A few years ago we were on the hunt for a larger residential property to add to our portfolio. One of our colleagues put us in touch with a Realtor who was supposedly the go-to person in this sphere of real estate investing.

We had a long conversation about what we were looking for: the type of building, the location, the unit mix and the demographic that we were targeting. Everyone appeared to be on the same page.

Before long, potential properties started to come across our desk. They fit our requirements perfectly except for one point: They all had negative cash flow once financing, maintenance and repairs were taken into consideration. In some instances the rents could be raised over time while in other cases the utilities could be stripped out, but the end result was nonetheless negative cash flow.

We explained our problem to the Realtor: There’s no positive cash flow. We can’t buy these properties.

The Realtor’s response: “These are great buildings. They are in terrific locations and will appreciate beautifully over time. You will do very well with these properties.”

To which we said, “That’s great, but where is the cash flow in the meantime? The shortages will come straight out of our pocket.”

Realtor: “It will all work out in the end. Expecting positive cash flow from these areas in this market is unrealistic.”

We quietly parted ways.

Real estate investing is not like a fairy tale. Everything does not always work out in the end with happy investors riding off into the sunset.

People lose money, lots of it, because they don’t pay attention to the fundamentals of investing wisely. Positive cash flow isn’t just nice, it’s crucial. In fact, cash flow is very much like oxygen: Without it you have a big problem.

If you’re buying real estate banking solely on appreciation you’re playing a gambling game.

It’s great if it works out the way you hope it will with values continuing to rise at a steady pace. But what if they don’t? What if they flat line or worse, decline? What’s your plan then?

If you have a property that generates positive cash flow month in, month out, you will not panic if the value dips for a short while or even a long while. With every single rent payment the tenants are paying down your mortgage and you get some extra cash in your pocket after all the bills are paid. You now have passive income!

Real Life Example

In 2006 the Alberta market was on fire. Multiple offers were the norm and many buyers were placing unconditional offers (i.e. no inspection and no financing clause) just to be able to secure properties. Values were increasing rapidly and anyone who had property there was enjoying a wild ride up.

Then the financial crisis hit in October of 2008. Over the next year, values would plummet by as much as 25% in some cases. People who had just bought properties now owed more on their mortgage than the value of their unit. While this is certainly not a good situation, it’s not critical either if the units in question are cash flow positive. You guessed it though: People bought into the hype and bought cash flow negative properties in the hopes that they could cash in on the appreciation gain. When the crisis ruined the party, you know what hit the fan.

How do we know this? We own several units in Edmonton and our property manager has told us stories of owners who just walked away from their properties because they either couldn’t afford them or couldn’t refinance them due to the significant drop in values.

If you think that this is something that can’t or won’t hit closer to home, think again.

It’s true that Ottawa isn’t the “wild west” and our market has been much more stable. We are also not facing a bubble situation akin to the one in Vancouver or parts of Toronto. And yet we have seen a loss in values in some pretty surprising areas of Ottawa in the last year.

One of our clients recently found a home in Barrhaven that he wanted to purchase. The house is in a growing, popular part of Barrhaven so we thought that it would be fine. When we pulled up the stats for the area we found that there had been a small loss in value in 2012; 2013 pretty much flat-lined there. Our client turned his attention to Morgan’s Grant and found another potential home. Once again the local stats revealed a loss in value in 2013; this time the drop was significant. We have since discussed this with a Realtor we trust and there are certainly nuances to the statistics. But the fact remains that there has not been good growth in that area and some properties have shown a significant loss in value over the last twelve months.

Does this mean that the two areas we’ve just mentioned are not good areas in which to buy a home? Absolutely not. It does however point to the fact that markets are affected by many factors, some of which are unpredictable. Enjoy the ride up when it happens, but don’t count on it.

What about Rent to Own?

If counting on equity appreciation for your profits is problematic, does that mean that Rent to Own deals are inherently risky since they rely heavily on appreciation for their returns? Yes and no.

Rent to Own deals typically have short, fixed terms. If you have a 2 year deal and one of those years suffers from negative growth, you have a potential problem and your returns will suffer. It boils down to two key factors: First, do you have positive cash flow? Second, did you use reasonable, conservative appreciation rates?

If you have positive cash flow, you can ride out any market storm. Buy-out agreements mean that you do not have to sell at a loss; you can wait for the market to turn around. In the worst case scenario, it may take a while but in the meantime your costs will be covered, you will still be earning cash and the mortgage is being paid down. Will you make as much money as you had projected? No you won’t. But if the worst case scenario is a small profit, that’s not a tragedy. Will the tenant buyers be happy about having to wait longer to buy? Of course not, but no one is happy in a bad market. The goal is to put a Plan B in place that minimizes the downside.

As for the appreciation estimates, if they’re unreasonably high then you have little hope of getting those inflated values in a reasonable period of time. The tenant buyers will be frustrated (or furious) – as they should be – and the people who put the deal together in the first place will lose credibility. Keep the increases reasonable and find a good, stable location to minimize the risk.

Here are our rules when considering another property for our portfolio, whether it’s a Rent to Own property or a buy and hold:

1. Strong positive cash flow is required. This is not negotiable. Ever.

2. Location, location, location. Buy in an area with strong economic fundamentals.

3. Expect conservative appreciation rates in a good area but it’s not a tragedy if it doesn’t happen.

If however you have super deep pockets and you don’t mind speculating then go ahead and buy solely for appreciation. The people who indulge in these kinds of investments are the ones who are looking for excitement and thrills from their portfolio.

If we want thrills, we ride a roller coaster. When it comes to real estate investing, we’re with Don Campbell: Boring is good.

Imagine that you find a 4-season property on a premium lot in a sought-after cottage location at a significant discount below market value because the owners live out of the country and they’re desperate to sell for personal reasons. MPAC has valued the property at more than $200,000 above the asking price. Comparable properties peg the market value at, conservatively, $50,000 – $100,000 higher than the asking price.

You go in with a low-ball offer and to your surprise the vendors sign it back without even countering. How often does that happen? If you guessed once in a blue moon you’d be right. So you’re thrilled by the opportunity. You have the place inspected and apart from the usual list of little items that could use some attention at some point – though nothing is pressing – you’ve got a great place on your hands. The major elements are sound, the upgrades are lovely and the whole thing is in good shape. So far so good.

Enter the lenders

The lender asks for the usual forty pounds of paperwork to prove that you earn what you need to and that you don’t owe too much, but that isn’t a problem because you’re in great shape financially and everything is in order. The lender comes back with a mortgage commitment for a 2 year term – can’t beat that rate – and a 30 year amortization. You’ve asked for the 30 year amortization because this is going to be a rental property and you want to minimize the monthly costs. You’ve crunched your numbers and the 30 year amortization gives you a good positive cash flow buffer.

You supply all the documents as requested and the lender confirms that they are just waiting for the appraisal in order for them to declare that your file is complete. No problem; you expect this.

It’s what happens next that throws you for a loop: One week prior to the closing date, the mortgage agent emails to say that you need to come in and sign another mortgage commitment because the lender “had to make some changes”: They are withdrawing the 30 year amortization and changing it to 25 years. Apparently the appraiser came back with a report saying that the subject property has an economic life of 25 years. Your lawyer suggests that the appraiser expected you to have a 25 year amortization and therefore chose that as the magic number for the economic life of the property.

What about the commitment?

But wait a minute, you have a commitment right? You call your lawyer to discuss this. How can they just change the rules one week before closing? The lender has had the appraisal for more than one month and now one week before the closing they decide that the information poses a problem? Plus, this is a two year term. The property clearly isn’t going to fall down in two years. There is no clear or obvious reason why the amortization needs to change. And back to the fact that you have a commitment – can they just change their mind like that?

As it turns out, yes they can. Because every single lender has a back-out-of-it clause somewhere in the commitment, or they refer to clauses listed on their website that state that they can change their mind at their discretion whenever they like.

In a Crocodile Dundee moment akin to “You call that a knife? That’s not a knife, this is a knife!” your lawyer tells you the story of a client who discovered on the day of closing that the lender had changed its mind and would not be funding the deal. Apparently they decided that the client was too risky, and they figured that out on the day of closing.

-So why do they call it a Commitment then if they can change whatever they like whenever they like at their sole discretion? That’s hardly a commitment.

-I have no idea but it happens more often than you might think.

And there you have it. When you obtain a mortgage commitment from a lender, think of it more as a Mortgage Proposal in which they propose to fund your deal according to certain parameters but as in any proposal things could change. If they pull your credit bureau report on the day of closing and they don’t like what they see, you may be in trouble. Or, as in our case, if the appraiser decides that the property has 25 years of economic life left rather than 30 years, the amount you have to pay every month will go up.

Bear that in mind the next time that you get a mortgage commitment. You will know that it’s a true commitment when the funds have been disbursed on closing day. Until then, keep your fingers crossed and be sure to have a Plan B in place.

Do you have a story about dealing with lenders? If so we’d love to hear it. Please share below.

When I first began to invest in real estate, I found a triplex that had been converted from a single family residence. The individual units were painted with at least six different paint colours. Think fluorescent, cheap and nasty!

In the main floor unit there were eight colours in the kitchen alone. And no, they didn’t match. Any of them. Needless to say, the vendor wasn’t getting much action on the property so I was able to get it for a great price. He tried to haggle a bit initially but in the end he realized that I was probably his best shot at a sale since I didn’t appear to be phased by his taste in paint. He relented.

From my perspective, I thought his paint job was a huge bonus. It scared other investors away – you know, the ones who like more conventional, pretty buildings – and I figured that I could easily fix an ugly paint job and flooring. I spent the next month renovating the interior to great effect. The problem, however, was that the place was also unattractive on the outside.

What’s the old saying, “An ugly house with a new paint job is still an ugly house”? After some reasonably simple renovations I made the inside of the place look good, but there was little to be done about the dismal exterior short of spending a fortune. That’s when I discovered some research through the Real Estate Investment Network: The #1 factor that influences potential tenants is not price but rather curb appeal.

If the place doesn’t look appealing from the outside, potential tenants will just keep on driving when they get there to take a look. Posting pretty pictures of the inside will help, but you still have to get them to walk inside. That’s not so easy if their first impression as they pull up is that the building is ugly.

The lesson

Do yourself a big favour: Ensure that any building you buy has reasonable curb appeal. Imagine that you’re a tenant driving by. What would you think of the place? Will you care that the inside is attractive if the exterior is off-putting? Probably not. It’s much harder to find good tenants for an ugly building.

Yes you can put in a bunch of attractive plants, do some landscaping, perk up the tired paint job and perhaps update the door, but the fact remains that an ugly building may  remain ugly despite your efforts. Even if you can make the changes necessary, do you want the hassles and the cost?

Patience is a virtue. Wait for the right property with reasonable curb appeal.

Check out the neighbours

In 1991 my husband and I went looking for a house in the west end of the city. If you remember those days, you’ll recall that houses sold in a matter of hours, particularly houses that were located in sought-after parts of the city. We found a house in an area that was growing rapidly. The house looked decent from the outside and met all of our check-list requirements on the inside. The only possible problem we spotted was the location.

The house backed onto a row of businesses that were zoned light industrial. Among them was a hot tub store, a mechanic’s shop and a stone mason. The day that we viewed the house, around 2 pm on a sunny July day, the stores appeared to be deserted. There wasn’t a sign of movement in their respective yards, each of which could be seen by the rear upstairs windows.

The vendor and his wife were in the house when we did our viewing, a fact which irritated our Realtor. The guy kept following us around the rooms, ‘helpfully’ pointing out the various features and upgrades he had made to the house in the years he had been there. I figured if he was going to be a nuisance and hang around, I would ask him a few questions.

– I see that your house backs onto a few businesses. Do you ever have any problems with noise or dust?

– Not at all. We hardly ever see them. The stone mason occasionally has trucks backing up to his doors but beyond that nothing really. It’s never been an issue.

– Do they ever leave their doors open?

– Oh sure but it’s never an issue. See how quiet it is right now? It’s pretty much like that all the time.

The guy was a Type A pain for following us around until our Realtor pulled him aside and asked him to leave so that we could view the property in private, but he seemed like a genuine fellow and his wife was very nice so we never suspected him of lying. When we had finished viewing the house his wife offered us a cup of coffee and said that they would be happy to answer any questions we had. We sat down at their kitchen table and I asked about the basement.

– Have you ever had any problems with water down there?

– Not a drop. That’s why we put carpet down.

Nine hours later we owned the house. We took possession in August and I proceeded to take some time off to paint the house. In early September, I tackled one of the upstairs bedrooms that overlooked the stone mason. It was a lovely, breezy day so I had all the windows opened. I painted one wall and then went into another room to wash my hands and reload the paint. Just as I was pouring the paint, I heard an ear-splitting, high-pitched wailing sound start up. That was my introduction to stone cutting.

Hello noise

By the time I figured out what was happening, the stone dust from the cutting operation that was taking place just outside my back yard had wafted into my house and covered my newly painted wall. That was just the beginning of the fun. The mason had just landed a very large contract and all of the stone for the project was being cut behind my back yard. The wailing sound continued every day for hours. In the evening, the mechanic’s shop would start up with the pneumatic drill. It turns out that they only closed their doors on very cold and very hot days. The rest of the time the door was open, and they seemed to do most of their business between 5 pm and 10 pm.

When I had my first child, she would often be awakened by the sound of a pneumatic drill at 10 o’clock at night. Complaints to the city went unanswered because the business was operating within its rights. Too bad for us.

So here’s what I’ve learned: Before you consider purchasing a property, look around for any negative site influences. Take the time to look and listen on different days and times. What’s the traffic like in the morning? At night? What noise is there and where is it coming from? If, as was the case in my situation, there are businesses nearby, you definitely want to do your homework very carefully. Businesses won’t necessarily care about your peaceful enjoyment of the property. They have a business to run and you may be in for many frustrations if you don’t know what you’re facing from the outset. This is a case of setting expectations for yourself.

If you don’t have the luxury of time, then see if you can speak to the neighbours. Knock on doors yourself and have a chat with them about the area: What do they like and what bugs them? When you ask people for their opinion you usually get an earful! Whatever you do, disregard anything the vendor has to say. This person has a house to sell. He may be as honest as the day is long, or not. The point is you don’t know and since he has a vested interest in selling the property his opinion is not reliable.

As for my basement, what do you think happened? You guessed it: Water everywhere when there was a month of heavy rain. When we ripped off the drywall to see if we could find cracks, we instead found a hole in the concrete that Mr. Reliable had simply parged over.  When the house was built there was apparently supposed to be a beam going into the concrete at that particular spot. For whatever reason no beam went into the slot and instead of filling it up properly, our friend left the hole as-is with a think coat of parging on the outside and drywall on the inside.

Never trust a vendor.

In late 2006, when one of my three-bedroom units became available, I received an application from a single mom with two young children. She had terrible credit, questionable references and a history of moving from place to place. She also spun a good tale about how she was working hard to try to make a life for herself and her boys but she faced so many barriers. She had recently landed a good job and she was determined to finally settle down for her kids’ sake. Since her background was so spotty, her parents were willing to co-sign the lease as added security for me.

At the time I had a three year old daughter and I was five months pregnant with my second child. My head told me in no uncertain terms to walk away from this woman, but my “mom heartstrings” kicked in to override all rational concerns. Everyone deserves a break, right? Surely I could do my bit to help out a fellow mom raising her kids alone. Those poor boys had endured so much already. Could I really turn them away? After all, the parents were co-signing. Surely everything would work out well since there was a back-up plan in case this woman, whom we’ll call Amy (not her real name), didn’t live up to her promises.

Amy was effusive in her gratitude. Finally someone was giving her a chance and thank you so much. Yes of course she would maintain the yard, to which she had exclusive access, and meet all other requirements. No problem.

The problems start

One month into her lease she stopped paying the rent. Then I got a call from the police: Her boyfriend (what boyfriend?!) had pulled a gun on the garbage collector because he was asked to move his car which was blocking access to the driveway. The boyfriend apparently fled and was now on the police’s wanted list.

A meeting with the police also revealed that they had been watching my building because they suspected that Amy was selling drugs.

At this point a few months had gone by and I had served the tenant with the proper notices stating she had to pay up or be evicted. I heard nothing. Every time I drove by the curtains were drawn and there was no sign of life. I finally left a notice taped to the door stating that I would be entering the next day to inspect the unit.

When I showed up the note was still taped to the door. I knocked and rang the door bell. Nothing. When I unlocked the door and and began to open it, her two large dogs lunged at me, growling and baring their teeth. I just managed to get the door shut in time to avoid the dogs. At this point I was eight months pregnant so moving with speed wasn’t always easy. The dogs continued to throw themselves at the door. I was petrified.

I called the Humane Society and waited in my car for them to arrive. I also called a large friend who graciously came out immediately to be with me as I entered the premises. The Humane Society staff managed to subdue and remove the dogs, photograph the environment and take a statement from me. Then I was allowed into the unit. What my friend and I saw when we finally gained access was shocking.

Abandoned dogs

The tenant had clearly left in a hurry with her boys, abandoning her two dogs in the apartment. She had left large bags of food on the floor of the kitchen and the basement. A raised toilet seat was their only source of water. At a guess, the dogs had been alone in the apartment for roughly three weeks. They appeared to be physically fine, but they were not very happy.

When the Humane Society workers removed the animals, we were left with a shattered unit: dog feces everywhere; chewed wood and claw marks on most of the door frames and doors; children’s clothes, toys and sports equipment scattered about; a fridge full of rotting food; and more junk than I have ever seen strewn on every surface both inside and out. I can remember needing to sit down from the shock of it all but not daring to touch any surface. Every square inch was disgusting.

When we turned to the parents for help, we discovered that they are mentally disabled and while their credit was good, they were essentially penniless. What little money they did have their daughter stole from them on her way out of town. It was a tragic situation in every conceivable way.

That mistake cost us more than twelve thousand dollars and a lot of heartache. This is how I spent the first few months of my youngest daughter’s life. And all because I let emotions guide my decision-making at the outset.

I learned a very hard lesson in 2006: As a landlord you have a responsibility first and foremost to protect yourself. By all means engage in charity work outside of real estate – donate your time, knowledge and money to worthy causes. But remember that investing is a business. It requires a rational analysis of the facts and the numbers. Treat every aspect of investing like a business. Renting a unit is not the time or the place for charity work.

If warning bells go off in your head as you’re making a real estate-related decision, do yourself a big favour and listen.

When you buy an investment property you know perfectly well that there are a lot of zeros on the line and therefore you do your homework, dot the “i’s” and cross the “t’s” before moving forward. And yet despite this we all still manage to learn many lessons, big and small.

Here are the first two in our series of lessons learned the hard way.

Lesson #1: What do you do with the snow?

Early in our investing career, we purchased a triplex in the spring after all the snow had disappeared. Naturally we thought about the grass and external maintenance but we didn’t stop to think about the mechanics of what would happen when the snow fell.

This property had a long, single lane driveway that could fit three cars. The back yard was fenced and the other side of the driveway was entirely fenced along the neighbour’s property. That meant that the only real opening was the front yard. We knew that the yard had lots of space for snow, but we hadn’t thought about the fact that we would have to move snow roughly 2/3 of the driveway from the back to the front.

After a particularly heavy snowfall the job was nearly unmanageable as the snow banks lining the front yard were huge. If cars were parked in the driveway you could hardly move around the vehicles and all the snow.

At first we tried to take care of the shovelling ourselves but we quickly figured out that this was madness. To make matters worse, we couldn’t hire a service since our tenants had to park in the driveway and their cars would be in the way. You can’t park on the street after a heavy snowfall because the City needs to send the plows through. We eventually hired a teenager to shovel around the cars every time it snowed, which wasn’t an ideal solution for tenants who had to leave very early in the morning.

These days, when we buy, we immediately ask ourselves two key questions: Where will the snow go and how will it get there? If the deal doesn’t have enough cash flow to have someone else deal with the snow, or if the property won’t allow easy access for snow removal equipment we don’t proceed.

Lesson #2: Buy purpose built

The triplex mentioned above was a converted house. The changes had been cleverly executed to yield three good units, however we discovered some of the problems inherent in such conversions, particularly with the wiring.

The wiring in the place was quite dated so we hired an electrician to come in and clean things up. He discovered a couple of switches in one unit that didn’t seem to turn anything on, and he couldn’t find the switch that regulated one of the outdoor lights. So he went digging.

What he found, after much sleuthing, was a mess. The people who initially converted the house into three units hadn’t spent much time worrying about ensuring that each unit’s electrical circuits were independent. It turns out that Unit #1 had a light switch for Unit #2. Unit #3 had the switch that regulated an outdoor light, so they were paying to keep the outdoors safe for all three units. The list of problems went on and on.

The story was the same when it came to plumbing.

After that whole fiasco I vowed that I would never again buy a converted property unless I was the one doing the conversion. Don’t buy someone else’s mess! When you buy a purpose-built property, things should be done correctly from the outset with a separate set of circuits for common areas.

We will be sharing many more lessons in the coming weeks. In the meantime, if you have a story please share it below. The more we share, the more we can learn from each other.

Speaking of learning, we have a workshop coming up on September 19th: How to Read Credit Bureau Reports, Spot Problems and Fix them”. Look for the Early Bird discount.

To your success!

The answer to the above questions is an emphatic NO! However, Rent to Own does attract more than its fair share of bad operators. Investors, like tenant-buyers, need to do their homework before entering into a deal. That’s true of Rent to Own and it’s also true of any real estate investment. When there are that many zeros involved in an investment, you need to do your due diligence properly.

But where do you start? How do you know what to look for? Unless you’re a savvy investor who has been around for a long time and done numerous deals, do you really know how to do your due diligence?

The purpose of this blog post is first and foremost to arm investors with the information that they need in order to evaluate rent to own deals and companies before investing. Rent to Own can be a very powerful tool to grow your income in the short- to medium-term IF, and only if, the deal is put together properly from beginning to end. Every step is critical to ensure success at the end.

The following is a list of the 5 Key Factors you want to consider before becoming an investor and putting both your money and your credit on the line.

#1: Who is offering the deal and what is their reputation?

In my blog post aimed at Tenant Buyers, I began with the same question very simply because the people who put together the deal will determine whether or not it has a hope of succeeding at the end. I cannot emphasize enough how important it is to move beyond the smooth talk and the claims of the people putting out the deal. Because there is no professional oversight in this industry, anybody can claim to be a Rent to Own expert. They put up a website, call themselves the Leading Rent To Own Company in Ottawa and voilà, they’re a so-called pro. You need to dig beyond the surface to see if there is any substance to the claims being made.

Google is your friend here. Do a search on the company and the people behind it. If you find evidence of a complaint, that doesn’t necessarily mean that there is a problem but it should cause you to dig further. Another thing to consider is the way deals are presented: Does the RTO company sound desperate? Are they offering all sorts of incentives to get you to jump in?

For a full list of the things to consider, read my first post addressed to Tenant Buyers.

#2: Do the projected returns set off any alarm bells?

In an ideal world we would all love to earn 20%-30% on our money. Wouldn’t that be great? But ask yourself, how often do you see those kinds of returns in legitimate investments?

The higher the projected return, the more questions you should be asking and the more alarm bells should be ringing. If the returns go above 20% in today’s market of roughly 3% average appreciation, then ask yourself just exactly how you’re going to get those kinds of returns. Those numbers are simply not credible and a good spreadsheet will prove it.

In real estate, there are only three ways to make money: Appreciation, cash flow and mortgage pay down. The latter is fixed; it’s not something you can manipulate beyond choosing a longer or shorter amortization, and you don’t get much of it in a two or three year deal. However, appreciation and cash flow can be manipulated and they do make the biggest difference to the returns so let’s take a look at both.

APPRECIATION

The fastest way to make money in a Rent to Own deal is to crank up the appreciation rate. That gives you a higher house price at the end and pads your returns. There’s just one problem: If the final house price is unrealistic it will not appraise which then means that the lender won’t support the full value of the house. Guess who will have to pay the difference? The tenant-buyer. Do they have the extra money kicking around to make that happen? No. Will they be happy with that outcome? Absolutely not. They’ll be furious, as they should be.

It is completely unethical to set up a deal with a buy-out price that has little hope of going through. These kinds of deals rob the tenant buyers of their deposits plus accrued option credits and they leave the investors in a difficult position: They now have to sell the house for a lot less money than they were anticipating. They will incur Realtors’ fees to get the job done which will further lower their returns. Add to that some repair costs to ready the house for sale and the result is a big financial mess.

So when you’re evaluating a deal, look for the appreciation rates used to determine the final value of the house. Then call a Realtor and ask for the last five years’ worth of stats for that particular house type in that specific real estate zone. Have a look at the Year-to-Date stats for the same house type and zone. Are the projected appreciation rates in line with the stats? If not, walk away.

MONTHLY CASH FLOW

The second best way to make money in a Rent to Own deal is to cram in as much positive cash flow as possible. While it’s true that you shouldn’t buy a property that has negative cash flow unless you’re certain that you can turn it around very quickly, it’s also true that the monthly costs for the tenant buyers have to be fair and sustainable.

We have seen deals where the monthly cost was determined by using a multiplier. That is, you take the purchase price of the house and you multiply it by a number (the latter varies by the company) and out comes the monthly cost.

The problem with this type of approach is that the monthly amount is not justifiable beyond saying “that’s just how we do it”. In order for the Rent to Own deal to be credible, the numbers have to be credible. What is the breakdown of costs: mortgage, property taxes and insurance? How did they calculate these numbers? Where is the positive cash flow coming from? Is the monthly rent (not including the savings portion) at least in line with the true costs of the house or local market rents? If not, why? Will the amount be a rip-off for the tenant buyer or is it justifiable in a credible way?

There shouldn’t be any magic multipliers or mystery numbers in Rent to Own. If you can’t understand the breakdown and it doesn’t make sense to you, then ask more questions and seek clarification. If, after you’ve tried that, it still doesn’t make sense then walk away. Don’t let a high monthly rent lure you into sweeping your concerns under the carpet.

It is worth remembering that real estate is a get rich slow approach. Greed gets people into trouble only 100% of the time. You don’t need to be greedy to succeed in Rent to Own. Leave money on the table for the Tenant Buyers. Ensure that they are happy and successful. The best way to succeed is to ensure other people’s success.

If the promises and the returns seems too good to be true, they probably are. Walk away and look for more reasonable returns. Solid, well-structured Rent to Own deals can yield 12%-16% in this market. Isn’t that better than what you’re getting with your stocks and mutual funds? You don’t need crazy numbers to do well.

#3: What do you know about the Tenant Buyers?

When a deal is pitched to you, here’s a good rule to bear in mind: If the package starts with a lovely description of the house and a line about how nice the Tenant Buyers are, run away!

The real asset in a Rent to Own deal is the Tenant Buyer. The house matters but not until you are sure you have the right candidates for the program. Look at it this way, if you have an ugly house but great Tenant Buyers, you still have a successful deal. Beautiful house but terrible Tenant Buyers? Big problem.

The deal begins and ends with the Tenant Buyers. One of the most important factors that a Rent to Own company should bring to the table is their ability to evaluate clients and to select those who have a very high likelihood of succeeding. Anyone can place an ad and get interested people, but it takes skill, knowledge and experience to be able to sift through all the applicants to find the people who have what it takes to succeed in a Rent to Own deal. Here are some questions to ask:

1. Does the RTO company know how to read and evaluate Credit Bureau reports? If they’re depending on an outside mortgage agent to do the heavy lifting, you’re hoping that the mortgage agent will be experienced enough to do the job well. We have worked with a lot of agents over the past four years and here’s the scoop: Rent to Own deals involve working with B files and not all mortgage agents are well-versed in this type of file. They may be the best in the business when working with A clients but knowing how to evaluate B files requires a different knowledge set. Consider also that if the RTO company doesn’t know how to fully read and pick through Credit reports they won’t be able to verify what the mortgage agent has told them. That’s a lot of risk considering what’s on the line. Do you really want to work with someone who doesn’t have a full understanding of where the clients are at and what it will take to get them mortgage-ready at the end?
2. What is the client’s credit history? Does their story fit with the story told by the Credit report? Knowing that someone has been through a bankruptcy is not enough. If they say that it’s because of a divorce, you need to know more: What are the specific circumstances that led to the financial difficulties? You need a lot of details before you can fully evaluate a story and a file.
3. How recent are the credit troubles? The more recent the difficulties, the less you know about the client’s commitment to fixing the problem. Bad things can happen to anyone, but in a Rent to Own scenario you need to know that the clients have turned a corner and that they are fixing the problems. What indication do you have that this is the case?
4. How much do they earn and can they prove it? There are a lot of situations in which people have cash-based or newly-established businesses. Or perhaps they work for someone on the side and get paid in cash. That’s fine, but if they want to qualify for a mortgage at the end of the term, you need to know that the income required to do the deal is provable and will be declared to CRA. You also want to ensure that the deal doesn’t rely on increases in income. Just ask any government worker how secure those are. They’re great when they come through but you don’t want to bet the farm on them.
5. Are they using Child Tax Credits or the Universal Child Care Benefits to qualify? If so, will they still be in place when it’s time to get a mortgage and will the lender accept them as income? Do you really want to work with a file that relies on those credits to qualify?
6. How much have they been approved for and what are the TDS (Total Debt Service) and GDS (Gross Debt Service) ratios? If the TDS is above 40%, the clients will need a higher Beacon score. Will they realistically get there?
7. Has the RTO company put together a realistic credit improvement plan and what plans do they have to ensure that the clients are taking the necessary steps? Is the term appropriate?
8. Will the Tenant Buyers have enough savings at the end of the deal? If they are only saving 5% they will be missing the 1.5% closing costs that lenders look for. Ensure that the clients are saving at least 6.5% of the final purchase price.
9. What is the deposit? Is it high enough to provide reasonable security in the event that the Tenant-Buyers abandon the house in the early days? Anyone who has been a landlord knows that it doesn’t take much time to do thousands of dollars worth of damage, without mentioning the carrying costs for a vacant building.
10. Where are they looking to buy? Is it in an area that has strong, stable appreciation rates? Is the house decent enough that you can sell it quickly and easily if the Tenants-Buyers don’t honour their end of the deal? Is it a house type and a location that are in demand? If not, the risks go up. If you’re not sure about an area, talk to a couple of Realtors and get multiple opinions to ensure that you’re not getting biased feedback from someone who has a vested interest in the deal.

If you have any reservations about how well versed the RTO company is in any of the areas above, step back, ask more questions to ensure that you feel 100% certain before proceeding.

#4: How thorough is the spreadsheet?

All professional Rent to Own companies provide a spreadsheet with extensive financial information outlining the breakdown of costs and income. You need to ensure that all of the relevant information is there and that the projections are realistic, not optimistic. Let’s take a look at some of the most important items that should show up on a deal spreadsheet:

1. Today’s purchase price and the final purchase at the end of the term. What appreciation rate has been used? Is it credible based on local (current and past) statistics? See above for that discussion.
2. Financing. How much of the deal will be financed and at what rates? Will there be a second mortgage and what will this do to cash flow? If there is more than one mortgage, what is the final Loan to Value? If it goes above 90%, you’re taking on a huge amount of risk. As a second mortgage holder you’ve got more risk than the first mortgage holder in the first place. The higher the LTV, the less money there will be  to cover your investment if things go south and the house needs to be sold. Proceed very carefully with second mortgages.
3. What mortgage rate has been used and is it realistic? Remember that the property will be a rental and many lenders use higher rates for rentals. If a very low rate is quoted, ask who the lender will be and verify that the rate applies to rentals for the term in question. This is also true of insurance rates – they are typically higher for rentals.
4. Legal costs. This is one of the areas where we see the most optimistic projections. For a Rent to Own deal, you will have legal costs for the purchase (roughly $1,400 – $1,800 not including the Land Transfer Tax), costs for the sale (roughly $900 – $1,200) and a discharge fee for the mortgage at the end of the deal (roughly $250 – $400). If you do the math, that means that you will pay anywhere from $2,550 to $3,400 for a single deal. If there’s a second mortgage on the deal, you’ll have set up costs of roughly $1,000 plus another discharge fee at the end over and above the other fees. If the second mortgage comes from an RRSP, there will be a set up charge in the hundreds of dollars plus annual fees. You want to ensure that every cost has been properly accounted for because if not, you’ll need to dig into your pockets at the end and that may affect your ROI.
5. Appraisal and inspection costs. Who pays for those? Are the numbers realistic? In our experience appraisal fees range from $285 to $400, and inspection fees are around $400 plus tax.
6. Banking fees. Where will the rent money go and in whose name is the account? What are the fees for the account and do they come out of the deal? Who pays for the mortgage? Many lenders will no longer accept third party payments which means that investors must make the mortgage payments from their own accounts. How will this be dealt with within the deal? What about the insurance and property taxes?
7. Are the property taxes and insurance rates realistic? Has the RTO company accounted for increases in rates over the term? Property taxes rarely remain static and insurance rates always go up more than anyone would like. Has this been taken into consideration?
8. Is the RTO company charging any fees and if so, when do they collect them? If they ask for high fees up front, ask why? Set it up so that they win when you win.

#5: Is the documentation professional and thorough?

Real estate investing is not a place for sloppy bookkeeping habits and casual agreements. There is a lot of money on the line in any deal. To fully protect yourself, beyond doing the homework above you’ll want to ensure that every step of the deal is properly documented and that the agreements are professional. Refer to my article for Tenant-Buyers for a discussion of the three key documents.

For an investor, it really boils down to the following: What happens if the deal goes south for any reason? How are you protected? Are you on Title? What skin does the RTO company have in the game? Are they on the line and liable for the expenses as well? Who will sell the house and what will it cost? If a Realtor is involved then there will be fees. Who will provide the funds if repairs need to be made before the sale? Who will pay the carrying costs (i.e. the mortgage, property taxes, insurance, heating and electricity bills)? Who pays if the tenants stop paying the rent?

Even if the agreements are written in a way that you find easy to understand, have your lawyer review them. Ensure that all of your questions are answered. If you don’t like the answers you’re given by the RTO company, then don’t proceed. It’s better to pay a few dollars to avoid a bad deal than it is to save a few hundred dollars at the beginning and pay thousands later on.

This blog post is very long for a reason: There is a lot to think about before you do a Rent to Own deal. There are no short cuts to success. Rent to Own investments are an excellent way of getting solid returns and growing your savings when they’re done properly. These investments offer many advantages to investors, including reducing or eliminating tenant hassles. But again, the deals must be structured properly.

Do your due diligence. Ask questions until you have all the answers you need. If you’re not satisfied with a deal being offered then move on and keep looking. Professional, ethical companies with a good track record do exist and so do great deals.

We welcome your feedback. Please post your thoughts below.

There are unethical operators in any industry, but Rent to Own seems to have attracted more than its fair share. It deserves the skepticism that exists in the marketplace. What is going on and what can you do to protect yourself?

One of the big issues in the Rent to Own industry is the fact that there is no professional oversight so pretty much anyone can claim to be a Rent to Own expert and put together their own deals. A quick look at online ads will reveal a plethora of people offering them. They range from groups (with no individuals named) to investors to real estate professionals to companies from other cities. So how on earth can potential Tenant Buyers know what’s real or even know where to begin evaluating the list of possibilities?

The purpose of this blog post is to arm people considering Rent to Own deals with key questions that they should be asking before they consider signing any documents or handing over money.

Question #1: Who are these Rent to Own people and what is their reputation?

These days, anyone can put up a website and offer a product or service. But who are they really? How do you know that they are credible and legitimate? The first step in evaluating a Rent to Own deal is to look very carefully at the company and the people involved. Find out who owns the company and then do a Google search on them. Here are a few things to think about when looking into their background:

1. What qualifications do they have? Do they have the training and experience to know what they are doing?
2. How long have they been involved in Rent to Own? Real estate investing of any kind requires expertise, knowledge and preferably experience. Inexperience can be very costly.
3. Which professional organizations do they belong to? If they’re running a professional Rent to Own company then they will certainly belong to professional trade associations. Find out which and do a search within those organizations to see if there have been any issues.
4. Have they written anything substantive about Rent to Own via a blog or other articles? One way to evaluate the knowledge of a professional is to see what they’ve written on the subject. Ask the owner(s) for links to posts or articles and see what you think of their positions and the information they have shared.
5. What is their track record? Can you find any areas of concern?
6. Can they provide professional references? That is, real estate professionals or lawyers with whom they have worked who can vouch for their credibility? Give the references a call; they may offer more insight in person or by phone.
7. Have any of their deals not worked out and if so, why? Ask them about their track record. There are always challenges in real estate investing. If someone tells you that they have never had any issues either they haven’t been at it very long or they’re stretching the truth. Find out what the challenges have been and how they have resolved the problems. Anyone can look good when things are going well. It’s the challenges that tend to expose people’s true nature.
8. Have they published a list of testimonials from people and professionals who have used their services? If all they have is a list of testimonials from “clients” with only first names or initials provided, then you don’t have much to go on. It’s better if they can give you professionals to whom you can speak.

Question #2: What is the buy-out price at the end of the Rent to Own term?

We see this all the time: People are so focused on the monthly costs that they pay little attention to the buy-out price at the end of the Rent to Own deal. In a previous blog post, The #1 critical question when considering Rent to Own, we looked at why the final purchase price is so important in determining whether a deal is credible or not. If the value of the house is too high, you will be unable to get a mortgage for the full value because the appraised value will be lower than the purchase price. In most cases, that spells disaster for the Rent to Own deal since few Tenant Buyers have several thousand dollars kicking around to put into the purchase over and above their deposit.

Here’s an example using real numbers to illustrate. Let’s say that a Rent to Own company states that a house you’ve moved into will be worth $300,000 at the end of three years. Three years later you turn to the bank to get your own mortgage and they in turn have the house appraised. Unfortunately, the Rent to Own company used unrealistic appreciation rates and the value of the house is only $285,000. The bank will only lend on a house value of $285,000. The missing $15,000 will have to be made up by you. Would you have that extra cash to put toward the purchase? In our experience, RTO clients are dealing with a number of credit and cash challenges, and the last thing they have is a lot of spare money. If you don’t pay the full price, the RTO company may insist that your option to purchase is null and void and that means that you’ve lost most, if not all, of your deposit and accrued savings.

First, ask the RTO company what appreciation rates they’re using and then turn to a Realtor to see if they are realistic for the house type you’re looking at and the specific zone in which you’re considering buying. Don’t use averages; insist on getting specific numbers that reflect the house type and the location. The ideal scenario is to have an area and house type that show strong, stable appreciation for the last five years. The appreciation rates used by the RTO company should be both plausible and conservative.

Most of the profit in a RTO deal comes from the appreciation in the value of the house which is why this is the number one area where unscrupulous companies will try to cram in profits. Add to that the fact that many clients don’t really question the final purchase price and you have a recipe for problems. In Rent to Own, you really want to start with the end in mind: Is the house price realistic?

Finally, you need to ask one more important question: What if the house price is actually lower than the agreed-upon price, even if the latter is conservative and realistic? This is real estate after all. Prices don’t always go up. What then? What protections are in place for you in this scenario?

Question #3: Will you qualify for a mortgage at the end and what is the Rent to Own company doing to help you?

The only reason that people look at Rent to Own is because they have credit and/or cash challenges that prevent them from owning outright immediately. If a Rent to Own company says that they can approve you for their program, that’s great but that’s only the beginning. The real question is, will you be ready to go at the end of the process? Here is a list of items that a Rent to Own company must provide to you in order for you to clearly understand what needs to be done to be mortgage-ready:

1. First you need an assessment of your current situation. What are your liabilities? Do you have any outstanding credit problems that still need to be resolved? What is your Beacon score today?
2. How long will it take for you to resolve your credit issues and why? What are the lender requirements when it comes to your particular issue (i.e. bankruptcy, consumer proposal, Beacon reject, etc)?
3. Are there any errors on your Credit Bureau that need to be resolved? We see problems on a lot of files. This is a common issue.
4. What is your affordability? How much can you afford to buy given your income and liabilities? Conservative estimates should be used for all factors in evaluating affordability and you need to ensure that you can qualify for the buy-out price.
5. What will your Total Debt Service and Gross Debt Service ratios be when you buy out? Are they in line with lender requirements?
6. What Beacon score do you need by the end of the deal in order to ensure that you qualify for a mortgage? If your TDS goes above a certain level, you need a higher Beacon score. Ask if this applies to you.
7. What steps do you need to take to improve your credit file?
8. Do you have enough credit instruments and are the credit limits high enough to meet lender requirements?

By the end of the evaluation process, you should have a clear picture of where you are today, what you need to do in the next two to three years and what it will take at the end in order to be mortgage ready. If you do not know the answers to any of the above questions then ask for more information. Ensure that you have a plan. You are responsible for executing the plan but you should have clear guidance from the Rent to Own company in order to increase your chances of success.

Also – and this is important – what process does the Rent to Own company have in place to follow up with you to ensure that you’re on track? If they shake your hand when you move in and then go silent for the duration of the term, they’re pretty much relying on you to be the expert in credit repair.

Rent to Own is about so much more than buying a house for clients. It’s about helping people repair past issues in order to get to a position of strength and independence. Yes, the client has to do the work but the RTO company should be providing a clear path to follow.

Question 4: What is the monthly rent and what does it include?

There are two key components to the rent in a RTO deal. First, there is the cost portion of the house and that calculation should be based on the true cost of the house being purchased. Use an online calculator to figure out what your mortgage payment would be if you were to buy the house today. Most RTO clients give a down payment of 5%. If that’s the case for you, assume that you’re going to be borrowing 95% from the bank, use a term length equal to the RTO term, use a 25 year amortization (i.e. currently required by lenders for purchases where the down payment is less than 20%) and use an average interest rate. That will give you an idea of what the mortgage cost would be. If you’re being charged more than that, ask why. There shouldn’t be any mysterious numbers in the process.

The cost portion also includes the property taxes and house insurance. Be sure to factor in average increases each year for both and average out the costs. The total of the mortgage plus the taxes and the insurance is the cost portion of the house.

Second, there is the savings portion. Currently, lenders require a minimum down payment of 5% plus 1.5% for closing costs. The least you should be saving within the program is therefore 6.5% of the final purchase price. If the savings portion proposed to you is less than that, you may not have enough cash to do the deal at the end.

In short, the monthly cost should include a cost portion that is understandable plus a savings portion based on real figures and the minimum requirements listed above.

Question 5: Is the documentation professional?

It might be OK to draft up a quick one-page agreement with a family member for a small personal loan but where real estate is concerned you want to ensure that all of the documentation is thorough and professional. Here are a few documents to look for:

1. Proof of deposit. Do you have a signed document confirming the amount you disbursed initially? There should be a paper trail for every step.
2. Lease Agreement. This document should outline the terms of your rental for the entire Rent to Own period.
3. Option to Purchase. This is the most important document of all. The Ottawa Real Estate Association provides a generic, professional document that you can use as a starting point. Ask a Realtor to provide this form. Schedule A should outline all of the clauses that protect both the Tenant Buyers and the investors. Ensure that everything is listed in detail including the amount you gave as a deposit, the amount you’re saving on a monthly basis and any other conditions related to the purchase at the end of the Rent to Own term.

Once you have gone over all of the documents and you are satisfied that you understand them, have them reviewed by your lawyer. It is important to understand your rights and obligations within the RTO program. If you have any questions or concerns, ask for more information and clarification from the company. If your gut is telling you that something isn’t quite right, listen! Call another RTO company and find out what they offer. Compare notes and documents. Above all, ensure that all of your questions and concerns have been addressed.

Rent to Own can be a powerful, effective tool for families when it’s done properly. Like any other industry, there are companies doing it well and others who are setting up their clients and investors for a big fall. It pays to ask a lot of questions and to do your homework thoroughly. Insist on working with honest, reputable companies. They do exist.

The secret ingredient to the success of investing in real estate – beyond the first law of location –  is the concept of leverage. What do I mean by leverage? Simply put, I’m referring to the fact that you are making a return on the bank’s money.

An example

Here’s how it works: Let’s say you’re buying a property for $200,000 and you’d like a conventional mortgage so you decide to put 20% as a down payment. In this case, that would mean that you would provide $40,000 plus closing costs towards the purchase of the house. Lenders typically use a multiplier of 1.5% of the purchase price to calculate the closing costs so for this illustration we’ll do the same. In this example, your closing costs would therefore be $3,000 (i.e. $200,000 x 1.5%). In total, you would spend $43,000. The bank would then lend you $160,000.

Now let’s assume that your property appreciates 3% in the first year. This means that at the end of the year the house would be worth $206,000. For you however, that represents much more than a 3% increase; in fact it’s a gain of 13.95%. Why? Because you didn’t spend $200,000 to buy the house, you spent $43,000. To calculate your Return on Investment (ROI) you take the gain (i.e. $6,000), divide it by the total amount of money spent ($43,000) and multiply by 100 to get a percentage. It’s true that you paid interest in that time which added to the cost but you also paid off some principal and therefore you benefit from the mortgage pay down. Even if we shave off some profit because of the interest paid, you’re still looking at a double digit Return On Investment. In short, you are making a return not only on the money you provided for the deal but also on the bank’s share. That is the power of leverage.

Stocks and mutual funds

Now let’s compare this to stocks or mutual funds. In the latter cases you pay 100% of the cost to purchase the funds and your returns are calculated on the full investment amount. If your fund had gone up by 3% then your ROI would be 3%; there is no leverage at play here unless you borrow the money for the funds. If you are using borrowed money to buy stocks or mutual funds, you are praying that the stock goes up sufficiently to cover the cost of borrowing and provides a reasonable return over and above that. Take a look at your investment portfolio and consider how many stocks and mutual funds would have met that criterion.

You may object by saying that real estate also goes down in value at times. That’s true, however if you have picked a market that is stable you probably won’t face too many negative value swings. Ottawa, for example, is a great place to invest precisely for that reason: It is stable and mostly predictable. In the last 50 years there have only been a handful of years in which values went down on average and most of those occurred during the technology crash of the 1990s. Pick virtually any area of Ottawa today and you will find nice, steady growth despite worldwide economic challenges. Ottawa will never win any awards for growth and frankly that makes it an ideal place to invest! Slow and steady definitely wins this race.

Back to the Realtor’s question: Yes it is possible to have strong returns in a rent to own deal and yes those investments are backed by real estate in a strong, stable city. Strong returns can occur while ensuring that the deals are fair and balanced for everyone involved, particularly the tenant buyers.

Look for realistic purchase prices, especially the buy-out price if you’re considering a Rent to Own deal; insist on reasonable cash flow that does not take advantage of the clients; and finish it up with professional documentation and a solid plan for execution.

Then enjoy the power of leverage!

Here’s the good news about mortgage insurance: If you die, the mortgage gets paid which means that your loved ones won’t have to deal with the financial stress of having a potentially large and on-going liability to manage on top of trying to cope with your loss. It certainly is a great idea to ensure that this gets covered. But the question really is this: Is mortgage insurance the best option? No, it isn’t.

Scope

First, when you insure your mortgage through a lender or a broker, the coverage is solely for your mortgage. What about your other debts and obligations? Your loved ones will have to deal with those too, and they are not included in mortgage insurance. If all you have is the latter, the lender will receive the equivalent of the balance remaining on the mortgage and your loved ones will receive nothing. Sure, they will no longer have a mortgage to pay but they still have to deal with all of the other financial issues, not the least of which is the cost of a funeral. It really isn’t cheap to die. Even so-called *low cost* options will set you back several thousand dollars. Just this week I received a flyer in the mail from Canada Purple Shield in which they claim that “…statistics show that the average cost for a funeral is over $10,000.” Who will pay for this if there is no insurance coverage?

Value

Second, the value of the policy diminishes over time as you pay down your mortgage, however your premiums remain the same. If for example you’re paying $70 per month to insure a $300,000 mortgage with a 3% interest rate, monthly payments and a 25 year amortization, five years later you’re still going to pay $70 per month even though the value of the payout will have dropped to $256,400. That’s a drop in value of more than $40,000 for the same premium. If instead you had opted for term life insurance, the value of the payout would have remained the same.

Term

Third, the coverage for some policies ends when you sell the house. Since the coverage is tied to a particular loan, the moment you pay out that loan (i.e. when you move) the coverage stops. If you had term insurance, it would apply regardless where you live or how many times you moved. There are mortgage insurance policies that are portable, thereby allowing you to change lenders on a loan, but again the problem of diminishing value still applies.

Beneficiary

Fourth, when you get your own life insurance, you designate the beneficiary and you may choose whomever you like. For mortgage insurance, the lender is the beneficiary. It may be that your beneficiaries don’t want to pay off the mortgage in full, choosing instead to use the money for other more pressing matters. If you have mortgage insurance they don’t have that freedom.

Cost

Finally, it’s almost always cheaper to get term life insurance. Let’s take a look at a real-life example. This past week we secured a house for clients at a purchase price of $355,000. Our investors obtained a mortgage valued at $284,000. Along with the mortgage commitment, they were offered mortgage insurance at a cost of $130 per month. These investors are in their 30s and 40s. Now let’s compare that with my own situation. My husband and I have term life insurance valued at more than $1.3 million dollars for which we pay $125 per month. Apples and oranges you might say. Yes of course because we are different people with different situations, but wouldn’t you want to explore what’s possible given the large difference in value for roughly the same cost? My point is that it’s worth having a conversation with an insurance broker to see what he or she can offer you for the same amount. While you’re having that discussion, consider the other items beyond your mortgage that you might want to insure as well: the cost of the funeral, any debts you have, money for your children’s education, funds to help your spouse through the next few years and so on. For the same price as mortgage insurance you might well be able to get coverage for a host of other areas of concern.

Mortgage agents make a commission on every mortgage insurance package they sell, therefore they have a vested interest in selling those policies. That said, I work with a number of excellent mortgage agents and I know that they have their clients’ best interests at heart. First and foremost they are concerned that the mortgage be insured, and that’s perfectly sensible. If you don’t want to check out other options for whatever reason then by all means sign on the dotted line for mortgage insurance. However the point of this blog post is to show that there are other, possibly better alternatives and that it’s well worth your while to call an insurance broker to see what your options are. The result will likely be that you get more and better coverage for a cheaper price.

The bottom line: Ensure that you’re insured.

What I’m about to discuss is important for everyone. However, this post is addressed to women in particular for one key reason: We tend to be more financially vulnerable. In case you haven’t guessed it yet, I’m talking about your Credit Score, otherwise known as your Beacon score. Let’s look at what it is and why it really matters to you.

In our Rent to Own business we see a lot of bruised credit profiles come across our desk and sadly many belong to women who have been through traumatic events like divorce. In other cases, women have no credit profile because their spouse has been the one who obtained all of the loans for whatever reason. If you have no Credit Score or a low score, you are vulnerable and your options may be severely limited.

What’s your Beacon score?

Let’s get straight to the key question: Do you know your Beacon score? Secondly, do you know why it matters? If you’ve ever tried to borrow money, get a credit card or rent an apartment, chances are that someone looked at your Credit Report to determine how likely it is that you’ll honour your financial obligations. In Canada, our credit history is recorded by three key agencies: Equifax, TransUnion and Northern Credit Bureau. These agencies keep track of key financial and personal information that banks, lenders and other businesses use to determine your risk profile. The good news is that no one can access this information unless you give them permission. The bad news is that this information is required for financial transactions where you are asking for a loan or for credit. If you refuse, you don’t get the money, the card or in some cases, the apartment. You may not need money or a loan now, but some day you will so it behooves you to pay attention to your score and to do everything you can to keep it high.

So how does the scoring system work?

In a nutshell, it’s complicated. Equifax and TransUnion use a scale from 300 to 900. If you have no credit history, you’re charmingly called a “Beacon reject” which essentially means that they have nothing on you. While it’s great that you have not developed a challenging profile, it’s not helpful that you have no history. Lenders typically don’t open the vault unless they have a Beacon score with which to evaluate your file. If you do have a Beacon score, then from a lending perspective it boils down to this: a good score makes you interesting to A-lenders (i.e. banks with better rates). If your score starts to get lower, then you’re in B-lender territory (i.e. alternate lenders or private lenders and higher rates). If your score drops down too low then no one will touch you. The precise line in the sand varies by lender but the goal remains the same: You want your score to be as high as possible to give you the most options and the best rates.

There are a number of factors that influence your score. The following is a partial list that addresses some of the biggest influences:

Credit inquiries

The more inquiries you have on your file, the more it looks like you’re shopping for more money or credit and therefore your risk factor goes up. Net effect: Your score goes down. Be careful about buying in to retail store offers for x% off if you get their credit card today only! Or the countless “freebie” credit card offers you get in the mail. Or having multiple car companies pull your credit when you’re shopping around. Be strategic about your purchases and your cards. Tell companies that they may not pull your credit to offer you a quote. They will have to do so if you proceed with them but then that’s one hit versus many.

Collections

These are bad for your credit, period. If you’ve got a collection outstanding, pay if off or resolve the issue asap. Don’t let a collection drag on for ages. You may end up winning the war (the amount owing) but losing the battle (your credit score).

Account balances

In a previous blog post Tackle debt or save money – Which is better? I addressed the issue of credit cards. If you maintain high account balances, it can be a signal to potential lenders that you are not living within your means and the result is a negative effect on your credit score. The ideal situation is to use your credit cards regularly and then pay off the balances in full when due every month. You need to use the cards to establish a credit history but you need to use them wisely in order for it to have a positive effect on your score. If you can’t pay off the full balance right away, then be sure to keep the balance below 35% of your credit limit.

Late payments

Equifax and TransUnion report the rating of your credit items on a scale of 1 to 9. A rating of 1 means that you pay your bills on time. A rating of 9 means that you don’t repay your debts or you have a proposal for repayment. Every time you make a late payment, it gets noted on your credit bureau report. The longer the delinquency, the worse the score. The solution is pretty simple: Pay your bills and your debts on time in order to maintain your score.

Sufficient credit

Some of our clients have avoided getting credit cards or loans of any kind because they fear it will lead them astray. Sadly they’re not developing any credit profile as a result. You need credit and you need to use it well in order to develop a good Beacon score. The general rule of thumb for lenders is what we call the 2/2/2 Rule: 2 Credit Lines with a credit limit of at least $2,000 for 2 years. That’s the minimum you want to have in order to develop a good score.

Too much credit

This is a difficult one. On the one hand, lenders want to see that you have credit and that you know how to use it well. On the other hand, they don’t want to see too much credit because that poses a risk to them. As a result, too much available credit can hurt your credit score. If your wallet is stuffed with cards then it may be time to do a triage down to the best cards for you. Bear in mind that older credit trumps new credit so be sure to hang on to the cards you’ve had for a while. If you’re unsure of what to do and which cards to eliminate, talk to an experienced mortgage agent. If you’re in Ottawa, email me and I can recommend a number of great people.

Here’s a surprising fact: Credit reporting agencies makes mistakes and sadly they’re not uncommon. Therefore it’s a good idea to pull your own credit at least once a year to ensure that the information is accurate and up-to-date. When you order your own report, there is no hit to your Beacon score so there is no reason to avoid doing it. At Equifax you can get a copy of your report along with your score for $23.95: http://www.consumer.equifax.ca/home/en_ca. To use TransUnion just click on the following link: http://www.transunion.ca/ca/personal/personal_en.page. We suggest you make it part of your New Year’s ritual to check your credit at the start of every year. Or use your birthday as a reminder – whatever works.

One last word for women: Having a strong Beacon Score is a key part of setting yourself up for financial success. Check your score today and don’t be discouraged if it’s low. Every challenge from your past can be reversed with time and good habits. We’ve seen it over and over again in our business and we’ve helped dozens of families move from credit challenges to strong credit scores. The process is the same for everyone: good decisions, one step at a time. Having a good credit score is also essential in protecting yourself in the event that you find yourself suddenly alone. I know that everyone thinks it won’t happen to them, but I’ve experienced loss and seen countless others go through that process too. It happens all too often. I’m writing a book about the lessons that I’ve learned and I’m interviewing women who have been through loss and divorce to hear what they recommend to other women based on their own experiences. You can read about those lessons and some of the stories here: www.ifihadknownbook.com. Bottom line: Be wise and protect yourself. Protection starts with a good credit score.