19 Jan

All Things Being Equity!

General

Posted by: Brent Batten

Equity, we know it’s a good thing to have, but oftentimes people don’t know what they can do with it or how to access it. I’ll give an example…recent clients, highly educated with a doctorate, were sitting on a lot of high interest consumer debt, roughly $125,000, accumulated while in school. they were also sitting on about $250,000 worth of equity they could access in their current home. They just didn’t realize they could tap into that equity, pay out the debt, eliminate about $2,000 in minimum payments they were making each month AND their mortgage payment only went up about $150.00 because when we refinanced their home, we put them in a lower interest rate.

That’s the power of equity.

To know what you can do with your equity, you really need to understand how much equity you can access, it’s really simple, you can access up to 80% of your homes appraised value. So let’s say your home is appraised at $800,000, you can access 80% of that or $640,000. In this example, let’s say you owe $300,000 on your current mortgage, you can put $340,000 into your bank account. Now should you? It depends on if you’re doing it for a specific reason. To just refinance for the sake of refinancing, doesn’t make any sense.

So what reason’s could you refinance for? In my view, you should refinance if it’s going to provide you value in return. If you’re going to take the money, complete renovations to increase your property value, use the money as a down payment on a rental unit, consolidate high interest debt, take advantage of lower interest rates, those are value adding reasons. Refinancing to afford a dream vacation, I wouldn’t recommend it, but if that’s where you get value from, then so be it. The reasons you may want to refinance are essentially endless, provided they make good financial sense.

Now you know the what and why, let’s talk about the how. Pulling out that equity isn’t a terribly complicated process, you’ll have to complete a mortgage application, an appraisal will be ordered to determine your property value, and from there, you can borrow up to 80% of that value. Whatever you still owe on your current mortgage will be paid out, and the remainder of the money will be deposited into your account, and you’ll start with a new mortgage. Pretty simple. Now if instead of a refinance to pull out equity, you want to use a home equity line of credit (HELOC), the same steps apply, only instead of receiving a lump sum payment, you’ll have the funds available to you in the form of a secured credit line. Like a regular credit line, as you borrow money from and then pay back funds to the line, the money will become available to you again. You won’t have a regular payment for the HELOC portion, you’ll have a minimum payment you’ll need to make.

So what’s the difference between doing a refinance and doing a HELOC? Think of a refinance as a one time payment of the money whereas a HELOC, you can spend the money and as long as you pay it back, it becomes available to you again, so it’s continually available. The only drawback is that with a HELOC, it can only make up 65% of your total borrowed amount. So in our example above, home is valued at $800,000, you can access $640,000 (80%) the maximum HELOC you can add is $416,000, the rest of the $640,000 has to go into a fixed term mortgage which is just like a regular mortgage. Depending on the lender, as you pay down the fixed portion, the new equity you build will be automatically added to the HELOC until you reach that maximum 65%.

Equity is such an important item in your financial toolbox because it allows you opportunities to build your financial future. Whether you take the funds and invest them into your retirement savings, or you purchase a rental property, you are taking steps to secure your future. As a big believer in using equity to build your financial empire through real estate, to me that is the single biggest reason to assess your equity and take steps to access it.

12 Jan

Fixed vs Variable Rates…the Good, the Bad, and the Ugly

General

Posted by: Brent Batten

For as long as there have been fixed and variable rates, there have been disagreements over which is best for a borrower. Sadly, there is no right or wrong answer, they both have their strengths and weaknesses. So let’s dive in and talk about the good, the bad, and the just plain ugly.

Let’s start by looking at the fixed interest rate. A fixed rate is just that, it’s an interest rate that will not change during the length of your term. If you pick a 5 year term, meaning your mortgage will be up for renewal in 5 years, for that entire time, your rate won’t change. That’s the main advantage of a fixed rate, you get stability. If you’re the type of person that can’t sleep at night worrying about interest rates changing or panic at the thought of your payment changing, a fixed rate is the ideal solution for you.

So what’s the downside to a fixed rate? Glad you asked, the downside is that a fixed rate will be higher than a variable rate. You’re essentially paying for that security and peace of mind. Which, again, if that’s what helps you sleep at night, then you may consider it worth it.

So far, nothing too ugly in there right? Well let’s get talking about penalties. Every mortgage has certain pre-payment privileges attached, it’s the amount you can pay towards the principle every year without penalty. So what happens if you pay more, in the event you want to refinance, want to sell and need to break your mortgage, well now you face a penalty called Interest Rate Differential.

Interest Rate Differential is a bit complex but the basics are that your mortgage provider will look at the discount you received when you initially started your term, the discount is what the posted rate for your term was, subtract your actual rate. Now that you know the discount, that number will subtracted from the posted rate that closest matches however much time is left in your term. That’s the interest you’ll have to pay. So here’s an example:

Posted 5 year Rate 4.5 %
Actual Rate – 2.5%
Discount – 2%
Mortgage Remaining – $600,000

You want to break your term with 2 years left, and the posted rate for a 2 year term is 3.5%, so we subtract your discount from (2%) from 3.5% to give you 1.5%. We now multiply $600,000 by 1.5% to give you an interest rate differential penalty of $9,000. That’s not a small chunk of pocket change for most people, hence the ugly!

Ok, so now that we’ve done a deep dive on fixed rates, let’s look at the alternative, a variable rate.

Like the name suggests, a variable rate is a rate that can change over the course of your term. It’s tied to the prime rate, so you’ll be quoted something like prime minus 1.1% giving you a rate today of 1.35%. So what happens if prime increases, well your rate will increase as well. If prime changes from it’s current 2.45% up to let’s say 2.70%, your rate will change from 1.35% to 1.60%. As a result, your payment will increase. So as I mentioned before, if you can’t sleep at night thinking about the potential for your rate to increase, this is not the product for you! So there has to be some benefit to a variable rate, right? Absolutely!

Since you’re giving up some stability, you are going to get a better rate than a fixed rate. Generally your rate will be about 1% less than a fixed rate at any given time. So there is a cost savings, however, that can disappear if rates increase significantly.

Prime rate can change 8 times a year. The Bank of Canada, pre-schedules 8 announcements a year, and at these announcements, they’ll determine if they’re going to increase the overnight borrowing rate. If they do, prime rate will increase, causing your rate to increase. Conversely, if rates decrease, your rate will decrease.

The pre-payment penalties on a variable rate mortgage are also more favourable then a fixed rate. They are simply 3 months interest. So given our example above, the penalty would be calculated as $600,000 x 2.5% divided by 12 months, then multiplied by 3 months giving us a penalty of $3,750. A difference of over $5,000.

So armed with this information, you’re now ready to decide what type of rate is best for you. It’s important to talk to your mortgage broker about your long term goals, together, you can chart an appropriate action plan and make sure you are in the rate type that works for you!

4 Jan

Appraised Value vs Assessed Value

General

Posted by: Brent Batten

So you’ve heard the terms before and like a lot of people probably thought they meant the same thing. In a way they are both determining a value for your property, but that’s where the similarities end. So what do they really mean?

Assessed Value is the value that the municipal or provincial government has assigned to your property. They use that amount as a way of determining your property taxes, so it’s a very important number. They come up with that number by using a model that consists of comparisons to other similar properties, the current real estate market, and any extenuating issues or circumstances with your property. In BC, you can search your property value using the BC Assessment site, located here. Every January 1st, the value of your property is updated and you have until January 31st to appeal the value. Now why would you want to appeal? Simple, to keep your property tax low. Will you be successful, hard to say. You would need a really compelling argument and supporting information to keep your assessed value low.

In an interesting turn, a gentlemen in Vancouver was successful in arguing that his assessed value was too low. That’s right, he went out of his way to ensure that his assessed value was higher by several hundred’s of thousands of dollars. This is an example of someone that doesn’t understand the difference between appraised value and assessed value.

So what is appraised value? This is a number determined by an appraiser to calculate what your property is worth in today’s real estate market. It is not related to taxes, it is simply there to determine if you were to sell your home today, what would it be worth. Generally appraisals are a combination of comparisons to other similar homes, the current market, and a visit to your home to inspect the building quality. The appraised value is the number that your lender and your realtor really care about.

Lenders want to ensure that the home they’re lending money for you to purchase or during a refinance is actually worth the amount you think it is. That’s why an appraisal is a critical part of the lending process. Now with that said, not all purchases require an appraisal, there are computer generated auto valuation algorithms that many lenders use to determine if the price is in line with today’s market. In the case of a refinance, it is almost always a requirement to have a full appraisal done.

The big question we see a lot is what happens if the appraisal is less then the amount I’m purchasing the home for? Well, now you have what’s called an appraisal gap. Here’s an example:

Purchase Price – $600,000
Down Payment – $35,000
Mortgage – $565,000
Appraised Value – $575,000
Appraisal Gap – $25,000

In this case, the lender will assign the appraised value of $575,000 as the purchase price. So now what? You have a contract to buy that property for $600,000. So here’s what happens now:

Purchase Price – $600,000
Maximum Value – $575,000
Maximum Mortgage – $542,500
Down Payment – $32,500
Additional Cash to Close – $25,000

You’ll now be responsible for coming up with the additional $25,000 if you’d like to close on that purchase. Hopefully you listened to your mortgage broker, and included a subject to financing in your offer, so you have a way out of the purchase should this happen!

As you can see, it’s important to know the difference between assessed value, appraised value, and what happens if there is an appraisal gap.