# Which mortgage should I pay down first?



## JA2285 (Jan 25, 2011)

Well I've been reading this website for a couple months.. I thought I would register and start posting.

I currently live in a townhouse in the lower mainland and have recently locked in a new house. Our current intentions are to rent out the townhouse and inturn build a bit of equity. My questions is which mortgage should I pay down or focus on? Or both? My initial gut feelings is to pay the new house as its a quite a hefty mortgage, but on the other hand its the lowest rate.. I would appreciate any insight you could provide.. thank you.


1. NEW House (Will be completed for sept 1st)
$597,500 Purchase value
$572,800 to be owing (after CMHC take their cut.)
35 yr amortization
Prime - .8 (2.2%)
5 year term

- I will inhabit upstairs, rent the basement
- Unit has a fully contained legal basement suite that will rent for $750-900 / month
- I cant see myself needing or wanting to sell this home anytime soon, its more space then what we need currently, in a good area and will provide plenty of years of use.
- This is a big mortgage, a part of me wants to pay down a portion of it incase we do see market correction.

2. Current town house (3 bed, 2 bath, 07 built, strata, no forseeable expenditures)
$324,000 Market value
$302,000 owing
35 yr amortization
Prime (3%)
1.5 Years into 5 year term

- Projected rental rate of $1650 per month minimum 
- Slightly cash positive, but with interest rates jump or a couple months vacancy that would be erased.
-Property close by to new home (couple blocks)
- Interest on this mortgage will be tax deducatable
- Depending on how the neighborhood develops will determine how long I hold it. If it remains cash neutral or cash negative within reason, and land lording proves not too challenging (fingers crossed, but expecting some learning speed bumps) I would consider holding it for 5 years and offload it and take that equity for something else. If the area develops the way it should, rental rates should climb and making holding this property long term much more attractive.

3. Invest and take advantage of low interest rates?


4. Other?


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## Jungle (Feb 17, 2010)

Well, since both of the mortgages would be tax deductible, I would pay the higher interest mortgage first. 

I do not your entire financial situation, but with this route, you are heavily tied into real estate. If prices go down 10%, you can lose $92,000 of the value of your homes.

Maybe sell the townhome and put the money on your new home purchase?


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## andrewf (Mar 1, 2010)

Agreed. Sell the townhouse. Barely cash flowing with interest rates at 3%, in a market that is very frothy. I'm not sure what the rest of your asset portfolio looks like, but you are probably too highly exposed to real estate.


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## JA2285 (Jan 25, 2011)

thank you for your input jungle! You raise a valid point about my exposure to real estate. As for my financial picture...

25 years old
live in girlfriend (lets factor 0 contribution from her , worst case scenario planned for)
0 kids (none planned for a while either)
0 credit card debt
0 debt aside from mortgages
11K in RRSPs (contributing for about a year), plenty of room left, looking to use some contribution room up this year once settled with the house.
0 TFSA contributions so far
approx 140-150K yearly earnings before tax

I have a relatively decent time until retirement and hope to make the best of my youth to maximize my earnings. I hope to get my RRSPs up as this is one of my best earning years so far.

I would say i'm relatively comfortable with leverage and risk at this point in time as expenses are the lowest they will be.


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## JA2285 (Jan 25, 2011)

andrewf said:


> Agreed. Sell the townhouse. Barely cash flowing with interest rates at 3%, in a market that is very frothy. I'm not sure what the rest of your asset portfolio looks like, but you are probably too highly exposed to real estate.


Thank you Andrew.

As you can see my assets are pretty much nil right now. My logic with the townhouse is as follows:

- Expect 0 capital appreciation, any increase is a bonus.
- Can carry property if vacant if I have to.
- Every year unit is held $7000 is chopped off the mortgage. (aslong as i put in less then $600 / month, I am ahead am i not? At the point, i am cash + still)
- Capitalize short term (less then a few years) on low mortgage rates. If rates rise to an uncomfortable level, off load unit.

I think it makes sense?


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## Sampson (Apr 3, 2009)

These numbers seem crazy.  But maybe that is Vancouver?

By crazy, I don't mean the house prices, but the amount of debt you have taken on.

$50,000 in equity, and owing $875,000 and only earning $150,000.


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## JA2285 (Jan 25, 2011)

Sampson said:


> These numbers seem crazy.  But maybe that is Vancouver?
> 
> By crazy, I don't mean the house prices, but the amount of debt you have taken on.
> 
> $50,000 in equity, and owing $875,000 and only earning $150,000.



Fair enough Sampson. I would be interested in what you would do in my position? Offload, the townhouse, the house etc?

Its becoming the sad norm in Vancouver and surrounding area. The house is a nice size but nothing extreme. Probably the right enough room to raise a small family.

How do you make it work in Calgary? thanks!


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## andrewf (Mar 1, 2010)

JA2285 said:


> - Expect 0 capital appreciation, any increase is a bonus.


This is not the worst case scenario. Prices in Vancouver aren't sustainable... I'd take the equity you have in the house and invest it elsewhere. Remember that prime will probably double during the life of that mortgage.


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## kcowan (Jul 1, 2010)

$110k net income
30% of that for mortgage $33k
New mortgage only partially deductible (Based on rental portion of house)

I agree that you will have too much RE. Look at selling the TH.


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## Ihatetaxes (May 5, 2010)

Sampson said:


> These numbers seem crazy.  But maybe that is Vancouver?
> 
> By crazy, I don't mean the house prices, but the amount of debt you have taken on.
> 
> $50,000 in equity, and owing $875,000 and only earning $150,000.


Agreed. What bank that approved this much debt for someone with no assets? Maybe they hired their mortgage consultant from the US. What happens if you lose your job and your tenant stops paying you rent and won't move out? What do you do when the value of your properties drops 20% over the next three years?


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## Sampson (Apr 3, 2009)

I would sell the townhouse, put the proceeds onto your residence.

Even servicing the mortgage on your residence, your income would be sufficient to pay that down, and do it with great vigor. Alternatively, you could invest a portion of that, your income is high enough that you really should be maximizing your RRSP contributions.

You just have way too much exposure to risk, if for whatever reason, you have problems with renting the units out, or lose your job, or anything other unknown, you don't have much/any capacity to withstand those unknowns.

Truthfully, might be most prudent to offload the house, and continue living in the townhouse. After you get to 30-40% equity, and your income continues rising, then look into a rental property. By that time, your RRSP/TFSAs and non-registered investing accounts hould be very very healthy too.

Good luck, but really consider reducing your debt.


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## OK-bachelor (May 24, 2011)

History shows that interest rates go up and down . Look at your income and figure out what will happen if interest rates are at 8 % and your payments increase accordingly . We all know interest rates will go up , which will cause inflation and a drop in real estate values , so base your plan on the worst case scenario , and don't leave yourself too vulnerable.


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## Charlie (May 20, 2011)

On the original question -- pay down the new home mtg first. Even though the rate is slightly lower, at max less then 50% is deductible (since you want to maintain your principal residence status), so overall, your cost is likely less.

I concur that you've put all your eggs in the real estate basket. You're the king of no-money-down real estate investing! Though a $325K condo rented at $1650/mo doesn't seem that big a downside. (likely about a 5% cap rate, which isn't so bad). Your bigger risk is that you've got $875K on very good floating rates. Your question is....are you OK with the risk? Are you OK if available rates go up to 5% (current five yr fixed) or higher? And if there's a special assessment etc. How confident are you that your condo mortgage will be renewed (investment prop's often need more equity). You won't get much additional cash from a sale since your equity will be eaten up by selling costs -- but you'll relieve yourself from interest rate, and other risk. 

I'd go hard on paying down debt (on the house first). Don't know if I'd sell the condo? Pay particular attention to the terms under which you might be able to renew your mortgages in a few years.

By Lower Mainland standards the prices seem relatively modest. Still nuts. And $875K of floating rate debt is a bit scary. Good luck.


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## andrewf (Mar 1, 2010)

Also, you should check your mortgage contract. It probably stipulates that you will be living there as your primary residence, and you'd be in breach of contract if you rent it out. Investment properties require 25% down, IIRC.


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## kcowan (Jul 1, 2010)

andrewf said:


> Investment properties require 25% down, IIRC.


and no longer qualify for CMHC insurance coverage.


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## jamesbe (May 8, 2010)

I'm totally confused how this is even possible....


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## Eclectic12 (Oct 20, 2010)

Jungle said:


> Well, since both of the mortgages would be tax deductible, I would pay the higher interest mortgage first.
> 
> I do not your entire financial situation, but with this route, you are heavily tied into real estate. If prices go down 10%, you can lose $92,000 of the value of your homes.
> 
> Maybe sell the townhome and put the money on your new home purchase?


Hmmm ... what makes both mortgages tax deductible?

The current town house when rented and no longer the principle residence will be tax deductible. It's probably a good idea to get a current market value assessment, as the difference between when it converts from principle residence to rental property usually needs to be reported as a capital gain - when the town house is sold.

The new house which becomes the principle residence, has the possibility of *part* of the mortgage being tax deducible for the rental part. 

However, it is important to check out the tax rules as claiming the wrong things can result in losing the designation of "principle residence" and having to pay capital gains when the house is sold, as per the following link:
http://www.taxtips.ca/personaltax/propertyrental/rentalexpenses.htm


Cheers


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## Jungle (Feb 17, 2010)

Eclectic12 said:


> Hmmm ... what makes both mortgages tax deductible?


He wants to rent out the basement on the new house and live upstairs.


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## andrewf (Mar 1, 2010)

In that event, at best only part of that mortgage will be tax deductible. He'd probably be breaking the covenant on his original mortgage by renting it, so that mortgage will need to be renegotiated anyway.

Given all this, it makes it pretty clear that the OP should sell the townhouse. He'd need to stump up some extra cash to make the 25% down lending criteria.


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## sprocket1200 (Aug 21, 2009)

housing bubble, i LOVE it!!!

keep both mortgages, wait until you are deep in trouble, PM me when you need out, i have cash...


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