Mortgage for Flipping Houses in Canada

Today, I received an email inquiry from a client (dentist) thinking about getting into flipping houses. He asked some great questions and by the time I had them answered, I had the makings of a great blog, which I will share with you.


On Sun, May 8, 2016 at 3:31 PM, T  wrote:

Hi Chris,

How have you been?   Hope you're enjoying the weekend. 
I've got a friend who is wanting to partner up to do some renovation projects in Edmonton. He's done a few projects  by himself in the past. The properties we would be looking at would be in the $250-350k range and we would be looking at putting in 20% downpayments split 50-50 between the two of us . 
I am just wondering if it is possible to get preapproval for something like that so that we can put in unconditional offers when we see suitable properties? 
Also, what sort of interest rates would be looking at - he is a permanent resident so I'm not sure if that would change things. 

Kind regards, T

On Mon, 9 May 2016 09:28 AM, Chris wrote:
Hey T - doing well, thank you. Very busy, which is good.
Regarding lenders, depends if objective is to fix and sell (flip), or fix and keep (buy and hold).  Two very different lending situations..... 
In a flip situation, lender's funds are needed for a very short term and will be more expensive to make it worthwhile to lend and because flipping is a very risky business (run out of money mid-project, projected selling prices fall before complete, cost overruns, etc.) and the lender does NOT want to get stuck with your half-completed project. Down payment requirements are 20 to 35%. For full-time flippers, I do have a private lender specializing in Alberta flips and will allow you to borrow up to 80% of the as-if-complete value of the home (after rehab value) as long as the mortgage does not exceed the purchase price less $10K (your minimum down payment).
In the buy and hold scenario, lender will make their money over the five year mortgage term instead.  Sometimes, there are ways to buy with intent to hold, but if circumstances change and you decide to sell, the "break fees" are not too bad. Rates are normal, currently 2.7% -ish on a "rental"  
There are significant differences in how income tax is assessed on flips vs holds, and that has to factored into your analysis as well. On a flip, 100% of the profit is taxable at your highest tax rates.  So a $100K profit might mean $40K for the government and $60K for you two. On a hold, only 50% of the gain is taxable (capital gain) at your highest rate.
As to being pre-approved, lending always depends on the property because the property secures the loan.  If the lender does not like the property (former grow-op for example) there will be no loan.  The only way to make non-conditional offers is have an independent source of money.
Moving forward, I would need to talk to your friend to determine his borrowing capacity and combine that with yours and see if there is overlap and with which lenders. Would that work?

On Mon, May 9, 2016 at 9:38 AM, T wrote:
Hi Chris,
Thanks that's helpful. That sounds good, if it looks like I'll be moving forward, I'll get my friend to make contact so you can assess his borrowing capacity.
In terms of the flip vs buy and hold, would it be possible to have a mortgage that is on a variable interest rate with no fixed lock in period - so there would be no break fees and that would give us the flexibility to do either.  You mentioned a 5 year mortgage period, it's usually not too difficult to get a 20-30 year period right? 
Also,  if we formed a joint company, but secured the loans against our personal names would it still be possible to get a loan and buy the house through the company. 
With capital gains tax, how long does the property have to be held to reduce the taxable amount to 50%. Also with that scenario I am assuming it has to be bought personally and not through a company? 

Kind regards, T

On Mon, 9 May 2016 10:58 AM, Chris wrote:

1. Yes, a Variable Rate Mortgage (VRM) from a traditional mortgage lender is what we try to make work first in these situations as the "break fee" is fixed at 3-month's interest on a "closed" mortgage (penalty to break). An "open" mortgage (no penalty to break) has a higher interest rate than a "closed" mortgage and it doesn't take long (~6-8 months) before the closed with penalty is a the cheaper option.

2. Majority of VRMs are 5 year contracts with the odd 3-year, and yes Amortization can be set at 25 or 30 years.
3. As to forming a joint company, I've "been there, done that!" It sounds much better in principle than in practice.  My advice is do your first deal or two in personal names and establish that you can actually pull it off, work together well, and make a profit. Corporation adds layers of complexity and cost and tax advantages are not as good as one thinks. Considerations:
  • Incorporation costs
  • Annual corporate minutes
  • Annual financial statements
  • Annual income tax filing
  • Corporate Annual Return
  • Annual GST Return
  • Bookkeeping
  • Financial Management of the JV
  • Dividend declaration and processing
Also good to know, many bank lenders will not lend to corporations, so you limit who you can borrow from.  For those that DO lend to corporations, personal guarantees are required regardless. Some will lend to holding companies only, not operating companies. Personal guarantee means the lender can come after (sue) you personally if you default, whereas when financing is in your personal name, typically your liability is limited to just the property, not your other assets.
Private lending on flips generally don't really care personal or business as your down payment is going to be higher and they are going to be rewarded for the risk they take.
As to income taxes, you will want professional advice.  Flipping house income within a corporation - as I recall - attracts the higher GRIP (General Rate Income Pool) tax rate, not the small business LRIP (Low Rate Income Pool) You will want to seek advice on this beforehand.  My wife and I did the buy and hold strategies initially corporate, then over time transferred everything to personal names as too much of a pain. Too high of a "PITA Factor!" (Pain In The Arse).
As a personal note, you (and I) being self-employed are in good positions to manage our personal income amounts simply by choosing how much income to pay ourselves from our business corporations. For example, if my wife and I sell a property in 2017, we can/will limit our T5 income from our mortgage brokering business as an offset, hence manage what tax bracket we fall into.  I call this "managing our line 150s" which is the line for Total Income on your personal tax return.
4. As to capital gains vs flipping income, there is no time rule, per se.  If you are ever audited, the CRA will look at and for original intent (perhaps even this email). If your paper trail indicates that you had every intention to keep the property, they will allow the lower capital gains tax. If the paper trail shows otherwise then CRA may require you to pay the higher taxes.  For example, if you pursue an "open" mortgage, it's harder to argue you were NOT planning to flip, whereas a 5-year "closed" mortgage might indicate otherwise.
Finally, on another note, there are many doctors and dentists who discover it is more fun and less work to be the bank on these real estate projects, than an active equity partner and there are many Mortgage Investment Corporations (MICs) that exist to attract and deploy capital on good projects.  My wife and I have a re-advanceable Line of Credit on our own home. We aggressively pay down our mortgage as the interest expense is NOT a tax deduction, and the principal repayment serves to increase the limit on the LOC by the same amount.  We can then borrow on our LOC and invest it in property or mortgages and the interest is a legal tax deduction. We don't mind paying tax, we just want to keep out of the higher brackets.
Here is a link to more information.
Hope this helps.  Call me if you want to explore ideas further. I am a big fan of KISS (not the band!).

On Mon, May 9, 2016 at 4:48 PM, T wrote:
Thanks Chris, very helpful and detailed info as always!   T

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