3 Rules For Mortgages on Rental Properties
If purchasing rental properties is in your future you must read the following. Even if you aren’t ready to pull the trigger yet, understanding mortgage strategy is vital. There are three rules you need to know.
1. You should always get a variable rate mortgage.
The biggest mistake you can make when buying a rental property is to choose the wrong mortgage. Many people make the mistake of choosing a 5-year fixed. It seems like a better option because it sets the payments for five years. This in theory makes the cash flow more predictable. Yet, there are two very important reasons to choose a variable rate mortgage on a rental property.
The first reason is that variable rates perform better than fixed rates. Very rarely does a fixed rate mortgage do better than a variable. Because this is an investment we want to choose the mortgage that will perform the best. Most people choose fixed rates because they feel more comfortable. They feel more secure. If variable rates stress you out you shouldn’t be buying an investment property. Choose the mortgage that will deliver the best returns.
The second reason to choose a variable rate mortgage is to mitigate payout penalty risk. 5-year fixed mortgages often come with the risk of higher payout penalties. That is a big problem. The reason it is such a big problem is because this is an investment, and it needs to be as liquid as possible just in case. If you need to sell the property or make a change to the mortgage you need the flexibility of a variable. The last thing you want to do on a great investment is hand a bunch of your equity to the bank to get out of the mortgage.
2. Your mortgage needs to be re-advanceable.
Once you make the decision to invest in real estate you need to set up your mortgages the right way. Not just your investment mortgages, but all your mortgages, including the one on the home you live in. All your mortgages should be re-advanceable if possible.
A re-advanceable mortgage gives you access to the principal you pay down on your mortgage. You get a line of credit for every dollar that you pay down in principal. There are two reasons this is important. The first is that having a line of credit available creates a rainy day fund. If you need to make repairs to the property or you have a vacancy you can use the line to pay for and write off the repairs. The second reason you want to have a line of credit is to buy more properties. If a great investment opportunity arises you will have the funds to pounce. Further, you won’t have to re-qualify or refinance to get your money out of an existing property, it will already be available.
3. Always consult your accountant & broker.
When you buy investment properties your first stop should be your mortgage broker. Your second stop should be your accountant.
Banks can make all the arguments they like about brokers. Unfortunately when it comes to flexibility and options banks don’t compare. Think about it, one financial institution, one set of products versus many. When buying an investment property you need to look at all your options not just one. The logic is simple and sound.
Right after you meet with your broker, if not at the same time, you need to meet with your accountant. Your accountant will double check your brokers logic and make sure accounts are set up right. You don’t want to find out that you missed a step setting up your mortgage and now you can’t write off the interest. Great accounting advice is imperative.
In summary, setting up your investment mortgages properly is vital. Great mortgage strategy combined with sound investment decisions will pay off. Poor strategy can be catastrophic. Make sure you always get a variable rate, a re-advanceable mortgage when you can, and great advice. Doing so will set you up for a future of wealth and happiness.
