Money Smarts Blog

Thicken My Wallet asked me a while ago to post more about the multi-use building that I was involved in purchasing as a silent partner, and my experience doing that sort of deal. Just to be clear, what I mean by silent partner is someone who puts money into an investment, but isn’t involved in the day-to-day management of it.

Some time ago a buddy of mine, who has been holding my hand while I learn about real estate, contacted me with info about a building he’d found in a small Ontario town he lives near. He sent me the general building info, and it seemed pretty good ($400K, bar and retail store on the main floor and rooming house upstairs).

My friend likes to be pretty aggressive with real estate, so he never has enough cash to buy everything he’d like to. He also likes to mortgage to the hilt so that he has as much possible cash for the next purchase as possible. Given this, he’s quite open to partnering with people (and has done so successfully in the past with his sister’s boyfriend).

I told him it looked interesting, asked for an income statement (which seemed too good to be true, but we verified it). We put in an offer conditional on a property inspection (and my buddy negotiated a vendor-take-back mortgage).

After the inspection was completed (and we managed to get $25K knocked off the purchase price due to some potential problems turned up by the report), we set up a corporation (my buddy took care of all this), and recently completed the purchase.

Originally my friend was planning to live there himself, so he was going to manage it in exchange for living rent free, but in the end he changed his mind, and what we decided would be fair would be that we’d pay him 10% of the gross rent to manage it (and treat this the same as any other property expense), then we’d split everything else 50/50. I live in Toronto so wouldn’t have been able to do any of the management duties.

I went to tour the building, but for the most part deferred to my friend’s experience. This isn’t necessarily a course I’d recommend to everyone, but I’ve known this guy for about a decade (we met at university) and I was in his wedding party, so I’m willing to trust is judgement.

There’s a fine line to walk between doing business with someone you’re close enough to trust, but not doing business with someone you’re so close to that it might jeopardize the friendship. Some people trust more easily than I do, and some people are more able to do business and keep the friendship out of it than I can. For me there’s a pretty narrow range where business and friendship intersects (and I’m always nervous when I’m in that territory).

As an example, I could see my brother suggesting him and I buy property together (with him as the silent partner). I’d be very uncomfortable doing this, as if anything went wrong with the deal, I could see it causing problem with the relationship (and I don’t want to lose my brother over money). On the other extreme, whenever you go to “real estate networking” events, you’ll find TONS of people who are very excited to partner with you on deals. I’d say if you’re that sick of your money, just send it to me instead of losing it to them.

We’re still in the early stages of managing the property, so I’ll post more details in the future once figures start rolling in (and mention if we run into any problems).

I’m writing this late at night the night before posting, so I may have left out important details. Please let me know if there’s any holes in the story and I’ll be happy to fill them in! 🙂

My friend Christine has kindly agreed to write a series of posts on her experiences with buying a home for the first time which will be posted occasionally.
See Part 2 – Down Payments and Financing

Going it alone or choosing a realtor

With the availability of information online on MLS (Multiple Listing Service), how necessary is an agent? After all, agents work on commission and are paid a percentage of the value of a home. The fee is paid through the seller, but a buyer indirectly pays through the negotiated selling price.

For myself, the decision came down to the practicality of having an expert do the initial culling through the listings. Because our top priority is to stay along the subway line, my husband and I are dealing with the “hot” neighbourhoods where houses can sell within a week of being listed. As home buying novices, we wanted the advice of an expert in finding the right home and not overpaying for it. Real estate professionals have access to MLS properties before the public and can fine-tune searches. Agents are also experienced in negotiating offers, have access to a plethora of specialists such as home inspectors, lawyers, and mortgage brokers, and can lead one through the intricacies of closing costs and legal requirements.

Choosing a real estate agent

Choosing the appropriate person to work with was therefore not a decision that we made lightly. Start with the recommendations of friends and people you trust. Look at an agent’s online profile and their recent listings to evaluate if they work in the neighbourhoods you are targeting and at your budget. How long has the person been in the business? Although I was confident about a friend’s referral, I still met with the agent to interview her and to determine if she was someone with whom I would be comfortable working. I was impressed with her frank advice and that we could sign a buyers’ representation agreement for as short a term as two weeks. My husband and I decided to begin with a one-month contract instead of a longer commitment to see how it goes.

Dual Agency or Buyer’s Agency Agreements

Several of my friends were fortunate enough to find their homes without an agent and then worked with the listing agent to negotiate the buying price and finalize the offer. Such a situation, whereby the seller and buyer use the same agent, is referred to as a dual agency. The seller must also agree to this arrangement. From the agent’s perspective, dual agency is advantageous as s/he would earn a double commission. However, the worry is whether the agent has your best interests in mind, especially in terms of price.

Engaging in a buyer’s agency agreement is a contract to use the services of a particular agent or company for a specified length of time. The advantage of such a contract is that the realtor has agreed to work for you and is obliged to disclose all available information.

Realtors also have a network of other experts they can connect you with such as home inspectors, mortgage brokers and lawyers. A real estate agent’s job is to make things easier for you, so do not be afraid to make use of their network if you don’t already have access to such professionals.

Read the next post in this series “What to Buy?”.

My friend Christine has kindly agreed to write a series of posts on her experiences with buying a home for the first time which will be posted occasionally.

See Part 1 – First Steps and Pre-Approved Mortgages.

Mortgage Down Payments

Remember that a mortgage is a fancy term for a loan; however, it is a loan that is secured against the value of your home itself. The original amount that is borrowed is referred to as the principal.

A conventional mortgage requires a downpayment of at least 20% the purchase price of a home.

First time home buyers can take advantage of the federal government HBP (Home Buyers’ Plan) whereby an individual is allowed to withdraw up to $20,000.00 from his/her RRSPs. Minimum repayments of 1/15^th of the loan are required each year, with the full amount to be repaid within 15 years. You are essentially loaning yourself the money for a home purchase. The downside is that the withdrawn money would be not be appreciating in your RRSP.

If you do not have 20% down, what are your options?

When a mortgage is taken out on more than 80% of a house’s cost, then it is known as a high-ratio mortgage and lenders require mortgage insurance to protect themselves in case of default. The insurance is required on the full mortgage and is either paid upfront or added to the mortgage itself.

Mortgage insurance is charged on the full principal mortgage. The calculation is based on the percentage of the mortgage compared to the total purchase price.

CHMC (Canadian Mortgage and Housing Corporation) and Genworth Financial Canada are the two institutions which provide mortgage insurance in Canada. Mortgage insurance premiums are available here.

Thus, with a house purchase price of $400,000 and a $50,000 down payment, the CMHC premium to insure a high ratio mortgage would be:

$350,000 mortgage x 2% (the rate for a loan 87.5% of the house value) = $7,000.

My husband and I decided to avoid taking out a high ratio mortgage and will be using a line of credit to top up our downpayment to reach 20%. We were leery of the compounding interest on a higher mortgage. As good savers, we are confident of paying off a line of credit quickly, so the borrowing cost will actually decrease as the loan is paid off.

Different Types of Mortgages

The lowest lending rate is only one of the considerations for a mortgage. These other variables will be discussed below and vary by bank or lending institution.

Fixed or Variable Rate — A fixed rate is a set lending rate for a specified period of time with fixed payments. A variable rate changes on a monthly basis against the prime rate. Therefore, while your payments remain the same, the amount that goes towards the principal loan versus interest changes.

Although historically, variable rates have saved money, it is a guess which direction rates will go in the next few years. Therefore, which route you go depends on your comfort level in terms of risk.

Open or Closed – Open mortgages allow you to repay the entire mortgage or make extra payments without penalty fees. Some closed mortgages charge a fee for extra payments, while other closed mortgages require that you wait until the end of the term. The degree of “openness” on a mortgage varies between institutions. If you wish to pay down a mortgage faster and will have extra funds for payments, you may not want to choose a completely closed mortgage.

Term – The length of a mortgage agreement can last from 6 months to 10 years. Short-term mortgages run for two years or less and are advantageous for borrowers who think that rates will be decreasing in the next few years. After the end of a term, a new mortgage can be negotiated with a different lender.

Amortization period – A period of 15 to 40 years can be chosen. The length of time that you choose to pay back your mortgage will affect the size of your payments and the amount of interest that you will eventually pay.

Payment Schedule – The frequency of payments (monthly, weekly, bi-weekly, etc.) against your mortgage will vary between financial institutions. Because interest is compounded monthly, making weekly payments will more quickly reduce your principal mortgage than paying on a monthly basis, even if the overall size of the monthly payment is the same.

Pre-payment Options – Essentially extra payments against the mortgage free of penalty fees, the terms and amount vary between lenders. As with a more frequent payment schedule, pre-payments help reduce the principal and the overall interest borrowing cost.

Read the next post in this series “Choosing a Realtor“.