Bank Lending Policy Initiative by MOF

Loosen your purse strings, Canada tells banks

OTTAWA (Reuters) - Canadian Finance Minister Jim Flaherty delivered a blunt message on Wednesday to the country's banks, telling them to loosen their purse strings and summoning them to a meeting to press the point.

"There is evidence now of a constriction in credit in Canada, not only for smaller businesses and for families, but for larger businesses. So this is something that we are going to continue to address with our financial institutions. In fact a meeting is being set up now," he told CTV television.

"We expect our banks to make lending available, to have credit available and affordable in Canada. We're acquiring a lot of their mortgages ... up to C$75 billion worth. We've given a guarantee with respect to some of their obligations. So this is a two-way street. We expect credit to be available through our financial institutions."

I have had many borrowers ask me why it seems so difficult now to obtain mortgage financing, despite the fact that the official policies regarding loans haven't really changed very much over the past few months - yet loans seem virtually unavailable no matter what the applicant presents in terms of qualifications.

Anecdotally I have been told by a loan manager for a local community credit union that the credit union hasn't made a new mortgage loan since May of 2008, six months in total. The real estate market in that community is completely dead,and last month there were only two sales in the entire community.

So do you think that these items are related? You bet they are. Banks and Credit Unions claim that their lending policies haven't changed... but they aren't lending money.

What the Minister of Finance isn't saying, is that the banks are actually directly creating the current economic crisis in Canada, even though there was no crisis until they made one! The real crisis in confidence is NOT the consumer but rather tha corporate elite at the banks, who no longer trust each other or their institutions. Bank Paper is not considered worth the paper it is written on, or the electrons used to count it. The feds have done their share all around the world. It is time for the banks, worldwide, to get over it... and do what they need to do to begin lending money again.

If they don't this recession will go from a serious recesssion to a full blown world wide depression, the end of which will be uncertain at best.

And it will have been created almost entirely by bankers, because they don't trust each other. At some point these people need to be held accountable for their completely irresponsible behavior. It may be bad banking to make loans in an environment of uncertainty, but it is bad citizenship to withhold credit from the entire world because of corporate cowardice.

Mixed Messages

It's been a whole month since my last blog entry on mortgage investing. The reasons for this are many but the biggest reason is that the fall is traditionally one of my biggest seasons of the year for private mortgage investments. As a result I find myself extremely busy dealing with new investments in mortgages and MICs by investors, and have found it difficult to find the time to contribute to this column.

In addition, of course, I also had to serve Jury duty in a trial in BC Supreme Court, which was interesting, if you consider "interesting" to be a pejorative. Twelve ordinary people come together to decide the fate of one of our fellow citizens, whether or not he is guilty of the crime of which he is accused. Human nature being what it is, I was amazed that we all managed to agree on a verdict, despite much discussion about the merits of the case during deliberations. I hate the jury system, but I still think it is better than allowing the experts to decide our fate as citizens.

Now, back to mortgage investing.

2009 will go down as the year of the great world-wide financial crisis, the likes of which few of us have experienced in our lives. According to all the economists there really has been nothing like it since the great depression.

This crisis was triggered by the US sub-prime mortgage collapse, and, quite frankly, incredibly incompetant lending practices south of the border. Unfortunately it didn't end there, as the underpinings of whole international financial system have ended up coming under assault as a direct result of a profound lack of trust in the system itself by the very people in the heart of the system.

When banks won't or can't lend money to other banks, financial liquidity dries up in a hurry. Much of the efforts of the various national governments and central banks around the world are doing everything they can to restore faith in the system, not so much in the minds of ordinary investors but rather in the hearts and minds of the major players in the industry.

There has been a lot made lately of the failure of the US regulatory agencies to control the conduct of US Banks, and there is probably a significant amount of truth to the criticism. However, the challenge is not merely about regulation and control, but rather more fundamentally - if nobody understands the investment products they are buying or selling, how can faith and trust ultimately be earned and maintained. A significant part of the failure of the international financial system has been the undermining of sophisticated financial products like derivatives.

This should not be taken to suggest that more sophisticated products shouldn't be bought or sold, but rather there needs to be more transparency and a better job done of disclosure of these complicated financial products. The banks who rely on these instruments to provide fundamental security for their loans need to be able to rely on the ratings assigned and on the disclosure filings as to the nature of the risks being undertaken when they invest in those instruments.

High risk investments are not necessarily bad investments, they are simply investments that require a risk premium appropriate to the amount of risk and type of risk. They should also represent only a portion of a balanced portfolio rather than a primary portion.

I've never criticised my relative who goes to the horse races ever Thursday and "invests" fifty bucks in his favorites of the day. Some days he wins, although mostly he doesn't. So this investment is extremely high risk, but once in a while he wins enough to make the whole exercise worth every dime. Those nights are great.... we all go out to dinner to celebrate his success as a gambler. However, if he started to gamble his nest egg, set aside for his retirement, I would be most concerned.

Of course, I found it equally perterbing when I realized that his investments in blue chip mutual funds were almost as risky as the race track.

Years ago I began to move out of stock market based investments into secured investments or real property. Yes, real property does go up and down. Just like stocks in the public markets. But there is a fundamental difference - real estate will always retain real value over the long run, as opposed to the stock of any given company, which has at least as good a likelihood of disappearing completely in 15 to 25 years as it does of thriving.

You want proof? Check out the names and positions of the top 1000 US listed companies in 1990 and see how many of them have completely disappeared in 2009. There are no properties that have fallen into the sea since 1990, and most have increased in value at a pace at least equal to the rate of inflation in the intervening period.

Real property and security based on real property, if managed with a degree of caution, will protect an investor for the long run. In the short run you can easily lose your shirt if you make a bad investment, or leverage your capital at the wrong time and in the wrong market. However, in the real estate world, time is generally your friend.

Just remember this - subprime mortgages in Canada have a default rate of less than one half of one percent. A portfolio made up of Canadian mortgages, even subprime mortgages, will have made money during the past twelve months during this market meltdown. There is few other investments that can make the same claim.

There are few guarantees in the world, especially in the investment world. But there are reasonable ways to mitigate risk, including lending in strong real estate markets in a stable country with good prospects.

And being persistent and patient enough to see the investment through.

Final Mortgage Insurance Guarantee Parameters

Those of you who are following this blog may remember my tirade a few weeks ago about the changes to CMHC insurance rules, particularly in regards to fixing a minimum credit score at 620 and removing all discretion from lending institutions in working with people on the "bubble" as it were.

The following is extracted from an email delivered to me by the Canadian Association of Mortgage Professionals in regards to this issue which answers a number of these issues.

On Friday, September 19, 2008 the Department of Finance issued its final
mortgage insurance guarantee parameters and accompanying explanatory notes.

The final guidelines follow the initial announcement on the
financial
guarantee for mortgage insurance providers issued July 9, 2008 by
the Department
of Finance.

There are two noteworthy changes from the draft parameters:

1. Elimination of reference to a Total Debt Servicing (TDS) number, replaced
by a
principles based approach;

2. Reduction in minimum credit score to 600 from 620. Three percent "basket"
for flexibility remains;

These modifications follow discussions with stakeholders, including CAAMP.
CAAMP through its submission focused its comments on the minimum credit score
and welcomes the decision by the Department of Finance to adjust the credit
score. For more information on the mortgage insurance guarantee parameters click
here for Schedule A and click
here for Schedule B. All of these changes come into effect October 15,
2008.

If you have any questions please contact jmurphy@caamp.org; 416-385-2333 ext. 31Jim Murphy, AMPPresident & CEOCAAMP/ACCHA

This is an example of how concerted effort on behalf of an industry can help to protect the public from a poor legislative or regulatory change.

More importantly, it leaves the job of evaluating credit risk in the hands of the industry as a whole, justifiably in my opinion, given the record of the Canadian credit granting industry in maintaining stability while the rest of North America goes to hell.

Stormy Weather - Any shelter in a storm?

Those of us who grew up on the west coast know all too well that when the weather gets really nasty, when you're out on a boat on the ocean, that it's a good time to head for a safe harbour. Preferably one where you can get out of the wind and waves, behind a solid breakwater if possible.

Well, the world economy is certainly going through a major storm these days, with the storm centred in the US Financial services meltdown as a result of the mortgage crisis.

Some investors are choosing to move to cash investments, others to precious metals, like gold. Both of these strategies are a little like adding ballast to the boat, stabilizing it but not really helping you get where you want to go. Holding cash or near cash investment is a sure fired way to go backwards against inflation and shrink your capital base. Holding gold is probably as high a risk as holding stocks right now... after all stocks are at historically low values and gold is at the top of its cycle of prices...

Actually the ballast in the case of gold might actually sink your ship... to carry the metaphor further.

Anyone who follows this blog knows that I am a big believer in mortgages and Mortgage Investment Corporation investments, because of their inherant stability and underlying security. Like all investments mortgages do require diligent review and careful allocation of funds, in addition to common sense lending (something not practiced in US backed subprime mortgage market previously).

But mortgages do represent a relatively safe harbour in an economic storm, with security based on something that every investor can understand... a home where the borrower has something real to lose in the way of equity.

AIG Bailout - Will they sell AIG Canada?

AIG Canada is one of the most secure investments in the AIG universe with strong Canadian government guarantees behind it. If the US government managed its mortgage industry the way that the Canadian government has, the US wouldn't be in the total mess that it is...
Both McCain and Obama are promising to increase regulation of the financial services industry after this mess.... sounds all too familiar... the leaders promised the same after the Savings and Loan screw up... leading to this???

I think it is unlikely that the US government will make sensible changes in the rules... in an environment with such strong state rights... including the right for any state to make stupid.

Price and Volume Changes in Canada

Headlines in the local papers in Vancouver this week were screaming about a decline in prices on sale of homes in Greater Vancouver of approximately 4% since the spring, and an increase in new listings of an alarming amount.

Excuse me. One of the things that drives markets, of course, is media speculation about the current trends in the market. Sometimes it seems to me that there are those in the media determined to create a real estate crisis even in the absence of one. New statistics from the Canadian Real Estate Association indicate a decline in the volume of sales from last year to this year, along with a significant increase in new listings. But the numbers hardly indicate a crash in the market across Canada, or even in British Columbia, with an increase in average sale price to the end of July of about 8% over the past twelve months.

I caution anyone thinking of buyer or selling to be careful and think for themselves.

Anyone who thought that the real estate boom of the past few years would continue indefinitely, without pause, hasn’t been around very long. It has already been a very long positive market, and it is time for a market pause or even correction. The question at the end of a long boom is how severe the correction might be.

I leave you with this thought. Residential vacancies in Greater Vancouver are less than 1%. Unemployment is at just over 4%, and is stable, despite rapidly increasing populations. Does this sound like a bubble? So when prognosticators tell you that the market here is going to hell, take their opinions with a grain of salt.

Issues in Mortgage Underwriting for Mortgage Investors

Technical Discussion – Strata Ownership in BC

One of our brokers approached me the other day with a question about a self-managed strata corporation in Richmond –

“I have a client with a Strata Townhouse in Richmond who wants to take a mortgage. But they have one of those 'self-managed' strata committees, ran by all of the owners themselves. Is this insane? Is it legal?? There are strata minutes available, but no financial statements. There is also no contingency reserve. Dumb question - Is this safe for a private lender to lend against a building built in 1984 that has proper insurance but no contingency fund? How can they protect themselves? “

The broker obtained a legal opinion on the deal, after verbally discussing it with me, and this is what the lawyers said,

…Self-managed stratas are more common than I would like… As for the Contingency
fund (CRF), the Strata Property Act requires them to keep one, and for good reason. Insurance covers some catastrophic situations, but a myriad of others would leave the owners (and more importantly, the lenders) high and dry - from the basic replacement of pipes, to the building envelope issues we see so much of. Add to that that some lender, or owner might get antsy that there is no CRF and petition to court to appoint an administrator to run the strata, effectively putting control in the hand of a bureaucrat.I would strongly recommend against such a loan.[i]

This got me thinking more generally about issues related to strata corporations, and the implications for lenders, investors and underwriters. A recent report by the Vancouver Island Strata Owners Association (“VISOA”) raises a number of issues arising out of current legislative deficiencies, and proposes remedies in a new Act or Acts governing various aspects of the issues.

There are a large number of issues addressed by the VISAO report, and I’m not going to attempt to address all of them, especially since a number of the issues are primarily related to deficiencies in the Acts that relate to the owners of the strata units or bare lots, not all of which directly impinge on a mortgage interest. Unfortunately most of them do, as the legal interests of a lender are derivative, that is, they are derived from the rights of an owner established under the various acts.

Strata or condominium ownership has grown to 25% of taxable properties across British Columbia, with there now being 460,000 individual strata units. In several large urban areas, strata homes now account for 50% of all taxable properties. Growth in strata homeownership is expected to continue as land prices increase and efforts are made to reduce the “environmental footprint” of new housing.[ii]

In many urban areas such as the Lower Mainland and southern Vancouver Island strata ownership is becoming the de facto standard form of housing for most new homebuyers, indeed the vast majority of home ownership in the next twenty-five years will likely be strata titled property. Increasingly, for lenders, there will be little choice but to invest mortgage dollars into strata properties, as there will be few opportunities otherwise, especially for private mortgage lenders who tend to lend in situations where banks are unwilling to do so.

The Strata Property Act (SPA), the Real Estate Development Marketing Act (REDMA) and the Real Estate Services Act (RESA) affect strata homeownership. Although the RESA and the REDMA are relatively recent (2004) creations in response to concerns of the real estate industry, no public review of strata legislation to address homeowner concerns has occurred since 1998. In the meantime, other provinces have moved ahead with legislation to address emerging concerns in strata (or condo) homeownership. In 2003 the BC government recognized there were significant issues with the SPA and committed itself to a review. This review has not occurred.

VISOA has identified many deficiencies in transparency and accountability under current legislation and has categorized them under the topics of:

A. Strata Governance,
B. Strata Management Licensees,
C. Disclosure,
D. Strata Development Approvals,
E. Property Taxation,
and
F. Strata Fee Equity.

The areas which primarily are of immediate concern to lenders are: Strata Governance, Strata Management Licensees, and Disclosure. Although there are serious issues related to Property Taxation and Strata Fee Equity are also of some concern to ownership, they are of less relevance to the vast majority of mortgage lenders as they do not directly affect the quality of the security on a mortgage loan placed on a strata title.

Strata Governance

The complexities of shared ownership and mutual obligations among individual owners and their corporate body require relevant knowledge of the Strata Property Act and simple, direct and affordable access to due process for enforcing the Act and resolving disputes. Current legislation provides for only cumbersome, intimidating and expensive judicial, arbitration or mediation processes to administer the Act. It effectively indulges irresponsible actions and leaves disputes unresolved.

The main concern for a lender here is the derivative consequence of unresolved or irresolvable conflicts related to the maintenance and/or repair of common property held by a Strata Corp. Because there are requirements that a Strata Corporation must obtain 75% approval for any significant expenditure, including substantial maintenance or repairs, a council with reluctant participant with over 25% of the votes at an annual meeting may find itself unable to make corrective investments or even to repair serious damage to a building. The owners may have a remedy, by suing the corporation, to force necessary repairs, but there is no efficient mechanism by which an owner can enforce responsible conduct by a strata council, especially one where irresponsible members form a substantial minority of the votes (ie: over 25%).

The mortgage interest in a property can be seriously damaged if the quality of a building declines through deferred maintenance or damage that is not repaired. The lender has little or no leverage on the owner to force the strata to take action. To whatever degree the owner is handicapped in enforcing responsible behavior by a strata corporation, the lender is even more vulnerable in that the lender has even less in the way of access to due process than does the owner.

And while the law requires the strata corporation to maintain a contingency fund to pay for repairs and other liabilities of the strata corporation, in the event that a strata council doesn’t set fees high enough to ensure an adequate fund, there is little that an individual owner can do to force the council to do so.

This is one of the reasons that a lawyer would be doubly concerned about a self-managed strata corporation. In the absence of a professional management company there is very little way for an owner (or the lender) to even know that there is a problem regarding the strata council and its conduct in maintaining and protecting the ownership interest.

There is no requirement for audited annual financial statements from the strata corporation so there is no way to know how adequately they have been reported. The preparation of Form 9 disclosure statements by self managed strata corporation is necessarily a function of the elected executive of the strata council. There are no consequences of misreporting or under reporting of potential liabilities against a strata property. The law provides a form of disclosure that requires certain behavior but does little to enforce it.

Lenders (and their lawyers) are understandably nervous about disclosures from self managed strata corporations. Even when there is a professional management company responsible for the strata management, there can be no guarantee of fair, plain, and true disclosure necessary for the registration of a proper security interest. Strata corporations rank with governments in obtain position on title for any obligations of a unit holder to the corporation. Failure to fully disclose potential liabilities to a lender may open a manager to legal consequences for failure to disclose, but practical remedies that do not include suing third parties for negligence do not exist.

Lenders also have no way of knowing when a strata corporation is getting into trouble, either as a result of deficient property management practices and deferred maintenance, or as a result of structure problems, i.e.: leaky condo syndrome.

These problems, and others, which arise out of a fundamentally flawed set of legislative Acts, can ultimately only be resolved by legislation designed to address them. Lenders, on the other, can’t wait for a pie in the sky solution but rather have to take measures to protect themselves.
Which is one of the reasons why many lenders, including private lenders, are seeking independent inspections on all strata mortgages where the strata is self managed, as well as on any strata mortgage where there are any alarm bells at all arising out of an appraisal or an investor interview done at the time of loan approval prior to loan advance.

While issues related to deferred maintenance, structure deficiencies, environmental hazards are potentially present in all real estate transactions and therefore all mortgages, where title is more complicated and processes for resolutions of disputes more difficult, the risk is exacerbated.
Therefore it would be prudent to obtain a higher level of disclosure on Strata Titled properties during underwriting.

Conclusions and closing thoughts

In regards to private investors making direct or indirect investments in strata mortgages, it is important during the review of an investment opportunity to comfort yourself as to whether or not a strata is managed by a professional management team, or self managed; and, either way, that there is an adequate contingency fund as well as a well planned and self-evident maintenance program for the whole strata building. Look closely at the appraisal for any evidence of deferred maintenance or potential deficiencies arising out of the design or execution of the design of the building in the first place. Have your broker talk to the borrower, and see if they have any concerns about the property.

At the end of the day, if investors are going to invest in mortgages, which are still one of the safest and most secure investments available in the marketplace, it is important that investors be aware of any potential risks, and the scale of those risks.

In the case example given at the beginning of this blog, clearly the lawyer is correct. Not only is the property self managed (an alarm bell all by itself, not necessarily fatal, but still of concern) but in the minutes of the strata meeting the disclosure of no contingency fund and some deferred maintenance, combined with an unwillingness to increase strata fees to cover necessary repairs would disqualify this strata unit owner from obtaining a second mortgage. It may also prevent the unit owner from refinancing if these deficits are not remedied within a reasonable period.


[i] This initial quotation is a quotation from an email exchange between a broker and our office.
[ii] All other references in this blog are to a report - Ensuring Transparency and Accountability in BC Strata Developments May 2, 2008, Vancouver Island Strata Owners Association - http://www.visoa.bc.ca/static/VISOA%20Report%20on%20Strata%20Legislation%20Issues%20-%20May%202,.pdf

More Trends for BC Real Estate and Mortgages

Beyond obvious sales figures and average sales prices being obtained in any given marketplace over the short term there are a number of things to consider. Market trends pertaining to mortgage investments should also take into account some underlying trends such as:

1. Rental levels and vacancy rates in rentals
2. Absorbtion rates of new properties being released into the market
3. Net migration into market areas
4. Employment and unemployment statistics

On the first item, rental and vacancy rates, the news is pretty positive for owners of residential real estate, and for lenders in rental housing markets, especially in BC. The rental report from CMHC ending in June for the first half of 2008 indicates a powerful demand for rental housing that has kept vacancy rates below 1% in the major markets of Vancouver and Victoria, as well as in the secondary markets in the southern part of the Province.

If you own market housing in BC you can rent it for a pretty fair price as well, with rental prices rising steadily across all markets except for the northern areas of the province.

On the second item, absorbtion rates of new housing, the results aren't quite as clear cut, although it appears that urban rates are still extremely high, despite a lot of new product coming on the markets. If I were an owner of a presale unit in anywhere other than Vancouver or Victoria I would likely be considering trying to sell it without a gain, or hold it for rental. Any speculative increase in value is probably moot at this point.

Vacancies in new housing coming into the market are still at historic lows, and given the extreme shortage of rental housing in virtually all markets in BC except for logging towns in the north, any surplus presold vacant property will tend to be absorbed into the rental pool. Investors in presold properties should hope that they own units in buildings that permit rentals, as resales next year may be a little slow.

As far as net inmigration into the Lower Mainland and British Columbia is concerned it will likely continue for the foreseable future, given the historically low levels of unemployment and high levels of jobs available. Again, with the exception of the logging industry, job growth is strong throughout the province, but particularly in Vancouver area. No pressure here for any reduction in migrations to the area. Given falling employment in Ontario and Quebec as a result of declines in manufacturing, inmigration to BC may in fact increase in the next part of this economic cycle.

BC, especially urban BC, continues to be a place where you probably want to invest your money in real estate and mortgage investments. In addition to being one of the best places on earth to live, it also still continues to be one of the best places on earth to invest your money in real estate, especially if you always maintain a long term view.

Trends without a direction

I have been reading through my regular real estate and mortgage blogs this afternoon, trying to gain a perspective of opinions out there in the mortgage brokerage world, as well as in the larger real estate community.

Several things jump out at me.

1. Everybody is trying to figure out whether or not Vancouver is going to have a major price correction in the next few months, and if so, how deep, and if so, how long before it turns around.
2. People are worrying about changes in the mortgage environment as a result of (a) the US housing slump and mortgage crisis or (b) the government of Canada's reaction to (a) above, and whether those changes are going to be good or bad for the mortgage investor.

For example, a recent headline in a mortgage industry blog referred to a comment by the chief economist of the Export Board of Canada, where he refers to an excess of building stock and a potential for a collapse in the housing market because of a surplus of new housing.

I went to the read the report and discovered that the economist made a passing comment about this possibility while directing his main comments at declines in European and Asian housing, basically stating that while Canada isn't in the same condition Yet, it soon could be, if these early indicators are true.

The housing market is not as torrid as it has been, and selling properties now requires a little more common sense than it did at the peak of the markets a year ago. However, in the Lower Mainland prices are still up, and sales are still pretty strong.

I remember the 1990's when you couldn't sell something to save your soul in Vancouver, and the whole Province had the Asian flu. Stats Canada still says that net inmigration to the Lower Mainland will continue at a high level for the foreseable future. Unemployment rates continue to be excruciatingly low!

Boy! Things in BC are really going to Hell! Not.

So, be careful what you read or you could completely miss the boat in terms of making good investments.

Credit Scores - Arbitrary and Unfair

Recent changes in government policy have required major changes in how mortgage insurance is governed in Canada, with restrictive policies pertaining the minimum Beacon Score acceptable by a mortgage insurer for borrower to obtain an insured mortgage.

I have a number of problems with the new federal policy changes for mortgage insurance, but my biggest concerns is with the Harper government now deciding to make hard and fast rules on subjects previously open to discretion on the part of the insurance companies and the lenders.

To me it doesn't matter if the hard number for a Beacon score is set at 620, 580 or even 680. What matters is that the government has given over control of the mortgage insurance industry and insured lending to private companies, Equifax and TransUnion, that are only accountable to their own shareholders.

Credit Scores are an arbitrary and unfair tool to be used to determine eligibility for mortgage insurance, and therefore for prime mortgage loans.

I have many problems with these unaccountable private agencies who have godlike powers already, without seeing them gain even more influence in the credit granting marketplace.
One of my complaints is that a person's single largest debt, a mortgage, is generally NOT reported to the credit bureau, which means that the Credit Score is based on how a person deals with a minority of their personal debts - indeed even a perfect mortgage payment record is not referred to at all.

In fact, a person can have a flawless mortgage record and haveCredit Score at all, unless they have trade credit, ie: credit cards or installment loans of other kinds.

Errors or misfilings on consumer reports are also not corrected except by a persistent and determined consumer who can prove that they are NOT guilty of an offense. There is no presumption of innocence here... even any collection effort, justified or not, is a black mark on a person's credit score without reference to the merits of the collection case at all.

Even if someone wins relief from a collection, the collection report still is a negative on the Credit Bureau report reducing a consumer's credit score.

And the federal government has now given these organizations an absolute power to destroy an individual's ability to borrow money for a prime mortgage.

Opportunity Knocks - Private Investor Alert

One of the consequences of the meltdown of the US subprime mortgage business has been the collapse or withdrawl from the Canadian subprime marketplace by many lenders, especially lenders who depended on floating their mortgage backed securities in the now defunct mortgage bond market. This phenomena has been evident in the Canadian market since the disappearance of both Accredited and Exceed from the subprime markets in the past year.

What is new, however, is the imminent elimination from the government backed insured marketplace of the so-called ALT -A and ALT B markets. It means that a whole range of borrowers will now no longer qualify for insured mortgages, especially those who previously would have done so. Borrowers will a Beacon Score of between 580 and 620 previously would have qualifed for insured loans from a number of lenders under both Genworth and CMHC policies, with certain provisos.

For the immediate future, what this will mean to private lenders is a HUGE opportunity to improve the quality and yield on their mortgage investment portfolios, as well as a major opportunity for making investments in Mortgage Investment Corporations (MICs) on a highly profitable basis.

On a quick survey of Canadian MICs yesterday I determined that on the basis of my relatively unsophisticated and nonscientific survey, most Canadian MICs across Canada are performing pretty well already, with returns ranging between 7% (in Saskatchewan) and 13% (in British Columbia) per year for the past couple of years, with longer term results being in the average range of about 11% to 12%.

For most investors, even in equities, these returns should be startling! An investment in a MIC is similar to an investment in a mutual fund in the sense that it requires little or no hands-on management by the investors, but the advantage of the MIC investments is that there is little or no volatility in the capital value: a dollar invested is always a dollar redeemed except in the circumstance where the MIC actually loses money - a rare event in Canada, it turns out. The variability in the MIC investment marketplace is in the rate of return to be earned.

Even investing in the worst performing of the MICs I surveyed yesterday an investor would have earned 7% in the last year, not bad at a time when the equities markets are down 20% to 30% in both major and minor markets.

This mortgage crisis has relatively few silver linings for the average person, but it has created a significant improvement in mortgage investment returns, both Private and in MICs. Astute investors should be seeking opportunities to invest in this alternative marketplace, and move both RSP and non registered investments to a more stable and more profitable investment than currently available in any other part of the marketplace.

Broker or Bank - The Borrower's Dilemma

The differential advantage to a borrower for using a broker is NOT the fact that the broker sends a mortgage deal to a non bank lender, it is the goal that a broker will obtain the best available deal for the borrower, from a bank or a non bank lender.

Brokers should have no loyalty to a particular lender, although it would be disingenuous to suggest that bonusing arrangements have no impact on mortgage placements with different lenders.

Also, commission rates vary from one lender to another, and from one product to another, which means that some brokers measure their income from a deal before they figure out what the best deal for the borrower could be.

These things mean that brokers are inherently in a conflict of interest with a prime "A" borrower because the placement of the loan can have a huge impact on how much the A broker will earn.

In British Columbia the Financial Institutions Commission recognises the potential for conflict of interest, and requires brokers to sign a disclosure of the conflict of interest, as well as a disclosure form which details any fees paid by the borrower directly to the broker. However, fees paid by the lenders to a broker are not disclosed in any required forms in BC, something that probably should be remedied in due course.

This is not only an issue for mortgage brokers. All consultants who make their living by being paid for the placement of products or services to their clients are also generally in a conflict of interest, and are to some degree driven to sell products based on what they earn from doing so. So the main difference with mortgage brokers is that the service we sell is fundamentally different in that we represent vendors of the single largest expense in most of our clients' lives - their mortgage.

Undisclosed differences in payments by different vendors of loans drives some brokers to make recommendations based almost entirely on how much money they will make by placing the deal with one lender or another.

The thing that protects the public from being abused by the conflict of interest is that the mortgage brokerage industry is incredibly competitive - any broker who acted contrary to the client's best interest would probably soon find himself out of business with no clients.

It is one of the distinctions that separate private loan brokers from A lender brokers. When someone borrows money from a private lender through a broker there is no failure to disclose. All brokers fees, appraisals, inspections, etc. are paid for directly by the borrower and the borrower is fully aware of any and all out of pocket costs, which include all payments made to the brokers.

So while most "A" brokers tell you that you will pay no fees for their services, what they don't tell you is that the method by which they earn their fees may be inherently contrary to the borrower's best interest.

At the very least the rules of the industry should require that these fees be fully disclosed, so that the borrower may make a fully informed decision about the relative merit of the advice he or she is receiving.

As for the conflict of interest a borrower encounters by going directly to a bank - there is no conflict of interest: the bank employee represents the best interests of the bank, only the bank and always the bank.

So a borrower has to make the best of two choices, one with the potential for a conflict of interest (the broker) or the one with no conflict of interest (the banker) since the bank always acts in its own self interest.

I am attaching the following article from Merix completely because it provides a comprehensive explanation of how mortgage insurance actually works for most consumers.

Clearly, based on what Merix is saying, the changes to government policy regarding mortgage insurance may have a significant effect on mortgage investors, if they are relying on Home Lines of Credit secured by mortgage insurance, whether provided by CMHC or by a private insurer.

However, most mortgage and MIC investors who are using leveraged funds are not borrowing money under the terms of insurance mortgages, nor do they tend to use extremely high ratio mortgages for investment purposes, so the change may not actually have as big an impact as one might otherwise imagine.

MERIX Comments on Changes to Government Guaranteed Mortgages

There has been lots of discussion in the news about the recent changes to government guaranteed mortgages announced by the Minister of Finance.

However we believe the majority of Canadians do not understand what exactly it means to remove the “government guarantee” from some of these lending programs.

We’ll explain…

Many Canadians generally understand how mortgage insurance works. We’re not talking about mortgage life and critical illness insurance, we’re talking about mortgage default insurance. This is the premium that is applied to your mortgage amount and is paid to a mortgage insurer, who in turn agrees to insure your mortgage with your lender in the event you default. In other words, it is protection for the lender incase their customer cannot make their payments. This is a mandatory insurance for mortgages higher than 80% of the home value.

Well that’s great, but what happens if a lot of people all of a sudden can’t make their payments and the insurer who is supposed to protect the lender is unable to cover their insurance obligations?

Enter the government guarantee.

The Canadian government will guarantee up to 90% of the mortgage amount against insurer default. So, this is security for the lender in the event the insurer defaults. This Government Guarantee is in place for CMHC (Crown Corporation) as well as the private insurers, such as Genworth Financial Canada.

The government guarantee is also a criterion for high ratio loans to be sold into the Canada Mortgage Bond program, which is a relatively new cost-effective funding source for banks and mortgage lending companies. These Bonds are bought up by investors all around the world due to their higher yield than Government of Canada Bonds combined with their “government guarantee”.

So what has changed?

Well, the Finance Minister looked to our southerly neighbours as well as across the pond and noticed some pretty dire scenarios which begged the question: Are we guaranteeing mortgages that are a little too risky? After an analysis of the mortgages that fall within their guarantee, recent trends, and industry consultations, the Minister of Finance decided to cease guaranteeing high ratio mortgages with the following characteristics:
- LTV ratios in excess of 95%
- Amortizations in excess of 35 years
- Non-amortizing mortgages (Interest-Only Mortgages).
- Applications where the beacon score of both borrowers is less than 620.

How does this affect me?

If you are a current homeowner, who is happy in your home and have no intentions of moving in the near future than this probably doesn’t affect you. However if you are a prospective homebuyer, looking for 100% financing and a 40 year amortization then your financing options are becoming a little more limited. Most of the big chartered Banks and many lenders have already pulled the above products. Other lenders, such as MERIX are offering these products until October 13, 2008 (please speak with your mortgage originator concerning rules around this deadline).

Let’s take a closer look at the 40 year amortization phenomenon:

Why is it appealing when borrowers know they are paying many thousands of dollars in interest over the life of their mortgage? Well there are a couple of predominant reasons:

New homeowners are increasingly concerned more with their payment amount than the house price or the interest cost over the life of the mortgage. It’s a decision made largely on cashflow.
The vast majority of people who take 40 year amortizations actually qualify for 25 year amortizations but choose the former and accelerate their payments, which reduce their amortization to 32 years. Registering their mortgage with a 40-year amortization helps protect them in the future should they need to decrease their payment.

From a purely mathematical perspective, according to the Ministry of Finance:
“Reducing amortization from 40 years to 35 years on a mortgage loan of $200,000 with a 6 per cent interest rate results in a $41 increase in a borrower’s monthly payment, but the borrower will save $49,000 in interest payments.”

Looking ahead…

If the decision to take 40 year amortizations is based on cashflow, then we’d suggest $41 per month on its own will not cause any major disruptions in the housing market. The reality is that new mortgagors will have to spend a little more in their monthly mortgage obligations but the impact to the housing market will be isolated to those who needed the 40 year amortizations and 100% financing to qualify for their mortgage. As a replacement for 100% financing, we may see the increase in popularity of Cashback mortgages once again. The 100% financing programs have all but made CashBack offers obsolete, however they may be a decent option for some people once again - even if the interest rate is higher.

In the short term, we may see a small spike in homebuying and refinance activity as people try to accelerate their timelines in order to take advantage of these fleeting offers. This may keep the market relatively strong through 2008. In the medium to long term, we don’t expect these changes to have much of an impact to the housing market. 35 year amortizations are still available and for that matter 40 year amortizations will still be available by some lenders, such as MERIX, for those customers who have the minimum 20% down payment for conventional financing.

For more information about 40 year amortizations, we encourage you to read “Why 40 Year Mortgages Aren’t 40 Years Long”, by Peter Vukanovich, President, Genworth Financial Canada. This article can be found here: http://www.genworth.ca/mi/eng/downloads/HT_April_2008.pdf


Sincerely,

The MERIX Financial Team
And Your Mortgage Originator





By partnering with professional mortgage originators, our customers can be confident they are receiving the knowledge they require to make the right decision. And this is the advantage of dealing with MERIX Financial.

MERIX FINANCIAL KNOWLEDGE IS ADVANTAGE

40 Year Amortizations and Zero Down Mortgages

I've had a number of my clients inquire recently about the 40 year amortization mortgage and zero down mortgages, and what the recent news about changes in government policy and mortgage insurance mean in the context of current real estate trends, particularly in BC and Alberta.

The first thing to remember is that the changes to the rules were relatively minor, reducing maximum amortizations only five years, from 40 to 35 years, and from 100% financing to 95% financing. While the changes do represent a significant policy initiative by the feds, it is more what they aren't doing rather than what they are doing that is significant to most investors in real estate.

So far the federal response to the credit crunch in the United States markets has been remarkably measured, considering the near hysteria across the border. There may still be some serious shakeups in the Canadian banking industry as a spill-over from the US problems, with Canadian chartered bank CIBC appearing to be in some potential trouble, although I suspect that CIBC will survive as an independant bank even after all of this is over.

The main thing that investors should consider is that real estate markets go up and down, but mostly they go up over the long run. In the short run this is not much comfort, especially for anyone committed to a property they have purchased at the top of the most recent hot markets. The changes to the purchase rules by the insurance companies, stricter credit rules or more stringent application of existing credit rule, may all have some impact on the markets by reducing market demand somewhat.

But my bet is that the reduction in market demand for housing will be "normal" in the Canadian sense of that word. In other words, be patient and the real estate market will eventually reward your patience.

If you panic, then you probably will get hurt, just as when you panic when swimming in the ocean.

If you are looking to acquire a property with nothing down, it might just be a little more difficult than previously, but that may also be a good thing if it means that people aren't going to get stuck with property they really can't afford.

Real Estate Outlook and Interest Rates

The Bank of Canada yesterday left interest rates alone. Based on the performance of the real estate markets in British Columbia currently they probably should have done exactly that... BUT! in the ROC property values are in the dumper and the economy is slowing rather quickly! The need to keep inflation under control is what is balancing the demands of the economy for liquidity, and with the rapid run up in the cost of energy and other commodities over the past couple of years, who can argue that inflation isn't a problem.

So, we have stagflation.... something totally familiar to those of us who survived the late 1970's only to go in to the crash of 1981. Anyone who lived through the crazy inflation of the late 1970's never wants the government to allow that level of devaluation of the monetary system to occur again.

So it sound like I'm endorsing the current policy by the BOC of doing nothing. Hmm... maybe I am, after all. It could be worse, we could have inflation threatening double digit inflation, or perhaps US style declines in house pricing. As it is, what we have is a bit of the economic flu, with a touch of stomach upset.

Take a couple of pills, roll over, and sleep until morning (or until 2009). Things should look better by the later half of 2009.

In the meantime, invest in mortgages and MIC investments to protect your income and your capital, and leave the volatility of the real estate markets to someone else.

Big Brother is watching YOU!

FINTRAC, our national financial transaction watchdog, introduced new regulations governing Real Estate Agents, which took effect Monday, require realtors to get identification and record the name, address, date of birth and occupation of buyers, sellers and any individual or corporation that contributes financially to a real estate transaction.

The government claims that all of these regulations tracking the flow of money are about getting on top of organized crime and terrorist organizations, and preventing the laundering of the proceeds of either type of crime.

I say its all about income taxes and tracking the flow of money, in an attempt to get control of the "grey", ie: underground economy. Over the past twenty five years, with the radical increase in various types of taxes there are an ever increasing numbers of individuals who are actively hiding their income and attempting to become invisible to CRA.

So if the government is having a hard time tracking all the various ways of masking income, they then have a need to figure out how to track the proceeds of that income. Thus, FINTRACK which gives the government enormous powers of investigation, and recruits everyone who works in the financial services industry, and now the real estate industry, into helping to enforce taxes on those who would try to avoid paying them.

Now, don't get me wrong. I think that everyone should pay their fair share of taxes, after all, we all use government services when we need to and nothing justifies someone trying to get out of their obligation, so my concern is not about the need to assess and then to collect outstanding taxes.

Rather, my concern is that governments have been using the terror attack on the World Trade Centre in 2002 as an excuse to increasingly invade what used to be considered private information and confidentiality. Not everyone is comfortable with the government having access to every nook and cranny of our private lives. Internet invasions, email scrutiny, etc. have all increased by the government in the past five years, and the agents of the government have also increased their surveilance of financial transactions.

It used to be that cash was a time honored way to pay for things. I remember in the 1970's paying the down payment for a house in cash, literally in one hundred dollar bills. Today it would be assumed that those were illegal or illegitimately obtained. In my cash the one hundred dollar bills were saved from years of doing yard work as a teenager, and yes I did file income taxes even as a teen.

My point really is that Big Brother really is watching you, and they have just increased their army of eyes by the number of realtors in the country. Should we be concerned? You tell me.

Real estate boom

The key to investing in Canadian real estate, or any real estate for that matter, is never to buy what you can't afford to support in the long run. One the most significant dangers in a rising real estate market is that many people jump in and buy properties based on the anticipation that they will be worth a lot more in a year or two. So the buyers don't worry about cash flow too much, or at all.

The reality of real estate investing is that if cash flow isn't KING it should be. And although the value of real estate tends to increase over time, there is no rule that says it will always go up in the short run. It may even go down, which is what has happened in the US markets, leaving a whole bunch of folks with properties worth less than the amount they borrowed against them.

Ouch, that's gotta hurt!

Unfortunately, this isn't new news. If you buy something you can't afford, on the basis that it will be worth radically more in the near future, you are doomed to crash and burn, if not in the near future, then today.

Because, according the Canadian Real Estate Association, the Canadian marketplace has crashed or at least has stopped going up significantly. Hmmm..... I'm not sure that I buy what they are trying to sell.

But the point is.... buy what you can afford to pay for... either from rental income or from income from your estate or work or ???? If you can afford to hold on to your purchased property for the long term, it will probably work out ok, even if you have to hold it until the mortgage is paid off someday. If you can afford to hang in there.... eventually the mortgages will be paid off, eventually rents will rise and make the place worth more .... eventually prices will go up, and allow you to recover your investment or make the returns you hope to make.

My son and I purchased property in the Lower Mainland of British Columbia in the early 1990's. A decade later it was still worth basically what we paid for it, and not in inflation adjusted dollars but in real dollars, so it actually went down in value between 1992 and 2003. During that period it was always rented out, and although there was small shortfall in our costs over and above the amount we collected, it was affordable.

If we had sold prior to the end of 2003 we would have potentially lost money on the property. And yet, in the next four years the property increased by more than 50% in value, at which my son and I sold and took our profits.

Brilliant! Well, maybe not. It was ok, but we could have done better if we had bought slightly differently, but we still did fine. But we only did fine because we could afford to ride out the lousy real estate market in BC from the early 1990'2 to 2002.

Market timing is no easier in the real estate market than it is in the stock market, but the real estate market does tend to be more forgiving to those with patience and time on their side.

Reverse Mortgages

I have just completed a CAAMP (Canadian Association of Accredited Mortgage Professionals) online presentation on Reverse Mortgages and their role in providing access to their home asset for seniors in Canada who own their own homes.

This is not the first time I've looked at Reverse Mortgages, but I dare say it is the first time I've really examined them from a number of perspectives, and while I like some of what I see, there is a lot that really disturbs me, particularly since one of the specific objectives of the Reverse Mortgage Companies is to make reverse mortgages "mainstream."

Seniors Money, one of the newest players in this arena, is promoting its product through the training seminar to Accedited Mortgage Professionals "AMP's" and seeking to increase its distribution by selling their product through mortgage brokers, financial planners and directly through their own sales force and web page.

First Promise - "At Seniors Money, we promise that that you won't have to pay that part of the amount you owe to us that exceeds the net sale proceeds of the mortgaged property as long as you are not in default on your mortgage and as long as you sell the mortgaged property for at least its fair market value on the date of the sale, based on an appraisal we may get. "

WHAT?! The implications of their first promise is that perhaps ALL of the equity in a property will be consumed by accumulating interest once a senior has borrowed between 15% and 45% of the appraised value of their property and stayed in the property for a period of time after the loan. If the amount you owe is more than the property sells for you won't have to pay the outstanding balance?

Excuse me. If this is their first promise, I'm getting worried about their second promise. Which is that you can set a minimum percentage of equity to retain in the property upon disposal by sale or death. 10% 20% or even, gasp! 50%

Talk about under promising and over delivering! Canadian real estate has been a strong hedge against inflation for a very long time. For a reverse mortgage to eat up more than the increased value of a property, with a loan advance of only 15-45%, the effective interest rate would have to be quite high.... oh, it is.

No don't get me wrong. There are lots of things I like about Seniors Money, in certain situations I think it is a very viable option for some seniors, but it is not for everyone and there are alternatives to accessing the equity in your property without risking the loss of that equity at all.

Instead - Borrow cheaply against your good name and equity, and lend the money through a mortgage or a mortgage investment company to someone with less good name and still good equity. You never use up the equity, but you gain a consistent source of income. What's wrong with that?

Mortgage Investing 101

For newer Investors in residential mortgages

Donald B. Wilson, BA MAOM
Mortgage Investment Consultant and Broker


First Word
Welcome to the world of profitable residential mortgage investing.

While some things may seem a little confusing, or even a little threatening, don’t be afraid to ask any questions you might have. And although you may have thought that you thought of everything before agreeing to fund a mortgage, you may suddenly discover you have a bunch of questions that never occurred to you previously.

Don’t be concerned, my job is to make sure that you understand exactly what is happening, and provide answers to any questions that might arise. So don’t feel bad if you have questions I haven’t yet answered.

Ask away!

Mortgage Investments – Questions to answer before you invest your money.

Mortgages represent one of most common investments in the world – by banks and institutional lenders. Banks like mortgage investing for the same reasons that you probably will. Good return on investment. Relatively lower risk than many alternatives.

Of course, there are many different types of mortgages but here I am only going to discuss residential first and second mortgages placed against property in the Province of BC.

When referring to a “first” or a “second” mortgage what we are referring to is the date of registration of the mortgage relative to any other mortgage placed on the property. Priority of a mortgage, at law, relates to the order in which mortgages are registered. So if I refer to a first mortgage, it means that no other mortgage is to be registered on title in priority to your mortgage. If I refer to a “second” mortgage I am referring to a mortgage that is to be registered behind a previously existing mortgage. Most private investments in mortgages are in “second” position and are called “Second” mortgages.

Second mortgages are generally considered to be riskier than first mortgages, which is why the interest charged to borrowers on second mortgages is generally higher than a first mortgage, and indeed, under certain circumstances, may be much higher.

The risk involved, however, is relative and varies considerably from one second mortgage to another.

Generally, most private residential mortgages are considered “equity” mortgages, which basically mean that they lean more on the value of the real estate than on the general credit worthiness of the borrower. However, the better the credit score of the borrower and the borrower’s cash flow position, the lower the interest rate will be, subject to the mortgage investment marketplace and the Loan to Value of the mortgage investment.

Typically second mortgage interest rates currently range from a low of 9% to a high of 18%, depending on a number of factors that are balanced by a mortgage broker when he quotes a rate to a borrower. The rate the mortgage broker will present will be a market-based rate based on the lowest rate likely to be acquired by an investor. In southwestern BC, at the current time, most second mortgages range from 12% to 14% subject to various factors including geographic location of the property, loan to value expressed as a percentage, use of the property either as a rental or homeowner occupied asset, etc.

For example, one of our lenders will place a second mortgage on property located in the Lower Mainland of BC, with a Loan To Value of 75%, to someone with good credit, at 10% to 12% per year. Another will place a mortgage on a property located in a declining marketplace outside of urban BC, to a loan to value of 75%, at an interest rate of 14% to someone with bruised credit.
So a significant part of the mortgage broker’s work is to determine what rate of interest will attract investment by an investor, and still be within the generally market rates otherwise available to the borrowers.

Before I propose a mortgage investment I will have priced the investment based on market conditions, taking into account various risk factors that affect the cost of the money to the borrower, and the rate of return to the investor.

More experienced investors may choose higher risk mortgages, as the investor has had more background in handling an occasional NSF cheque, or isn’t concerned about perhaps having to foreclose on the property to recover their investment. Their desire for a higher rate of return balances the higher risks involved.

The difference in the level of risk between most second mortgages does not mean that there is a significant risk of losing all your money. Rather, higher interest mortgages generally reflect the possibility that you will have to collect your payments actively, or even engage lawyers and extra expense to recover your investment dollars and/or your payments.

As long as the investment in a mortgage is made with reasonable parameters there is little or no risk of losing all your money, but you might have to wait to get paid at the higher risk levels.

Assessing Relative Risk and Reward

When investing your savings in a mortgage it is important to assess the risks involved.
If you put your money into a Canadian bank account, there is virtually no risk of total loss, but you will earn almost no interest income from it, either. At 2% your money is actually losing value every year against the Consumer Price Index and the underlying inflation rate. Government T-bills pay a little better, perhaps 3% or 4%, but using the Rule of 72 your money will double its value ever 24 years at 3% or every 18 years at 4%. Safe but not exactly sensible necessarily, since the value of your money will actually decline if your net rate of interest returns are the same as or close to inflation.

At the other end of the risk spectrum are investments in many different investments, including commodities like coal, corn or futures in metals. Those investments, when managed by skilful experts may result in being able to double your money in a few months or a year or two at the most. However, the risk of loss is extremely high. In other words you will likely lose some or all of your principle making these types of investments.

The same thing is true of investments in stocks and bonds, or even mutual funds based on stocks and bonds. The higher the rate of return published, the more likely the risk of losing some or all of your investment dollars. It doesn’t always have to happen. Sometimes investors do very well indeed investing in stocks on the various exchanges around the world. One might choose to have some exposure to this marketplace, but one should be cautious about exposing critical retirement money to the risks represented by equity markets where values are based on the volatile buying and selling of stocks.

The last type of investment really available to most investors is debt investments of one kind or another, where the risk of loss is lower, but the rate of returns is also lower. Mortgages are in this class of investments, however, their rate of return in substantially higher than most other equally “safe” or “less risky” investments.

Even within the mortgage investment world there are additional ways to reduce your risk of loss:

Mutualisation of mortgage risk – by investing in a mortgage pooling arrangement, (like a Mortgage Investment Corp.) decreases your risk by spreading it out over a large number of second mortgages. It also slightly reduces your net returns because typically MICs invest in a mixture of lower risk first mortgages and some higher risk seconds and charge the investors for the costs associated with administration.

Investing your money in a number of smaller mortgages instead of one large mortgage. This is the method preferred by most small mortgage investors, since the more mortgages represented in your portfolio, the less likely you are going to find yourself with more than more of them not performing at any given time.

Reliance on competent professionals all the way down the line. Seasoned investment professionals are more likely to successful with you than beginners. Check out some referrals. Ask lots of questions. If your mortgage broker balks at answering your questions at any time, be concerned, very concerned.

Make sure that the lawyers doing the work are always available to answer your concerns and question. Lawyers preparing mortgages for you, have a duty of care to you. Don’t hesitate to ask questions of the law firm preparing the documents and registering the mortgages for you. I use a number of different law firms to prepare documents for private mortgages I broker. The firms I use are all experienced lawyers, with skilful conveyancing staff. What they all share is that they always recognise their duty of care is to the lenders (the investors, you guys).

Review your documents when you receive them from the lawyers, and make sure that what you were told you were getting is exactly what you in fact have received. If there are any doubts or questions, call me (or the law firm) for clarification, or in the event of an error, rectification.
Mortgages are held in your own name, unless otherwise specified in writing. This is important, and the priority of your mortgage should always be consistent with what you have been presented by the broker. The Investor Disclosure sheet provided by me is your statement of intention by the broker. The actual mortgage should conform entirely to what has been disclosed. If there are changes to any of the material facts, the law firm will contact you directly confirm that you still wish to proceed with the investment. The lawyers provide you with assurances that the disclosure form accurately reflects the mortgage reality.

Ultimately, investing in mortgages can be relatively low risk, and mostly requires that you ask suitable questions to determine whether what you are investing in is a lower, medium or higher risk mortgage.

As your broker I’m most interested in maintaining your business, and reinvesting your money when it comes out of a mortgage at the end of the term of the mortgage. This will only happen if you are satisfied with the outcome of the processes.

The process of approving and then issuing a mortgage

I will send you a variety of documents that help describe and illustrate a potential investment opportunity in a mortgage. The documents I will send you will include:
Mortgage Investment Disclosure Statement
Mortgage Application from the proposed borrower
The Credit Report on the proposed borrower
Property appraisal, assessment or Agreement of Purchase and Sale with MLS listing.

Since the value of the property is the critical issue, the basis on which the value is given is important. Generally I order and provide an appraisal prior to funding, although it may not be available immediately. On lower Loan to Value loans a BC Property Assessment report may be sufficient. On a new purchase, if it is an MLS sale, then the Agreement of Purchase and Sale is usually sufficient to attest to fair market value. If it is a private sale, then I would require the borrower to provide an appraisal from an approved appraisals firm.

Once I send you the various information sources listed above I will generally request that you review and decided to fund or not to fund a specific mortgage. I will leave an investment opportunity in your hands for a relatively short period of time before sending it to the next potential investor, as I am expected to give the borrower an answer within 24 hours of a request for a loan. Clearly I have to make sure that I find a home for the mortgage quickly, or I will lose the mortgage opportunity to another lender or broker.

So if you are interested in a mortgage I have presented, it is really important to let me know right away, so that I can send a commitment to the borrower, and get the process of registering the mortgage underway at the lawyers’ offices.

I will let you know when the funds are expected to arrive at the lawyers office, and the method by which they can best be transmitted or deposited to the law firm. It is at this stage that many investors first have contact with the conveyancing staff of the law firm, or talk with the lawyer handling the conveyance (registration of the mortgage) to answer any questions they have.
Funds are deposited to the trust account of the law firm, the mortgage papers signed, and the funds issued to the borrower.

You then receive post-dated cheques and put the money in your account on a monthly basis.
After the end of the term of the mortgage, most commonly 12 months, you will receive your principle investment back, or you will ask me to arrange to renew the mortgage.

The law firm represents you in the preparation and registration of your mortgage investment.
The lawyers who draw up the mortgages and register them do all of the following in the course of doing a mortgage:

Title search prior to make sure that they have a comprehensive list of everything on title that needs to be removed before advancing the new mortgage.

Contacts the insurance provider of the mortgage borrower to make sure that valid general insurance is in place, and that a rider is attached to ensure payment of the mortgage in the event of a major claim.

Sees to it that any prior charges are paid out of the proceeds of the mortgage excepting for authorized mortgages.

Makes sure that property taxes are paid, if not, then they are paid out of the proceeds of the mortgage.

Collect post-dated cheques to your benefit from the borrowers for 12 months that they forward on to you for deposit.

Pay any charges or costs arising from the mortgage from the proceeds of the mortgage prior to paying out net proceeds.

• 
  Prepare a dispersements record for the borrower detailing any money deducted from the proceeds of the mortgage

Ensure that any statutory documents required by various levels of government are completed including BC Disclosure Statements
Collect payment from the borrower for all costs
After a week or so after all funds have been advanced the lawyer will send you a copy of the title showing your mortgage registered on title, a copy of the mortgage document actually registered, and post dated cheques for 12 month.
Last Word
Once you have invested in a few mortgages, much of what I’ve written above will seem self-evident and hardly worth mentioning. Most of my investors review the mortgage documents I send, decide to invest or not based on their own assessment of their risk comfort level, make the investment, and then simply collect the payments until the mortgage term expires, and then repeat the process as necessary.
One nice thing about mortgages is that they don’t take a lot of ongoing investor involvement. If there is any problem with a mortgage, call me (your broker) and it’s my job to figure how to collect the outstanding payment, or instruct council on your behalf to foreclose or otherwise act to the collect your money. Truthful, few of my investors have ever seen a missed payment or an NSF cheque. And few of the mortgages I’ve placed have ever going into foreclosure.
It is my job to make sure that you always have full disclosure of any relevant information about a potential investment in a mortgage. It’s also my job to make sure that your mortgage is set up properly through a qualified legal professional.

House Rich! Cash Poor!

What the mortgage investor knows that you don’t.

What if I were to tell you that using your existing assets in a better way you can dramatically increase your passive income, reduce your net tax bill on your existing income from employment, and substantially increase your freedom from having to work in a job at all?

Unbelievable! You might well say.

Well, not really. Actually, it’s true. If you have significant equity in your home, a reasonably good credit rating, and a desire to increase your take-home real income then listen up!

And be prepared to be surprised at how simple and logical it is to use the equity in your home to maximum efficiency, and without a significant risk of losing your home as a consequence of taking action.

First Principles

Most Canadians were raised to believe that debt is a bad thing, in and of itself. If this notion has you firmly in its grip, and you don’t think you can get past it, then you might as well stop reading this article right now, as the whole point of the strategy is to use leverage against your largest single asset, your home, to acquire other assets that produce a significantly higher return than the cost of borrowing the money.

So if the very idea of borrowing money bothers you, then remind yourself of one simple fact – if you had never borrowed money you probably would have never owned a home.

Most financial advisors acknowledge that there is two different kinds of debt. There is “bad” debt borrowed to pay current expenses or luxury items, which advisors would generally recommend against. Then there is “good” debt – money borrowed to earn income or acquire assets that will eventually increase in value, but which have an investment return at some point in the future.

So there are circumstances where borrowing money for a sound purpose, and with a sound plan to invest those monies in income earning investments, can be a good idea. Once you get to really understand how and why it works as well as it does, it is far more than simply a good idea, it is a compelling one.

What makes it compelling is the simplicity of applying a few simple ideas to your own situation and putting it to work.

If you bought a home a few years ago, especially in British Columbia or Alberta, but almost anywhere else in Canada these days, and have been paying off your mortgage and watching the value of your property increase, then you are a good candidate to enjoy the fruits of the increase in wealth represented by your home equity.

Let say you bought your home in 1985 for a pretty average price, then, of perhaps $150,000 to $200,000. It wasn’t easy to buy your home, but you scraped together the down payment, of perhaps 25% down, perhaps less. And between then and now, more than twenty years later, your home is now worth upwards of $700,000 to a million dollars.

Nothing else you own will likely have increased as much as the value of your home, unless, of course, you own other residential real estate in similar markets.

So it would seem that leaving your money in your house isn’t such a bad idea, if it could increase in value by so much, doubling and redoubling in twenty years. The problem is that while it very well may continue to rise in value over time, it will continue to increase in value whether you owe nothing against it, or borrow 75% or 85% of its value to invest elsewhere. And the rate of return on your invested capital is dramatically increased if you reduce the amount of your capital tied up in the property.

So if you come to me I will arrange a Home Line of Credit, otherwise known as an HLOC, which can drawn down and paid up as you invest in private mortgages or a Mortgage Investment Corporation.

The HLOC will cost you anywhere from Prime less .5% up to Prime plus .25%, depending on your Credit Score and other elements on your loan application. In other words in today’s interest environment you will pay between 5.00% and 6.25 for your line of credit. Since this money is for investment purposes it is fully tax deductible against earned income from any source.

If you invest this money in second mortgages, secured against residential real estate you could currently expect to earn an average interest rate of 12 to 14%, an annual rate of return of slightly more than 15%, when all penalties and other lenders fees are included. If the funds are invested in a MIC, the rate of return will be slightly less, more in the range of 12% to 14% depending on the specific mix of mortgages held in the portfolio of the company.

Either way, you have a nice net return of between 5.5% and 9.5% for every dollar invested in mortgages. That is an amount up to $5,500.00 to $9,500 per year net income before taxes in passive income on money current sitting passively in your home doing nothing.

Given the example above where the property is currently worth $750,000.00 and the line of credit is 75% of the value of the property, that would equal an investment of $562,500.00 earning a net income after the cost of HLOC interest of between 30,000 and $90,000 a year, without having to go to work for one day.

Wow! Something to consider.

A word about risk

Isn’t leveraged investment dangerous? Will I lose my home? Or find myself in a cash crunch if some of the mortgage investments don’t pay? What if I have to foreclose?

All investments have risks. The nature and degree of risk is critical, and you should always have a clear understanding of precisely what it is that you are risking, the likelihood of catastrophic loss, and probably most importantly, the effect of a catastrophic loss on your personal financial success or failure.

Let me be clear. If you invest in residential second mortgages on properties in BC or Alberta in strong markets through a reputable mortgage broker you could lose all your money.

It's not likely, unless of course you completely abandon your sense of self preservation, or simply don’t pay attention to the disclosure documents you are provided by your broker.

So when you invest in mortgages there are a few simple rules to protect yourself from making poor investment decisions.

Read everything sent to you by your broker and make reasoned decisions based on a fully educated understanding of the situation your borrower is in, the security of your mortgage and lands and buildings on which it is based, and the disclosure statement made by the broker.
Accept no substitute for being fully accountable. As your broker I am your agent. I act for you, in your best interests, and to your best outcomes. At the end of the day, however, the decision to invest or not to invest in a particular mortgage or mortgage based security must be based on your own best judgment.

Be honest with yourself about your goals for investment, and your tolerance for risks of different types. Just because I’ve said that I don’t think it is likely for you to lose all of your money on any deal, doesn’t mean that a deal won’t drive you crazy if it ends up requiring your attention, or distracting you from your day-to-day life.

If collecting NSF checks will drive you nuts, invest in a Mortgage Investment Corporation, where an administrator and her staff will handle all that jazz. The management will charge something for the service, but the investment will feel more like a traditional investment, without the day to day hand holding and personal involvement required in direct investment in mortgages.

There is more than one way to offset, ameliorate, mitigate, or reduce the risk of investments in mortgages (or in other investments for that matter). Understanding and managing risk is a critical component in successful investing. If you feel more comfortable leaving individual investment decisions up to the experts, then invest in pooled mortgage products or investment funds. On the other hand, don’t underestimate your ability to assess the risks involved in home mortgages. It might not be simple, but it something you can learn, and learn relatively quickly.
Don’t put all of your eggs in one basket. Diversify even within your mortgage portfolio. Don’t put the majority of your money into one mortgage or even a single investment marketplace. I don’t recommend that an individual place more than 20% of his available mortgage investment capital into a single investment. If there are difficulties in collecting or managing a single mortgage, it shouldn’t be sufficient to upset your cash flow to the point where you are having to pay for the LOC from your other sources of income.

The whole point of investing in mortgages with LOC funds is to produce more income and make a better retirement by leveraging your assets. It is not to create a stressful cash flow drain, so work with your broker to reduce stress and risk, while at the same time pursuing a highly profitable strategy.