Are You Hurrying to Invest Before Mortgage Rates for Investment Properties Go Up? Check This Out First
Thanks to historically low mortgage rates, real estate investments are an attractive option for people looking to diversify their portfolios. Low interest rates mean low monthly payments and lower interest cost over the life of your loan. We keep hearing about how interest rates are about to go up (and they have started creeping up a bit here and there) but they are still well below where they had been before they started declining in the wake of the 2008 housing collapse. Before you sign a loan, though, here are some things that you should know about how interest rates can affect your investment.
Most real estate investors, who are evaluating interest rates, are planning to hold onto a property and rent it out rather than flipping the property after renovating it. After all, it doesn’t make that much of a difference what your interest rate is when you’re holding the house for six or eight months. If you are thinking about flipping the property soon after you move from the lease to ownership, you’ll probably be in the house between two and four years, but the cap rate for you is still an important number to know.
So if you’re purchasing a rental property, you need to figure out the return that you could get overall before researching interest rates. To figure this out, you need to know the capitalization rate, also called the “cap rate.”
Figure out what you want to charge for rent. Let’s assume it’s $1,500 per month.
Then, figure out your operating costs (insurance, repairs, utilities if applicable, but not the loan). Let’s assume $500 per month.
Now your net operating income is $1,000 (rent minus operating expenses) per month. Annually, your net operating income would be $12,000. Divide this by the purchase price. Let’s say it’s $360,000. That gives you 0.033, or 3.3%.
Theoretically, this property gives you a 3.3% return annual return on the asset value. Remember when that $1,000 sounded like a lot each month? Well, this return could be better. So you might want to think again and look at another property, even before you call HOS Financial to find out the interest rate.
Your mortgage payment comes from four metrics: the principal (the price of the house), property taxes, interest and homeowner’s insurance. If your taxes and insurance stay level, lower interest rates mean that you can qualify for more of a loan. This is why home prices tend to go up when interest rates are down, because people can afford to pay more, sellers realize this and push up prices, and then you have a spike. So in some cases a low interest rate market means that it’s a seller’s market. This might seem ironic, but if you wait until interest rates go up a bit and housing prices stagnate, then you can get a better deal on the price. You’re going to pay more on the interest on the mortgage, but you’re getting a better return on that principal investment.
The borrowing process
One reason why the housing crisis hit in 2008 was the fact that lenders had been rubber-stamping mortgage approvals left and right. There were a lot of unethical practices that led to a ton of mortgages going out there to consumers who didn’t have a realistic shot at paying them back. So now, to protect banks (and the consumers), it’s tougher to get a mortgage. The banks want more documentation, and their credit score and income requirements are tighter. For investment purchases, they want to see heftier reserves in case of vacancy. HOS Financial has connections with a wide variety of lenders throughout Canada, but you should know that documentation is important for all of the reputable ones.
With all this in mind, there are plenty of investment properties at attractive interest rates in Canada. If you feel like the time is right for you to get into the real estate market, call us at HOS Financial, and we will help you get started.