Talking to old timers I often hear stories about interest rates in the 70’s and 80’s.
“I bought my place in 1985, for $75,000 we were paying 10% back then and that was a great rate…”
The worst Christmas present we ever got in Canada was an investment crushing 21% in December 1979.
I’ve had my share of horrible rates. Being an expat investing into Canada made financing a very small pool full of high rate sharks. Our worst rate was 8% on a first mortgage and 13.5% on a second. I know second mortgage rates are higher but it still doesn’t make me happy to pay them.
“Lying in a hospital bed with a broken leg and knowing that the guy next to you just had his leg amputated doesn’t make your ankle hurt any less…” Dr. Phil McGraw
Interest rates significantly affect the cash flow a property produces. The lower your mortgage payment and ALL other expenses, the more money you have coming into your bank account/wallet every month. The less you pay in interest and the more on principal guarantees that future sale-day pay-off is bigger as well.
If you buy your property for cash flow and equity then take appreciation as a welcome bonus you can offset the losses in paper assets. Soon enough the market will see appreciation again then you will get all three profit points.
Buying with a low interest rate can be a double-edged sword to a newbie investor. Rates go up which means you must “stress test” your property at higher rates. Run your property numbers at rates from low to high go up to 7 or 8% (or whatever rate seems outrageously high when you are reading this).
How does your property fare at the higher end? There will be a point where you don’t cash flow anymore but it shouldn’t be one point over where you are now. You should have a 3% range for safety.
How do you protect yourself against soaring rates?
- Reserve Fund - Keep a minimum 3 months reserve fund in your property account. As your reserve fund decreases replenish the balance before taking cash flow.
- Lock in - If you’re in a variable rate then be prepared to lock in when rates seem ready to rise. Get the lowest rate and longest term you can factor in a potential sale date. If your intention is to sell in 6 months, then riding the variable may make more sense.
- Pay more than your current rate – If you current rate is 3% then pay 5% when the rates increase it won’t be as painful. This does decrease cash flow but will pay your principal down nicely.
Market timing is for speculators. When you buy a quality piece of real estate your profit begins from day one. You’re not trying to time the market but you have an asset where tenants are paying down the mortgage and giving you passive income.