sell their mortgage “paper” it means they are offering the mortgages to investors and turning a profit in the process while also getting back their money for the next mortgage. This is the way all banks operate, despite the fact that the original issuing bank happens to service the mortgage. Commercial paper, in this credit crisis, is very difficult to sell, and many lenders are tightening their guidelines to ensure that they are able to sell paper (and thus stay in business) throughout the crisis (which, by the way, is far from over).

So what exactly are the differences between a commercial and residential mortgage? The most prominent are:

1. Rate
2. Amount of down payment required
3. Pre-payment terms
4. Amortization
5. Timeline for Approval and Conditions of the Approval

RATE

IF YOU ARE FINANCING COMMERCIAL PROPERTY YOU WILL PAY A HIGHER RATE.

This isn’t something you can avoid. The BEST 5 year rate I have seen on commercial money in the past week was 5.42% on a 5 year term, but in the residential world I can get 4.70%. In most cases, I am getting quotes of 6.25% – 6.45% on 5 year terms from other commercial lenders. I always have people call me wanting to buy a property that has a commercial unit in the basement with residential upstairs. They intend to live in it (irrelevant as it is a commercial property), and are upset when the best rate I can find is 6.00% when they see my blog advertising 4.70%. The mortgage behind the scenes is different and clients need to expect this.

Rate is the lender’s return for the RISK they are taking with your mortgage. You may think the risk is small, but commercial properties are often very hard to sell, and if the lender has to foreclose (always something they consider) they want to know how long it will take them to offload and sell the property. So, the rate is higher. This is a fundamental fact that must be accepted.

DOWN PAYMENT

Secondly, commercial mortgages generally require a substantial amount more down payment. Typically, you will need 35% down payment when purchasing (or need to leave 35% equity in the property in the case of  a refinance) commercial property. This is not a totally hard and fast rule as we can often get an additional 10% financing from private lenders – but rarely more – unless the property has amazing cashflow. The normal commercial lenders want 35% down, but they will allow us to get a 2nd mortgage for an additional 10% (or whatever we can arrange). The max I have seen through conventional bank commercial financing is 80% and that was on a strata unit for a 30 year existing client of the credit union who had millions of dollars on deposit with the credit union. Normally, you only get 65% financing. You cannot get 5% down commercial mortgages (in 99.99% of cases – there are exceptions but it isn’t through banks – it is usually through the Business Development Bank of Canada who also takes an equity stake in the company in these cases).

PRE-PAYMENT TERMS

In most cases, in a residential mortgage, you are able to make lump sum pre-payments (without a penalty OR with a penalty) as well as increasing your monthly mortgage payments. Also, the banks are not allowed to prevent you refinancing (or getting 2nd mortgages). The terms in the law is that a lender cannot “clog the equity of redemption” for a RESIDENTIAL borrower. Lastly, if a borrower sells the property, the lender MUST let the mortgage be paid out.

In a commercial mortgage, this might not be the case (depending on your lender). Some lenders do not allow ANY pre-payment at all. Nevermind a penalty. That doesn’t matter. To them the mortgage is an investment with FIXED cashflow. They may not allow ANY extra payments, or ANY accelerated payments. In fact, there are a couple lenders out there who do not allow ANY payout of the mortgage (even if the property is sold!!!). This situation requires the mortgage to stay with the sold property, and is often a sticky point that buyers are unaware of if they are used to residential mortgages.

AMORTIZATION

In a residential mortgage, you can often get a 35 year (or even 40 year in some cases) amortization. In a commercial transaction, the norm is 25 years or “remaining useful life of the building.” If the building is, say, 25 years old, needs some repair, and really is only usable for another 15 years, then the mortgage will be NO MORE than 15 years – but usually only 10 (remaining economic life minus five years – for standard commercial properties – exceptions apply). This results in often FAR higher payments than clients expect if they are used to residential transactions. The higher payments can often be a deal breaker if the lender thinks the commercial property’s cashflow doesn’t support the payments (even if the client thinks they can “afford” the payments they may not “qualify” for the payments)

TIMELINE OF THE APPROVAL AND CONDITIONS OF THE APPROVAL

Most times residential mortgages can be “buttoned up” and fully approved within 48 hours if your mortgage broker is really pushing hard, but normally within 5 business days for a standard transaction. In a commerical transaction, from application to funding is normally around 60 days. The reason is that a commercial transaction has numerous additional requirement. For starters, you will need a commerical appraisal (generally takes 3 to 4 weeks) as well as a phase 1 environmental (also takes 3-4 weeks). Yes, you can get it faster, but expect the prices to double. There may be additional geotechnical studies, other more in-depth environmental studies, and even when you get it all approved, you face a much more lengthy legal process to have the mortgage registered and the documents prepared. Generally, expect 45-60 days for a NORMAL commercial deal. If it is a complicated deal with multiple properties, development potential, and/or construction and building, it may take far, far longer.

SUMMARY

So there are the differences. They are many, varied, and depending on the property or lender there can be even many more differences that this article does not cover as the number of situations and permutations are vast. If you are considering buying commercial property, PLEASE CALL ME FIRST even if just to get a layout of how the deal will look. It costs nothing for my advice and info, and it could save you a lot of time, hassle, and money.

Through all my writing and explanations about mortgages and products, I’ve forgotten the fundamentals. Why use a mortgage broker? How are mortgage brokers paid?

I’ll address this in two forms:

1. Why use a mortgage broker

2. How are brokers Paid? Do I (the borrower) pay them? The banks?

WHY USE A MORTGAGE BROKER

First, and most importantly, we are skilled and educated professionals. We are familiar with many lenders in the market (if not ALL lenders), all the unique rules and policies of the lenders, and can best advise you which lender will give you the best rate, service, and pre-payment priviledges.

A lot of people get hung up on rate. “What is the best rate you have?” asks many a caller when they find my website. This is a very short-sighted and narrow view of your mortgage. The rate is equivalent to the “price” you pay. However, focusing exclusively on rate, is like staring at the sticker price on a 1979 AMC Gremlin for $1,000 and saying, “that’s the car for me!” The fact that the underlying car is a piece of garbage, and doesn’t suit your needs, is just (if not more) important than the price. You need to balance rate with other factors such as:

- Speed of approval
- Service after funding
- Pre-payment priviledges
- Flexibility of payments (skip-a-payment, etc…)
- Penalties to refinance or pay out
- Portability

With over 30 lenders in the market, and each having 5+ products, that is over 150 products that you need to know about to make an ideal choice. As a registered mortgage broker, I am able to navigate these murky (and often changing) waters and provide you with UNBIASED THIRD PARTY ADVICE. We are paid by the lenders, and are essentially paid the same at most lenders. Where your mortgage ends up only matters to me insofar as it is the ideal product for YOU in YOUR unique situation.

Mortgage brokers are mobile, available at non-traditional hours, and can come to your home on evenings and weekends to make the process more convenient.

Last reason to use a mortgage broker: our services are FREE! More on this below….

HOW ARE MORTGAGE BROKERS PAID

When dealing with your “garden variety” mortgage that is done through a bank YOU PAY NO FEE FOR THE SERVICES OF A MORTGAGE BROKER. We are paid by the banks.

Do you pay a higher rate by using a broker?

Answer: No. You often pay less.

Why?

Because mortgage brokers are paid a one time commission for sourcing out a mortgage. The bank only has to underwrite and approve the file based on the supporting paperwork. All the client “touch” and education is done by the brokers. Once the mortgage is done, the bank continues to collect the interest, but the broker is paid and no longer on the payroll. With a branch mortgage, the bank has to pay the employee, rent, and other overhead even after the mortgage funds.

You do NOT pay a higher rate when using a mortgage broker.

The mortgage broker’s commission is NOT built into the rate or fee you pay the bank.

On a typical transaction for a typical home there is NO FEE for a broker’s services.

The only time there are fees (for a reputable broker) are in non-standard situations dealing with private lenders due to bankruptcy, dismal credit, foreclosure, or other mitigating factors. In these situations the banks CAN’T lend the money (and thus pay the broker).

THE BOTTOM LINE

By using a mortgage broker you get a better rate, better service, and education in the process, and all this comes with NO FEE. It is truly a win win situation for both the client and the broker.

If you would like to receive true broker service and rates, please call me, 7 days a week, 365 days a year at 604-657-6775 and I will attend to your situation personally.

“Mortgage Helpers,” “In-Law Suites,” “Rental Suites,” “Unauthorized Suites…” I’ve heard a lot of different names for them, but it all means the same thing: rental income to help with the mortgage payments.

The question is: How much mortgage does a rental suite ACTUALLY help you afford?

How much does $750 of rental income from a suite really help with your mortgage?

Many clients and realtors do the math that if the suite earns $1,000 of rental income, that they can therefore “afford” $1,000 more mortgage. While this looks fine on paper, the lenders do not treat it this way. “Affording” more mortgage and “Qualifying” for more mortgage are two totally different things.

Depending on whether the rental income is an “unauthorized suite” (not disclosed to the city authorities to avoid additional property taxes and construction oversight), or whether the rental income is “authorized” is an important point. This is of particular importance when a property has one or MORE unauthorized suites.

Depending on the amount of down payment, the lender you are dealing with, and the type of property (authorized or unauthorized suites) there are two types of rental treatment. They are:

1. 80% Rental Offset

2. 50% ADD BACK to Income

These are the nuts and bolts that a mortgage broker has to play with when trying to qualify a client for a mortgage. They are also WILDLY misunderstood by clients and realtors as to what they mean and when they apply.

80% RENTAL OFFSET

This is, by far, the preferred method by clients and mortgage brokers because it is more intuitive, easy to calculate, and helps you qualify for far more mortgage than the other method. What this means is that you take the amount of the rental income ($750 in the example we are using) and find out what 80% of it is (0.80 x 750 = $600) and then find out how much mortgage THAT new payment supports. You will need to know your way around a financial calculator and the current interest rate environment, so I’ll help you out with that by saying that the answer is $120,000 of mortgage (assuming 4.99% interest and a 35 year amortization).

In other words, you would qualify for $120,00 “more house” if the lender you were using (and if your credit and financial situation and property allow for it) uses this method. It’s not as easy as saying, “I want to use the 80% offset rule” to your broker because your situation has to qualify to use it (a topic covered at the end of this article).

Why 80% and not 100%? The lender has to assume you are going to have 20% of that income lost due to vacancy, damages, repairs, or maintenance. They will only give you credit for 80%.

50% ADD BACK TO INCOME

This is the traditional method, and it offers far less bang for your buck. However, depending on your situation the lender may insist on using this method whereby you take 50% of the rental income, and add it to your personal income, and then figure out what you would qualify for if you made that extra money.

The math on this one is a little harder and more difficult to explain so I will provide you the answers. So, to continue with our example, if you earned $750 of rental income you could add half ($375) to your income. However, the MAXIMUM amount of that (credit score depending) that can go towards mortgage payments is 44% of that $375. Or, in other words, $165 per month. If your credit score is lower, it could be as low as $150 per month.

We’ll use the best case scenario as it will show that this manner of calculation is still very weak. So, using this method, you only get to see how much $165 will qualify you for. Again, using a financial calculator and assuming 4.99% interest and a 35 year amortization, the MAX you can get if you use this method is $33,000.

Clearly, the 50% Add Back method is inferior.

THE COMPARISON

80% Rental Offset Method VERSUS 50% Addback To Income Method
$120,000                 VERSUS                   $33,000

So why would anyone want to use the second method? They don’t! It’s a lender decision. You need a qualified mortgage broker who knows which lenders use which method of calculation before you can figure out which method will be used.

WHAT DETERMINES WHICH METHOD WILL BE USED

This is a complicated matter, one made more-so by the fact that there are three mortgage insurers out there with two sets of rules, but I will outline a few scenarios where you will be FORCED to use the 50% Addback rule, and for the most part, all other situations will be the 80% Rental Offset.

If you are putting less than 20% down payment, and the suite is unauthorized, you may have to use the 50% Addback rule. Why do I say “MAY have to?” There are three mortgage insurers in the market (CMHC, Genworth, and AIG) and NOT ALL LENDERS USE ALL INSURERS. In fact, in light of the current economic climate, most of them are only using CMHC and CMHC says that if you put less than 20% down, and suite is unauthorized, then it’s the 50% Addback rule for you. You need to work with an experienced mortgage broker that will know which lenders use which methods as your local bank may not be the best option for you if you are buying a rental property.

If you are putting less than 20% down payment, and the property has multiple suites, you may have to use the 50% Addback rule. Just having extra suites does not mean you will get the better treatment. In fact, having extra suites complicates the matter further as many lenders only will use the income from one of the suites (and often at the 50% addback rule).

If you are planning on buying a house with a rental suite, and living in the suite but renting out the main floor you will NOT get to use the rental income from the main floor to “qualify” for the mortgage. The lender assumes automatically that you, the owner, will occupy the largest portion of the house and will rent out smallest. It doesn’t matter if you have proof to the contrary, signed affadavits, or letters from lawyers. It does not matter. The bank assumes you live in the largest portion and treats the suite rental income according to the other criteria it has as to the 80% vs 50% rule.

If you are putting 20% or MORE downpayment on a property, your broker can very likely get you the favourable 80% Rental Offset rule, or at worst, 70% Rental offset. Either way, it will be better than the 50% add back rule. The more down payment you put up, the better the treatment of rental income (in most cases).

WHY DO LENDERS CARE ABOUT AUTHORIZED OR UNAUTHORIZED SUITES?

There are several reasons, but the most commonly cited by lenders when I put this question to them is that the city COULD crack down on unauthorized suites and thereby reduce an owners income (or, raise their taxes such that the income is offset dramatically). It has to do with risk, just like anything else in lending, lenders are balancing risk (of foreclosure and default) versus the reward (earning interest).

CMHC is a government run organization, and it is for this reason that they want suites authorized – they are a government body. The other two insurers will allow the more favorable 80% Rental Offset rule but fewer and fewer lenders are using them.

Bottom line: you need the services of a registered mortgage broker to assist you with choosing a lender. Give me a call. I am available 7 days a week to answer questions at 604-657-6775.

Happy investing!