The Bank of Canada predicted that mortgage arrears would peak at 0.5% in Q2-2021, and although inauspicious, it presents a win-win opportunity for investors to step in and help struggling families remain in their homes.
Buying foreclosed homes is typically associated with the United States, notably during the Great Recession, but according to the Real Estate Investment Network’s (REIN) How to Avoid and Buy Foreclosures report, a more benevolent way of investing in these properties is through pre-foreclosures. Technically, one missed payment puts a mortgage in arrears, but a debt settlement plan is often the next course of action. Non-judicial pre-foreclosures are a way for investors to enter into agreements with borrowers in dire financial straits by fronting some capital and working out payment plans to avert actual foreclosures. A power of sale clause must be added to the mortgage agreement in case the lender needs to recover its investment.
“Financiers’ modus operandis are not to have the property back, so they want to work with the borrower to find a solution, and typically a borrower in default’s MO is to hold onto the property and create a plan to that end. It opens the door to creative solutions,” Jennifer Hunt, REIN’s vice-president of research, told CREW.
Not every borrower risking foreclosure wants to keep their property, though—in fact, Hunt says that, impelled by the COVID-19 pandemic, there’s a growing number of Canadians who are changing careers, and some would like to offload the debt burden of their homes—while others require hard money loans that the investor can register against the property for added security.
“Have a good conversation with that borrower and see if there’s an opportunity for an equity stake—provide capital and create a repayment plan, or a loan modification plan, and negotiate for a portion of that property,” said Hunt. “You could receive a percentage of home equity for that loan.”
REIN’s formula for markets in turmoil, which typically begin with a reduction in GDP, and for which the pandemic was the impetus, is 18-24 months, and that aligns with the Bank of Canada’s anticipation of arrears peaking next quarter. Unfortunately, that necessitates patience from the investor because it could take a while for appreciation to grow—REIN calculates appreciation using Canadian inflation, which is about 2-4%—however, paying down the mortgage is one way to get there faster.
“As most real estate investors know, the majority of the return on their investment is about paying down the interest and the principal on the mortgage,” said Hunt. “The tenant pays you and you pay the bank. You get your bank statement once a year that shows the paydown, and it’s an area where the investor is receiving their ROI.
“Most investors look for cash flow, but when you do the math, most people cannot live off of their cash flow because the margins in some markets are very, very tight. When you dig deeper into where the bulk of the benefits come from in real estate investing, it’s in mortgage buydown with both the principal and the interest.”
According to the REIN report, begin the process by securing a mortgage pre-approval letter and then begin the search, either by visiting targeted neighbourhoods, searching online, or making inquiries through a buyer’s agent. Ultimately, Hunt says the investor will have the most success finding a pre-foreclosure candidate through a referral source, like their own banking account manager or mortgage broker. If a home is listed on the MLS, it’s already in foreclosure and it could be too late for the struggling borrower.
Additionally, ensure there are neither existing financial obligations nor legal issues with the home, get a home inspection, and compare prices.
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