Guarantor

A person who promises the lender she or he will repay a debt if the principal debtor defaults.

A guarantor will be requested if the clients who apply for a mortgage are unable to obtain financing by themselves. Circumstances where this could happen would include: insufficient employment history, poor history of debt repayment or un-confirmable income.

Just because someone is willing to be a guarantor does not mean the mortgage will automatically be approved. The guarantor becomes part of the mortgage application / approval process. The guarantor will have to disclose his or her assets & liabilities, income, and have a credit check done. The total ‘picture’ of all applicants is considered by the lender.

Once approved, the guarantor will have to sign the mortgage documents, showing his or her obligation to the lender. Before signing, the guarantor should obtain ‘independent legal advice.’ The guarantor should consult a lawyer who is not part of the real estate transaction, and who will explain to the guarantor exactly what his or her responsibilities will be should the primary debtor default on the mortgage.

A guarantee is a secondary obligation arising only on default by the primary debtor. A creditor (the lender) has no rights against the guarantor until the primary debtor defaults. However, as soon as the primary debtor defaults on even one payment, the lender may request payment from the guarantor. The lender does not have to notify the guarantor of the default before starting an action to enforce the guarantee.

Consequently, it is very important that you understand what you are signing if someone asks you to be a guarantor. Get legal advice from your own lawyer.

Assuming a mortgage

If the buyer of a property in Ontario takes over the conditions of the seller’s mortgage (the amount owing for the remaining term at the existing rate), this is called assumption of the mortgage.

As a BUYER, you need to look at this carefully. In some cases, it will work in your favour, especially if the high ratio insurance premium has already been paid.

The first thing you have to do is to find out the details of the mortgage you could be taking over – what is the amount of the mortgage remaining? What is the interest rate and when is the renewal date (the date the rate ends)? How much time is remaining in the amortization?

You need to make sure that the mortgage amount is enough for your needs and that the rate you are assuming is comparable to (or better than) current rates for the same length of time. You also need to consider the conditions of the mortgage contract – you may find it contains conditions you don’t like.

If interest rates have been going up, then assuming a mortgage could be very much in your favour.

However, if rates have been stable, or going down, you will probably get a better mortgage by going to your mortgage broker and applying for a new mortgage.

All of the major lending institutions insist on the purchaser qualifying for the assumable mortgage, so if you would not normally qualify for a mortgage, you will not qualify to assume a mortgage either.

If you are SELLING your property in Ontario, and you have a good interest rate, you should first look into using any portability option offered by your lending institution. Usually you must be purchasing a new home at the same time as selling the old home, and you still need a mortgage.

However, there are two main reasons for letting someone assume your mortgage in Ontario:

  1. If the real estate market is depressed in Ontario and you have a good interest rate on your mortgage, an assumable mortgage may help you to attract potential purchasers.
  2. If someone assumes your mortgage (the whole amount) your lending institution should not charge you any penalty.

If you are selling your property and your lending institution does NOT insist on the buyer qualifying for your mortgage, the most important thing to check is whether you will be released from that mortgage! If not, you could still be liable for the debt even though you have sold the property!

Amortization vs Term

Amortization

This is the length of time it would take to pay off the mortgage assuming:

  • that the interest rate never changed
  • all payments were made on time
  • no additional payments were made

In Canada the shortest amortization is usually 5 years, and the longest is 40 years. Currently very few lenders will agree to an amortization longer than 35 years. It is to your advantage to choose the shortest amortization that you can afford. This will save you thousands of dollars in interest in the long run. The table below shows how much interest is paid (over the whole amortization period) on a $100,000 mortgage at an interest rate of 7%.

mortgage amountamortizationmonthly paymentinterest paid
$100,00015 years$893.25$60,784.80
$100,00020 years$769.31$84,634.64
$100,00025 years$700.42$110,122.72
$100,00030 years$658.60$137,099.74
$100,00035 years$631.86$165,386.56

You can also reduce your amortization (and therefore the amount of interest you pay) by doing any of the following:

  • Increasing the frequency of your payments
  • Increasing the amount of your payments
  • Paying additional amounts on your payment dates
  • Making lump sum payments
  • Selecting a shorter amortization at renewal time

Term

The amortization of a mortgage is made up of smaller time periods called ‘terms’. A term can be anywhere from 3 months to 25 years. The term is the period of time that you will pay a set interest rate. At the end of the term, you will renew your mortgage for a new term at the prevailing rates of interest.

Generally speaking, the longer the term, the higher the interest rate will be. For example, a 3 year term could be at 6.60%, a 5 year term at 6.75%, and a 10 year term at 7.05%. You are guaranteed that your payments will not change for the length of the term. Let’s use our $100,000 mortgage as an example again: (assuming a 25 year amortization)

Mortgage AmountTermInterest RateMonthly Payment
$100,0003 year6.60%$675.90
$100,0005 year6.75%$685.05
$100,00010 year7.05%$703.51

As you can see, in this example it is just over $25 per month more to guarantee the interest rate for an extra 7 years! No one can predict interest rates in the future, and many people prefer the security of longer terms. Discuss which is the best term for your circumstances with your mortgage broker.

5 Things you need to know about cap rates and multiples in valuations

By JT Dhoot

The term cap rate or multiple (or some variation thereof) will sound familiar to anyone who’s tried to value a commercial property or a private business. Stakeholders such as investors, brokers, lenders and appraisers often use these seemingly simple metrics to calculate the market value of an asset. Here are five things you need to know about cap rates and multiples.

The annual cash flow (or some other measure of economic benefit) of an asset can be divided by a cap rate or multiplied by its equivalent multiple. The resulting value will be the same, as shown below.

Value = Annual Cash Flow / Cap Rate = $50,000 / 5.0% = $1,000,000

Value = Annual Cash Flow x Multiple = $50,000 x 20 = $1,000,000

2. Cap rates and multiples are used to convert a single period of economic benefit into value.

The “economic benefit” is typically expressed as an annual amount and although cash flow is preferred, practitioners can also use other metrics such as revenue, earnings before interest and tax (EBIT); earnings before interest, tax, depreciation and amortization (EBITDA); and/or net operating income (NOI), to name a few. In the end, how the cash flow is calculated determines the characteristics of the resulting value (enterprise value, equity value, terminal value). In other words, capitalizing (dividing) or multiplying the annual cash flow of an asset will produce an estimate of value but understanding how that cash flow estimate was derived (before debt vs. after debt, before tax vs. after tax, Year 1 vs. Year 5, TTM actual vs. normalized pro forma) is of critical importance. The cap rate (or multiple) is inseparably linked to the economic benefit to which it is applied, meaning that estimating one in isolation of the other can result in a misleading estimate of value.

3. Cap rates and multiples assume the economic benefit will continue in perpetuity.

Using our earlier example, purchasing an asset for $1,000,000 at a 5 per cent cap rate implies the purchaser will receive $50,000 in the current year and all future years – or does it? Implicit in the cap rate (or multiple) is a growth rate, meaning the investor would expect the $50,000 to grow at a constant rate of x per cent in perpetuity. This is similar to the valuation of a stock using the Gordon Growth Model, also known as the Dividend Growth Model.

4. Cap rates and multiples reflect the perceived risks associated with the underlying cash flow.

All else equal, greater perceived risk means a higher cap rate (lower multiple), which ultimately results in a lower valuation. Let’s look at two potential investment opportunities:

Should you apply the same cap rate (or multiple) to Investment A as Investment B? No, although each investment generates $50,000 in cash flow.  Investment B has more risk even though it has similar growth prospects. In other words, a prudent investor would choose the less risky option (Investment A) over the riskier option (Investment B) if the investor was paying the same price in either situation. Alternatively, the investor would pay less for the risker option (Investment B) by using a higher cap rate in his/her valuation.

5. Cap rates (and multiples) do not distinguish between return ofcapital and return on capital.

Assuming the cap rate used in the acquisition of an asset will equal the investors return on investment is almost always incorrect (more on this in another article). In real life, cash flows and values rarely increase at a constant rate…investors use varying degrees of financial leverage (debt), and taxes can have a material impact on how much cash the investor is left with in his or her pocket at the end of the day.

Summary

Cap rates and multiples are easy to use but as they say, “The devil is in the details”. While some investors focus solely on the cap rate (or multiple) when evaluating investment opportunities, sophisticated investors understand these metrics are only a starting point. Is purchasing a property at a 5 per cent cap rate or acquiring a business at a 4.0x multiple a good deal? As with most things in life, it depends.

Tags: Cap rate,commercial lending, valuations, commercial mortgage

Credit Score TidBit

Here’s a tidbit of info for those that don’t know. Have you ever had a client tell you that their credit score was good because they just pulled it through Equifax’s consumer platform, only to pull a report yourself and see it way lower than your client thought? This is because the consumer is seeing their “Credit score,” and we are seeing their “Beacon score.” Seeing as they likely won’t know what the difference is, here are a few specific differences between the two:

1. The Beacon score is specific to the mortgage industry and the factors there within / The Credit score is more broad and includes predicted habits in all areas of credit.

2. Beacon looks at one’s past 24 months of reporting / Credit looks only 6 months back.

3. Beacon only recognizes a trade line as an influence after 3 months of reporting / Credit recognizes trade lines after first report.

4. Beacon predicts potential delinquency within the next 2yrs / Credit predicts within the next 1yr.

These are the reasons why Credit scores are generally higher than Beacon scores. Consumers can obtain their Beacon score but I believe it is an extra $30 or so. I’m sure we can all remember multiple times a client has said that their score is great, only to hear us tell them it actually isn’t.