I can`t wrap my head around RRSP seconds...please help

[DarrylFlint]

HI ALL...I`ve been at this game for a while now and FINALLY it looks as though I am about to do my first RRSP 2nd deal. It seems relatively simple except that I think maybe I am missing one of the fundamentals somewhere. Please help me to understand.

For ease of math let`s assume that I will be borrowing $30K at 10% (not compounded) for 5 years. At the end of the term my lender will be getting $45K returned (30K + 3K(5 years). So far so good?

Now the question...where is this extra $15K coming from (refinance, sale, etc.)? Only putting 30K down on a property what is the likelihood that it will appreciate significantly to make this reasonable? This seems like it`s great for the lender of course, but it looks like now I will have to wait an additional 5 years to cash out?

Second question...what are the typical repayment schedules that investors are using right now? I know that some companies require the full amount of interest to be paid each year...but in the above example that $3000 owing each year is quite likely to destroy the positive cashflow and thus the whole reason for doing the deal in the first place. I understand some other companies don`t have minimum requirements, is this true? Is there a legal minimum that must be paid back each year? I think that it used to be 2% of the interest owing with a balloon at the end of the term? Does anyone know if this is still the case?

Thanks.

 

[MonteDobson]

QUOTE (DarrylFlint @ Sep 24 2009, 08:26 PM) HI ALL...I`ve been at this game for a while now and FINALLY it looks as though I am about to do my first RRSP 2nd deal. It seems relatively simple except that I think maybe I am missing one of the fundamentals somewhere. Please help me to understand.

For ease of math let`s assume that I will be borrowing $30K at 10% (not compounded) for 5 years. At the end of the term my lender will be getting $45K returned (30K + 3K(5 years). So far so good?

Now the question...where is this extra $15K coming from (refinance, sale, etc.)? Only putting 30K down on a property what is the likelihood that it will appreciate significantly to make this reasonable? This seems like it`s great for the lender of course, but it looks like now I will have to wait an additional 5 years to cash out?

Second question...what are the typical repayment schedules that investors are using right now? I know that some companies require the full amount of interest to be paid each year...but in the above example that $3000 owing each year is quite likely to destroy the positive cashflow and thus the whole reason for doing the deal in the first place. I understand some other companies don`t have minimum requirements, is this true? Is there a legal minimum that must be paid back each year? I think that it used to be 2% of the interest owing with a balloon at the end of the term? Does anyone know if this is still the case?

Thanks.
Hi Darryl,

The $15K is mortgage interest payable monthly, annually, balloon payment etc, or a combo of all these. It is whatever you negotiate with your private lender who holds this money in their RRSP. Whichever way it is strucured, it is due and payable based on the terms and conditions of the 2nd mortgage that you and your lender set up. If it is set up as a balloon payment at the end of the term, then you need to have a plan to pay it back (principal + interest) when the mortgage is due via sale of property, re-finance or perhaps your lender would choose to renew for a longer term.

For you it is more beneficial to have as little cash out of pocket on a monthly/annual basis to help your cashflow. Your lender will like to see cash coming into their account every month. So there is a trade off between interest rate and risk (ie. you make all payments up front = less risk and lower interest rate of say 6-8%, you accrue most of the interest until the end of the term = higher risk and higher interest rate of say 10-15%). Another factor in this equation is the LTV, which the risk/rate correlation is obvious. Most RRSP planholders such as Olympia Trust require that at least 1 interest payment be made per year at approx prime +1%. Our last deal we did 4% paid annually, plus the remaining 6% to accrue and due at the end of the term (ie 5 yrs).

Lastly, Be sure you are not leveraged too high. If the property won`t sustain the cashflow, or if you can`t make the money you borrow earn a return higher than the interest you are paying (ie. 12%), then I would question if it is worth it. The idea behind a 2nd mortgage is to pull your equity out to buy more property, however, you also need to be aware of the risk/rewards behind it.

If you have any further questions on this topic, feel free to contact me anytime.

 

[kboughen]

QUOTE (DarrylFlint @ Sep 24 2009, 10:26 PM) where is this extra $15K coming from (refinance, sale, etc.)
Here are some options that would allow you to payback the $45,000 ($30,000 + $15,000) in 3 years;

• Refinance this property
• Refinance a different property
• Sell this property
• Sell a different property
• Negotiate an extended Term with the existing RSP investorReplace the existing RSP investor with a new RSP investorPut an RSP second on a different propertyBring in a JV partner in on this property or a different propertyDip into your reserve fundSome combination of the above

 

[wgraham]

Good points by Kevin and Monty. I might add one more point. Seconds sound sexy and sophisticated to put a 2nd/VTB mortgage on a property but make sure you do the math comparison against a CMHC insured high ratio mortgage. Often, if you are putting a large second at a higher interest rate it is more economical to go with the CMHC option.

 

[DarrylFlint]

QUOTE (wgraham @ Sep 25 2009, 11:38 AM) Good points by Kevin and Monty. I might add one more point. Seconds sound sexy and sophisticated to put a 2nd/VTB mortgage on a property but make sure you do the math comparison against a CMHC insured high ratio mortgage. Often, if you are putting a large second at a higher interest rate it is more economical to go with the CMHC option.


These are some excellent solutions and definitely some great ideas to think about...my thanks to everyone.