Benefits and Risks of using a US Mortgage as a Canadian Investor
One of the many advantages of investing in real estate is the ability to leverage your investment dollars with inexpensive borrowed money. With positive leverage you can increase your returns in the short-term and triple or more your returns over the long term. With higher returns though, of course come higher, or should I say different, risks that you will want to consider. In the past, most of our clients have purchased with “all cash” or used Canadian financing to make the initial purchase the home, but them used US based financing later as a means to lock in currency gains and/or diversify with additional purchases.
Before we start, it’s important to review just why financing Florida real estate is so widely used. A good read about this can be found in our article “Supercharging your Returns with Smart Financing” (Coming Soon).
- Using a Mortgage with your Florida real estate investment supercharges your return on investment (click for a detailed example). It can take an average return around 4-5% up to 15+% with minimal increased risk.
- Mortgages make it possible for even the “small guys” to invest in Florida real estate. Most of us have a limited amount of money we can invest. $50,000 won’t buy a great property, but with $50K plus a mortgage of $150,000, suddenly you can buy a great property.
- Mortgaging allows you to diversify. Even if you did have $200,000 lying around, it’s always a good idea to spread your risk over multiple properties. Even only using 65% leverage to purchase 3 homes with the same amount of money, you can diversify into different areas and eliminate the possibility of one vacancy dropping your income to zero, ever.
- Mortgage interest is a 100% deductible expense on your income taxes*. There is no limit to how much interest the IRS allows you to deduct on an investment property. The use of a mortgage can help bring your “on paper” rental income to zero for high income earners. Pushing your profits more to capital gains (at a much lower rate) or to when you retire and will be in a lower tax bracket.
Canadian Landlords be sure to read “The 3 most common ways to buy Florida Real Estate From Canada.” If you obtain a mortgage in Canada and use the funds to purchase an investment home in Florida, the CRA allows you to deduct that interest expense from your rental income obtained from your Florida home**
- For Canadian and other foreign investors, mortgaging can act as a hedge against currency volatility. If the US dollar is strong using a dollar denominated mortgage lowers the amount of your native currency you have to use to purchase. If the US dollar weakens, you can pay down the mortgage with stronger native currency. If the US Dollar gets even stronger, you have US dollars being produced to continue paying the interest while you make a higher return after currency conversion on your rental income.
- You will have less equity cushion in a market downturn. With 20% down, a market slowdown of 5% can wipe out 25% your investment. This is the negative side to leverage. However, the beauty of real estate is that a paper loss doesn’t affect you unless you needed to sell immediately. There are no margin calls with a mortgage and as long as you do not sell, the market will come back. A loss will stay a paper loss and you can make up the downturn on the next upturn that is always around the corner in this cyclical market.
Mitigate this risk by leaving a cash flow cushion between the mortgage payment and rental income. Even in downturns, rent rates don’t typically fall commensurate with housing prices. So even a small cash flow cushion can be more than enough to ensure you can weather a downturn.
- You have to make that payment! Lenders offer low rates and higher leverage with a mortgage because it’s backed by real estate. If you can’t make that monthly payment, your investment can be at risk of being foreclosed and taken away from you.
Mitigate this risk by being conservative in your use of financing. Always make sure that the income from the property will be more than enough to cover the mortgage payment and allow cushion for unexpected repair expenses along the way. Always keep a contingency account of at least 2 months’ worth of all expenses.
In Florida, it can take 6 months to two or more years to have a home foreclosed on. So you really have to be in a rough spot to lose your entire investment by not making the mortgage payment. Lenders don’t want to foreclose!
- Negative Leverage, Be careful using financing that has an interest rate higher than what the returns would be with an all cash purchase. Never take on debt with a payment that you would have to come out of pocket to cover every month after your rental income.
Mitigate this risk by giving yourself a cushion between expected expenses and income and always base your income on current rental rates. While rents do tend to move up over time which can turn negative leverage positive, we don’t’ recommend counting on this!
- You will be limited as to how you can take title. Some owners use the liability protection offered by incorporating and having the property owned by the company. Unfortunately financing in the US is scarce for residential real estate that is held in a corporate name. The few specialty lenders that do this typically have much higher interest rates and closing cost that make using the financing long-term unwise. The risk then, is keeping an investment property owned in your personal name vs. a corporation.
Mitigate this risk by having good insurance! Insurance, whether a property is owned in a corporate name or personal name, should be obtained either way. From a homeowner’s policy, to a personal umbrella policy. Consult with your insurance agent and possibly attorney to determine what level of insurance is wise for your situation.
- “Subject to Financing” offers are less attractive to sellers. So when you are making offers on homes, especially in todays competitive environment, an offer that is subject to obtaining financing is less attractive than an “all cash” offer. This can result in some lost deals on the most in demand property.
Special Notes for Canadian Landlords:
*Important to note: Consult your tax adviser if you are purchasing a property you will be using yourself (2nd home or vacation rental you will use on occasion) You may not be able to deduct the interest expense or only partial interest expense, if you use the home personally.
**ALWAYS consult your cross-border tax adviser for confirmation this applies to your tax situation.