3 Ways To Refinance Your Mortgage And Invest In The Toronto Real Estate Market In 2022
Introduction
If you’ve owned a home in Toronto over the past 2 years, you’ve done very well. On average, detached properties in the 416 area went up 40%. So on a $1.5M home, that’s a $600,000 bump in equity. Of course, you can keep the money in the house, and you will still continue to make money as your home price continues to go up.
But if you want to make better use of that equity, there are ways you can put it to work, reinvest it, and help grow your wealth even faster. If you’re new to this and want to learn how this is done, then keep watching. In this video, I’ll be walking through three ways to refinance and access the equity in your existing home, specifically related to real estate investing.
Why Refinance?
With a typical home mortgage, a portion of your monthly payments go towards paying down your principal and a portion goes towards interest. So what this means is that the equity that you own in your home will start to go up while the debt portion of your home will start to go down. On top of this, real estate increases in value over time, so that also further bumps up the equity portion of your home.
Most lenders now allow you to borrow up to 80% of your property’s market value as long as you qualify. So if you currently have less than 80% of your property’s value borrowed, then you can refinance your property to access it and reinvest it. The big question is, is refinancing to reinvest actually a good idea?
Yes it is! The money sitting in your home is your gain. So, technically, you can sell your home and then reinvest in a bigger home with the extra gains you have. But the benefit of refinancing is that you don’t need to sell your home if you don’t want to. You can collect rental income on that money, and you can defer selling fees and taxes until a later date. Because we avoid things like land transfer tax, possible capital gains tax, and fees, you end up getting a bigger chunk of money to reinvest, which means better total returns for you.
Here’s another thing: Normally, the interest on your principal residence is not tax deductible. However, when you refinance a portion of your principal residence for the purpose of investing, the interest on the refi might now become tax deductible, which is another big benefit. Just note that if you want to do this, you need to make sure you do it correctly. So, definitely seek advice from a professional accountant if you want to employ this strategy.
Refinancing is a good idea, and it works especially well for real estate because it’s very possible to buy another property with no money out of pocket. The downpayment and closing costs can come from refinanced funds, and then you can get a new mortgage to cover the rest of the purchase price as long as you can qualify for another mortgage.
With a $1.2 million house in Toronto today, with all borrowed money, you’re going to be cash flow positive, close to break even, and you’ll gain rental income and appreciation on the second property. So if you’re ready to get started with refinancing to grow your real estate portfolio, let’s learn the three main ways that you can get this done.
Cash-Out Refinance
The first way is to cash out refinance by breaking your old mortgage and replacing it with a new one. The difference between the two mortgage amounts, minus bank fees and penalties, will be paid to you in cash, which you can use to reinvest. This method is very popular with real estate investors who are growing at a fast clip, and most of these investors tend to be on variable mortgages.
Let’s take a look to see how exactly it works. When you break a mortgage with a variable rate, the penalty would be 3 months’ interest. Assuming you are on a 1.7% variable rate, the penalty would equal 0.425% of your loan amount. On a $1 million loan, that’s a $4,250 penalty.
But after you do the refinance, you might be able to access enough equity to get into your next investment purchase with the perks of rental income and appreciation that I just talked about, which can be huge. It gets even better if you’re able to refinance and get a better discount post-refinancing. Say you manage to secure a 1.6% variable rate on the refi, so you end up saving 0.1% of your loan amount per year. Over five years, that’s half a percent in savings, which more than makes up for the penalty.
So, when does cash-out refinancing not make sense? I’d say it’s not as good of an idea for fixed rate mortgages, and investors really felt the pain in the past couple of years when rates dropped a lot. When you’re on a fixed rate mortgage, the penalty for breaking a mortgage ends up being the higher of 3 months’ interest or a calculation based on interest rate differentials.
Essentially, the banks don’t want to lose out, so the penalty you’d have to pay would equal your savings if you break your mortgage and get a new one. In other words, refinancing a fixed-rate mortgage to get a lower rate does not usually make sense. Instead of having to pay for the difference in interest rate over the rest of your term, you end up having to pay for everything up front as a penalty. Your cash out amount gets reduced drastically by tens of thousands in many cases, and you’ll have less money to invest with, lower absolute returns, and in the Toronto real estate investing world, it can likely mean the difference between investing in a freehold with better returns and a condo with lower returns.
Home Equity Line Of Credit (HELOC)
Another popular way to access the equity in your home is through a home equity line of credit, or a HELOC. The advantage here is that once you have a HELOC set up, you can borrow money up to your limit without having to go through the process of breaking existing loans, paying penalties, or taking new loans. The downsides are that HELOC rates tend to be higher and you can’t get a fixed rate if that’s something that’s important to you, so most people tend to use HELOCs for shorter-term loans like renovations.
Let’s say you want to upgrade your existing home and put in $100,000 in renovations. After renovations, your home price might go up by $200,000, and you’d do a cash-out refinance on the property post-rents to pull your renovation money out and get the best borrowing rates, but let’s talk about renovation money. If you need to borrow $100,000 for half a year, how should you go about it?
If you go the cash out refinancing route, you might have to break your existing mortgage before you renovate. On a $1 million variable mortgage, your penalty is $4,250, just like what we discussed before. It’s not bad, but there can be a better way. So let’s see how a HELOC compares. The good thing about a HELOC is that there’s no penalty involved, so even though HELOCs are around 1.5% higher than the current variable rate, you’re actually only paying $750 more than a variable mortgage to borrow $100,000 for half a year. For example, getting a HELOC for short-term loans like renovations actually makes a lot more sense.
The second scenario where a HELOC might make sense is if you are looking for stronger cash flows. Here’s another thing: With a HELOC, instead of paying back a bit of your loan principal and interest each month, you only have to pay for the interest portion.
So, say you’re deciding between two investments: A has 5% annual appreciation and a 3% cap rate, and B has 2% annual appreciation and a 4% cap rate. From a total return standpoint, A has better total returns, but you might not be comfortable with the cash flow situation since you’ll be running negative after your monthly mortgage payments.
Now if you got a HELOC for A, then you would end up being cash flow positive, which then gives you better holding power. And because A has better total returns, you end up making more after factoring in a higher HELOC rate. Just to wrap up on HELOCS, a regular mortgage in the long run usually makes more sense because the rates are lower, but it’s also deal dependant. As you saw from our examples, there can be instances where HELOCS works out better.
Blended Mortgage
The last refinancing method I wanted to discuss is called a blended mortgage, and I would say this is probably the option that’s great for all other scenarios. It’s exactly what it sounds like: you blend your old mortgage with a new one, so you end up getting a rate that’s somewhere in the middle.
The best thing about this is that there is no penalty for accessing more equity, and so this can be a huge benefit if you are currently on a fixed rate mortgage. Because you are blending your current rate with either a better rate or a worse rate, your new blended rate can be better or worse than your existing rate, but will never be the best rate on the market.
If I were to summarise it, blended mortgages aren’t the cheapest mortgages, but they maximise the equity that you can pull out, and it’s not reduced by a penalty. More to invest in means better absolute returns and a better selection of investments, so you might end up being better off than going with a cash-out refinance and simply choosing the best rates out there.
A blended mortgage actually comes with a couple of variations. You can do a blend to term where you increase your loan amount but you keep your loan term the same. Take a look at this example I found on RateHub.ca. If you have an existing 4.5% interest rate and you borrow more money at 2.99%, then you might end up with a new blended rate somewhere in between at 4.09%.
You can also do a blend and extend. In this case, besides increasing your loan amount, you also extend your term. This works well when you have a higher fixed rate and then interest rates drop drastically, since you end up putting a lot more weight on the lower interest rate, which can drastically lower your blended rate.
How We Can Help
If you’re looking to refinance your home and buy another investment property in Toronto but you don’t know how to go about it, let’s chat! We’re a real estate sales brokerage, so we help you buy real estate, but we’re so much more because we focus specifically on real estate investments in Toronto.
If you need help, we can review your current situation, help you figure out how to optimise your portfolio, direct you to the right mortgage rep, and then eventually help you buy the best investment property that fits your needs. We’re an end-to-end brokerage, which means our team also provides renovation guidance, leasing and property management if you need it. Just connect with us if you want to learn more about our services!
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