You may have heard of people who invest in private mortgages by buying an existing residential mortgage. This can be done directly with the owner, or through a mortgage broker. This form of investing may or may not interest you, but it is helpful to at least understand the concept.
When buying an existing mortgage, you buy it at a discounted rate, depending on the yield or return you want to receive on your money. In legal terms, normally the mortgage is assigned to you, and the original lender notified and any consents obtained. Any associated costs are normally borne by the person selling the mortgage. The benefits of buying a discounted mortgage are that you:
receive additional interest on your money because you are receiving interest on the amount of the discount immediately. For example, if you pay $30,000 for a $45,000 mortgage, you are receiving interest on the $15,000 discounted amount that you are presumably saving. This is assuming you already have the money sitting in a term deposit, GIC, etc. You are also making money on the interest on the full $45,000.
receive additional money because your discount calculations are based on the current outstanding principal balance of the mortgage, and not on a reducing principal balance which occurs as the loan payments progress. The amount of principal reduction on mortgages in the first three years is fairly minimal anyway. Most of the payments go towards interest. It is a quantifiable financial advantage to you, though.
have the potential opportunity to refinance the mortgage with the original lender before the end of the term, but only for the duration of the term, if the interest rates drop lower than the original mortgage. You would only want to do this if you are still financially ahead, after taking into account any pre-payment penalties. There are several other creative options available to increase your yield, or return on your original investment.
There is a “rule of thumb” for quick calculation of the discount amount. For example, if the rate of interest on an existing second mortgage is 10 per cent, and you wish to have the mortgage produce a return of 15 per cent, the five per cent difference is multiplied by the number of years remaining in the mortgage term (the time left until the maturity date, when the principal balance is due and payable). The outcome of the calculation will be the discount which is subtracted from the mortgage amount to determine the purchase price of the mortgage. This is just a guideline. You will want to obtain a spreadsheet of the precise amount.
Here are some examples to illustrate the point:
| Current Mortgage Principal |
$10,000
|
$20,000
|
$50,000
|
$75,000
|
| Rate of Interest |
14%
|
12%
|
10%
|
8%
|
| Interest Required |
20%
|
18%
|
16%
|
14%
|
| Mortgage Difference |
6%
|
4%
|
8%
|
6%
|
| Term Remaining |
3 years
|
4 years
|
5 years
|
2 years
|
| Amount Paid for Discount Mortgage |
18%
($1,800) $8,200 |
16%
($3,200) $16,800 |
40%
($20,000) $30,000 |
12%
($9,000) $66,000 |
Now that you have a better understanding of investing in discounted mortgages, you can see why having a real estate lawyer to protect your interests is so critical. You can also understand why having a tax accountant to advise you is so essential to maximizing your net profit and minimizing your taxable income.
