Shave years off your investment plan 

Many investors spend a great deal of time and effort thinking of complex ways to speed up their investment plan to build wealth faster. Here’s a simple and easy way to shave years off the investment clock. Like most things in real estate, this strategy will depend on your personal situation, your current finances and your willingness to make small sacrifices now for large gains later.

One way to build wealth faster is to buy a rental property first and then buy a principal residence second. Here’s why.

When a person wants to buy a home in Canada, there are different lending rules depending on whether the property will be used as a principal residence or an investment property. When a property is purchased strictly as an investment property a minimum 20% down payment is required.

However, if the same property is purchased and lived in (now considered to be a principal residence) then under CMHC guidelines, for as little as 5% down CMHC will insure the mortgage. This is not limited to first time buyers either. This is available to any home lived in as a principal residence. If your credit and job history are excellent and you are an employee, not self employed, many lenders today will even lend you the 5% down payment through a line of credit for your principal residence!

Once you have built up enough equity in this property, you can now refinance it and use the money to buy your principal residence with a 5% down payment once again and keep the initial property as a rental.

So instead of buying your principal residence first, consider buying a property that you can live in for now and when the time is right, you can turn it into a rental property. This works best for 2 to 4 unit properties. Yes, under these rules you can buy a duplex, triplex or even a 4 plex with 5% down as long as you are living in one of the units. Again, the lender may even lend you the 5%.

Let’s take a look at what would happen if you purchased your principal residence first. In order to use the equity in your home for a down payment on a rental property, you must retain 15% equity in your home. Therefore, you’ll need 35% total equity to account for the 15% equity allowance in your home and 20% equity to be used for the down payment on the rental property. Therefore the LTV (loan to value) of the home would have to be 65% LTV. (100% total value minus 35% equity = 65% debt).

Based on today’s interest rates and assuming a market appreciating an average of 3% per year, the two charts below illustrate the difference between buying a principal residence first and then a rental property second, versus buying the rental first and then the principal residence second.

The first chart below shows that it will take approximately 8 years to build up enough equity in a principal residence before a homeowner could use that equity to buy their first rental property.

Using the same market assumptions, the next chart illustrates a person buying a home, living in it as their principal residence, refinancing it when the time is right, keeping it as a rental and using the equity to buy a new principal residence.

Again, a person must still retain 15% equity in the first property, however when they refinance they will only need a total of 20% equity. 15% equity remains in the first home plus 5% equity which is used for the down payment on the new principal residence. Therefore the LTV (loan to value) of house #1 would have to be 80% LTV. (100% total value minus 20% equity = 80% debt).

After only 3.5 years, a person could own two properties - a rental and a principal residence.

The compound effect of this strategy is that the equity is now building on 2 properties starting in year 3.5. By year 7, you could have 3 properties, whereas with the traditional way, you will still have only 1.

The equity difference in year 7 is $236K versus $147K. That’s over $2,100 per month extra each and every month starting in year 3.5. What would you do for an extra $2,100 per month or $79K?

Now, many of you may be saying, “But I already own my principal residence. I’m stuck. What do I do?”

Here’s a way you can still benefit from this strategy:

1. Examine the home you are in now. Could you collect enough income to cover all your expenses?

2. Do you have a minimum of 20% equity in your home now if you are an employee or 25% equity if you are self employed?

3. If the answer is “yes” to both questions above, then consider turning your existing home into your first rental property and buying another home by using some of the equity in your existing home.

4. If you answered “no,” then you may want to consider selling your existing home, moving into a home that would be suitable as a rental later (meeting the criteria of question #1 above). Once moved in, put a plan in place when you will have enough equity to turn this home into a rental so that you can move into your final principal residence.

Making small sacrifices now for large gains later can pay off nicely. You don’t need complex strategies to speed up your wealth. By using simple, proven methods you could shave years off your investment plan.

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