Refinancing to Invest – Put Your Equity to Work for You!
This post is the first of a three part series that I will be writing detailing how and when to use the equity in your existing home or rental properties for investment, recreational properties, and maximizing returns.
The equity in your home can be accessed and utilized to earn even greater returns for those clients willing to look at alternative strategies to doing so. Many Canadians view their home as an investment, but this is incorrect thinking. Everyone needs a home and will have a housing payment unless they own their home clear title. During the time in which they own the home, a person will benefit from the appreciation of the home by building equity in their home. However, it is possible to take advantage of that equity and put it work while still also benefiting from further appreciation. In effect, you can use the bank’s money to go out and make more – and the interest on this is tax deductible!
Before jumping into refinancing, it is important to look at your existing mortgage and determine if there will be penalties to get out of your existing term and into a new product. In over 90% of cases, unless you have an open term, there will be a penalty that is roughly equal to three months payments. The banks have the legal right to exact this penalty, but there are ways to get around it or mitigate if you are using a mortgage broker familiar with the lender’s policies. The options to get the equity out of your home are many, but the most commonly used are:
* 1. Blend and Increase
* 2. Refinance
With a “Blend and Increase” you will leave your existing money at the existing rate, and borrow the new money at the current rates. This will keep your mortgage with your existing lender, and will, in most cases, avoid an interest penalty. However, for blending and increasing there is no guarantee that you are getting the best possible rate on the overall structure. This is where it pays to have a broker shop around for you and go to multiple lenders and see if any promotions or specials are available that would result in a lower overall rate even if you take the penalty into account. Once you’ve made a decision on the most cost effective structure, you can decide on whether to keep your existing lender or go to a new one. Oftentimes, banks compete most aggressively to get new clients, and moving your mortgage instead may be the best option.
By paying out your existing mortgage and getting a new one at another lender but facing a penalty, you would be doing a “refinance” where we would be restructuring the debt and possibly starting the mortgage over again. This may result in substantially reduced monthly payments, more cash flow (to invest, if you wish), and a better overall rate.
Once you have the equity out of your home, how you invest it is up to you. You could buy stocks, bonds, mutual funds, real estate, or invest it in your own company. The choice is yours. At this point you still own the home and are still benefitting from the appreciation of the home, and at the same time can use that newly tapped equity to invest and earn additional income. This is a way of using the bank’s money to make money and is commonly referred to as using “Other People’s Money” to invest. So it is possible to earn double the returns using just your mortgage when it is properly structured. And oftentimes, if you restructure the mortgage properly, you may end up with lower overall payments, and the added benefit of using Other People’s Money to invest.
A couple of caveats here:
You will still need to “qualify” for the extra money with the bank. Just because you have the equity built up in the property, does not mean you can automatically borrow against it. The bank will want to see a good track record of credit repayment and solid, verifiable, taxable income (in Canada) in order to approve you for more money.
Just having a small amount of equity will not allow you to put this plan into action. In general, to avoid any fees (such as CMHC fees which can be thousands of dollars) you will need to have at least 20% equity in the property. Put another way, your mortgage will not be allowed to exceed 80% of the market value of the home. Who determines this value? A qualified appraiser will provide a report to the lender that supports the value of the home, and so long as your mortgage is not greater than 80% of the value, you can avoid any fees from the bank or CMHC to set this up.
Doing a proper analysis of which lender, which product, and which rate is not a simple task and should be left to a qualified professional. Speak to a mortgage broker about the best option, and whoever you choose to deal with, make sure they respond to your inquiries promptly, and clearly understand the concept of refinancing for investment purposes.
