What is your credit score and how it's calculated

The credit score is also referred to as a FICO Score and is a mathematical formulae created by Fair Isaac and Company. The credit score is used by most companies to see if you are a good credit risk or not. Equifax and Trans Union will crunch the numbers from the credit report, and spit out a number somewhere between 300 and 900, or even no number or R for Reject.  A score over 680+ is considered excellent. How Scores Are Calculated FACTOR WEIGHT POINTS Payment History Bankruptcies, late payments, past due accounts and wage attachments, collections, judgments 35% 315 Amounts Owed Amount owed on accounts, proportion of balance to total credit limit 30% 270 Length of Credit History Time since accounts opened, time since account activity 15% 135 New Credit Number of recent inquiries, number of recently opened accounts 10% 90 Types of Credit Number of various types of accounts (credit cards, retail cards, mortgage, line of credit, loans etc) 10% 90 POTENTIAL TOTALS 100% 900 How you can improve your credit score 1.     Order a copy of your credit report annually, review it carefully and correct any significant errors: a.     www.equifax.ca b.     www.transunion.ca 2.     Pay your bills on time 3.     If you have a questionable credit history, you should open a few new accounts, use them responsibly, and pay them off on time 4.     Don’t open accounts then don’t use them.  Having 6 or 7 of the same type of credit card does not work in your favour 5.     Have a credit card or instalment loan can help boost your score, so long as you don’t have a high balance 6.     Keep balances low in relation to the available credit.  If the credit limit is say $10,000, keeping the balance below $2,500 (or 25% of the limit) will improve your score, balances over $7,500 (75% of the limit) will decrease the score.  Going over the limit has an even more negative effect 7.     Pay off credit card debt instead of moving it around to lower rate cards.  Moving balances to other credit cards and closing out the old account can hurt the score.

Buying under a corporate name, pros and cons

As an investor, you may have been advised to put your investment properties in a corporate name.  There tends to be two primary reasons for this:

1. Income tax benefits: You can take a dividend income which is taxed at a much lower income tax rate

2. Limited Liability on you personally: If you were sued (ex: a tenant is injured on your property) or had a legal case against you as a landlord, it would be against the corporation and not you personally so it can assist in protecting your personal assets in this type of situation 

So the title of the property will be in a corporate name but you need to know that ALL lenders will require your personal guarantees on a mortgage.

Personal Guarantees: A personal guarantee means that even though the title and mortgage will be in a corporate name, the owners/directors (you as the borrower) are personally liable for loan to be paid. You cannot hide behind the usual corporate protection mentioned above. Should the loan default, the lender can pursue the corporation AND then you personally (and you assets) for full repayment and any default expenses.

The only time personal guarantees may not be required is if:

•      the property is underwritten commercially

•      the corporation is established for at least three years

•      the corporation can provide three years full financial statements and corporate tax filings that are strong

•      the corporation has a high asset base, and

•      the corporation has positive cash flow and consistent net profit

The key thing here is to remember that from the lenders prospective we are asking for the best of both worlds... we want residential discounted rates and terms but we want the tax benefits and limited personal liability of having the property under a corporate name.  More and more lenders are saying you can’t have both so decide where you want to be either residential or commercial? 

Our recommendation: There are still lenders allowing registration under a corporate name under their residential guidelines; however the corporation may have to be a real estate holding company as opposed to an operating company.  Be prepared that you may also have to increase your down payment depending on the overall application. 

And always remember to seek professional legal and tax advise as your situation might be quite different from others

The pros and cons of rent-to-own

By Mark Weisleder - a lawyer, author, instructor, columnist and keynote speaker for the real estate industry.
Original article can be found here

The changes to the mortgage rules announced by Finance Minister Jim Flaherty last July are making it more difficult for first time buyers to get approved for a mortgage. Other buyers may have good credit but not enough of a down payment. At the same time, landlords are looking for good tenants to rent their units. Rent-to-own may provide a win-win for both owners and tenants.

Here’s how it works:

A landlord rents the home or condominium under a basic home lease. For an extra payment, the tenant receives an option to buy the home at a later date, for a set price. Let’s say the home is worth $250,000. The parties agree the tenant will have the right, but not the obligation, to buy the house in three years for $280,000.

The fee for this right, or option, is usually 2 or 2 ½ per cent of the final price. In this example, 2 percent of $280,000 would be $5,600. Then, each month, the tenant pays an extra fee, say $200, that also is applied to this option price. At the end of the three-year lease term, the tenant has put up close to 5 per cent towards the purchase price option. In this example, it would be close to $13,000.

If the tenant exercises their right to buy, they can use the $13,000 as the down payment and apply for a mortgage to finance the rest of the purchase.

Here are some of the advantages for the tenant:

•You may not have the down payment now, but you will have it at the end of your lease, as a result of the additional payments;

•If your credit is not good, you can improve it by making timely payments of rent;

•You can try out the neighbourhood and if you change your mind later, you can just cancel the option;

•If the market price of this home is more than $280,000 at the end of your lease, you still get to buy it for the same $280,000.

•If the market collapses and the home is worth less than $280,000, you do not have to go through with your purchase.

Here are some disadvantages:

•There is no guarantee that a bank will give you your financing when you exercise your option. You still have to improve your credit score or find someone to co-sign your application;

•If you don’t go ahead with your purchase, you usually have to forfeit the option payment.

Here are some advantages for the landlord:

•Tenants on rent-to-own typically take better care of the property, thinking that they may own it one day;

•Your profit is fixed at the time of the option.

Landlords need to make sure that the option payment is covered in a separate agreement, and is not included in the lease. If it is included in the lease and then the tenant defaults, it can be harder to evict the tenant from the property. Landlords also need to conduct a thorough credit and background check, to make sure that the tenant looks like they will have the means to make all of the required payments.

Rent to own can work for landlords and tenants if you are properly prepared in advance.

Why invest outside of large cities?

When thinking about buying a rental property for a long term many investors are naturally drown towards big cities.But way too often investors forget the most important factors – cashflow and ROI (return on investment). Let’s look at a few examples in Toronto. 

First one is a 2 bedroom condo. You might be lucky to find something for $300K and maybe even rent it for $2000 (unlikely but never the less). Your mortgage is $1142 (4% interest 30 years amortization, we will use it going forward), one month vacancy is $167 ($2000/12), $200 taxes and of course there is condo fee, say $400. So your income is

$2000 – ($1142 + $167 + $200 + $400) = $91

assuming no repairs need to be done (and there is always something). This adds up to $1092 annually or 1.8% with 20% down payment.

You probably have better luck with a house where there are no condo fees. Let’s say you found something in the outskirts of Toronto for $400K and you can rent a basement, not just house itself and get $2500 total income

$2500- ($1523 mortgage + $150 insurance + $250 vacancy + $300 taxes) = $277

Again with a house you are more likely to need repairs, but we leave it out of equation to be consistent. So we have 4.2% annual income with 20% down.

Not very impressive if you ask me. Of course many would remind me about property value increase, but I still don’t have my crystal ball and can’t speculate on this. And after all I’ll have to sell the property, pay capital gains and lose my asset to get that money. Aren't we looking at a long-term investment plan?

So what to do if you want to secure your money in a real estate but get high ROI at the same time? Look a bit further, not big cities. We recently acquired a duplex for under $100K in Sarnia which rents for $1300. So here is what we have:

$1300 – ($380 mortgage + $100 insurance + $108 vacancy + $100 taxes + $130 management fee) = $682

With 20% down we are talking 40.1% annual return or 10 times more than in the big cities. Notice that I pay 10% property management fee, so I don’t have to worry about broken toilets or finding new tenants. As you can see we have better returns and fewer headaches.

Of course there is more to this, but details of remote property ownership is  a topic for another article. Let me know if you are interested.

Investing in condos. With and without buying.

Recently I came across a list of world’s fastest growing condo markets and was amazed:

1.       Toronto with 132 new condos currently being built

2.       Mexico City - 88

3.       New York - 86

4.       Chicago - 17

5.       Miami - 16

Huge gap between Toronto and any other city in the world! Of cause, Toronto still has a long way to go from 1875 high-rises to New York’s 6000, but nearly 100 000 people arriving to Toronto every year. Add to this many baby-boomers who prefer "no hassle" condo style of living, mix high-paid young professionals who enjoy being close to work and entertainment and you get yourself a great cocktail named "booming condo market". No wonder everyone if not investing, but at least talking about it! So what are the typical ways to invest? 

Well, first of all you can buy existing condo and rent it. In cities such as Toronto you most probably will get your mortgage and taxes covered by rental income. If you play your cards right, rent might even cover part or all of the condo fees. Though this investment option is very popular, one must remember to cover all payments out of pocket if property is vacant (usually 1 out every 18 months) and budget for repairs and maintenance (few hundreds every year). People who invest in this scenario are not looking for monthly cashflow, they buy for equity (property value) growth. It is profitable in booming market and there is no limit of how long you can hold such condo, as long as you have enough cash to keep it.

What if you want to take advantage of growing condo prices but don't want to be a landlord? Well, buying condo units before they even built might be your choice. This scenario requires significant amount of cash (25-35%) of unit price, but amount is usually paid in 3 stages, all before building is registered. Main advantage is that you don't need to get a mortgage until building is registered. Your goal would be to find a buyer by that time. Usually you invest for 1-3 years and take advantage of increasing property values AND lower purchase price. How much profit you make will depend on how early in the game you get your hands on this development. The earlier - the better. Good agent might be your best ally for this.

For folks who want as little headache as possible syndicate mortgages is probably the best way to go. This is when you will act as a bank and lend money to a builder. Projects may vary from 1 to 5 years. Look for the ones that offer quarterly interest payments and have reserved fund to pay it. This way you get some cashflow and large payment at the end of constructions. Additional bonus often offered by builders is preferred shopping for units in this construction. You will have a chance to buy before general public. That way you can invest $25 000 (usual minimal required) into syndicated mortgage and if you have more - buy some units at low price.

Whichever way you choose to invest, remember to consult with professionals, such as your lawyer. And let me know if you need any contacts ;)