I am sure you have all heard of the BoC announcement today!… No one saw those extra 25 basis points coming, but of course, it’s been loud and clear that they are planning to increase rates, so from that respect, no one is surprised. I am not going to offer you predictions on where the rates will go, the internet is way too full of that already. Instead, for any of you who have concerns about rising payments I am offering you 6 simple tips on how to better manage your cashflow and effectively reduce your monthly payments going forward.
Tip #1: Don’t let the fear and the noise surrounding us these days make you rush into locking a 5 year fixed rate mortgage.
As you may have heard us say many times, variable rates mortgages have a lot of advantages for investors. Variable rate mortgages are usually much easier and cheaper to break, and therefore offer flexibility real estate investors need. Fixed rate mortgages on the other hand tend to be more costly to break. So really watch the fine print before you make any commitments. Don’t assume the savings are a slam dunk either, even after today’s announcement, fixed rates mortgages are still around 2.0% higher than variable rates on average (this is guaranteed to change in the next few days, and there is a difference between lenders, but for now we are using 2% for quick math). Think of this 2% as the premium the bank is charging you to insure against the risk of higher interest rates. It also means variable rates need to go higher by another 2% before locking in starts to make sense, and not only that, but that rates will NOT come down back during the remaining term of your fixed rate mortgage (usually 5 years). I offer you no forecasts or guarantees, but all I can say, the pure odds are in your favour to save money if you stick with variable. If you are very concerned and rates are really keeping you up at night, lock into a shorter term fixed rate mortgage, such as 1 or 2 years.
Tip #2: Consider switching to a capped variable rate.
A few lenders on the street offer a capped variable rate option. Under that option, as the prime rate that impacts variable rate rises, your monthly mortgage payment stays the same, the percentage of payment that goes toward principal declines, and the percentage of payment that goes toward interest increases. This is a good option if none of the other alternatives discussed below work, and you are okay with taking longer to pay off your mortgage because you are now paying less principal as rates rise.
Tip #3: Extend the amortization of the mortgage or a loan.
If you have two loans of the same amount—one at a lower rate but shorter amortization and the other at a higher rate but longer amortization—you will see that your payment on the first loan would be higher. Having said that, your interest savings would be bigger because you are paying off the loan over a shorter period at a lower rate.
Extending amortization is a way to lower your monthly payment on a loan as the rates rise. As increasing the amortization will extend the life of the mortgage, discuss with your mortgage advisor alternative methods using the prepayment options to pay down the loan over the original amortization time horizon.
Tip #4: Replace expensive debt with cheaper debt.
Although the rates are rising, the cost of secured debts such as mortgages and lines of credit remains relatively cheap within the bigger scheme of things. One option to create capacity within your budget is to replace expensive debt with cheaper debt.
Let’s say you have a car loan with a monthly payment of $1200, and there is $30,000 left on that loan. It may make sense to pay it off using your secured line of credit and reduce the monthly payment from $1200 to $118—which is the interest payment at prime (4.7%) on a $30,000 loan.
Now you have extensive capacity to handle a rise in payments somewhere else in your portfolio, and, overall, you are at neutral or better from a budget and a cash flow standpoint.
Tip #5: Convert a portion of a mortgage to an interest-only payment.
An interest-only payment on a loan is often lower than an interest and principal payment. If you want to ease up the impacts of rising rates on your cash flow and budget, paying an interest payment would be lighter on your pocket. Having said this, you must be conscious of how long you want to stick with interest-only payments and convert those back to principal and interest or pay more than the interest every month so you can still get ahead.
Advanceable mortgages on the street allow you to divide up a loan into interest-only (line of credit) and principal and interest loans at the time of application and then convert an interest-only loan at any point in time back to a mortgage.
Tip #6: Take a short and long mortgage.
You do not have to choose between fixed or variable. You can choose both! Advanceable mortgages allow you to slice and dice a mortgage into multiple components of varying terms and rates. For example, you can have three loan components, one as a variable, one as a fixed rate, and the third as an interest-only line of credit. Tools like this can help you hedge while offering flexibility and better options for managing your cash flow.
It is not a secret, nor a hoax conspiracy theory to say the Bank of Canada is actively trying to scare us into spending less! It is one of their stated official policies to tame inflation. They will continue to threaten even more increases until the economy cools down. Don’t let the fear get to you, and force you to take irrational actions. If the higher payments are a problem, most of all, don’t panic and know there are many options to help reduce that stress.
For investors that have been sidelined in the last 2 years waiting for opportunities with better cashflow, it may be time to go shopping soon. Prices have come down enough in some areas that even with higher interest rates, cashflows are likely starting to make sense again.
Many of you have heard me repeat the quote “Luck favours the prepared”. It is a reminder that deliberate planning and thinking ahead allows us to see opportunities others may miss, and we see solutions when others only see problems.
We have developed an interest rate sensitivity calculator to help you assess the impact of increasing rates on your current property portfolio and cash flow and to help guide your decision as to whether you should stay put, lock-in, or consider one of the tools shared earlier. Download a copy HERE.
Every situation is unique, and there are pros and cons to each option. Book a complimentary planning session with one of our senior advisors if you wish to discuss hedging or cash flow management strategies specific to your situation. For questions, email us at email@example.com.
Good luck, you are prepared!