Individual mortgages can be quite a gamble when investing in the Canadian real estate market. They require patience, tons of research and, most of the time, a leap of faith. Traditionally, this bureaucratic hassle has been passed over to specially appointed private lenders. But is there an alternative to this? Yes, there is, and it comes in the form of a Mortgage Investment Corporation (or MICs, for short).
What Are Mortgage Investment Corporations?
As stipulated by Section 130.1 of the Income Tax Act, Mortgage Investment Corporations are companies enabled to allow investors to invest in a mortgage pool. Investors contribute to a mutual fund by acquiring shares in a MIC, thus creating a surrogate fixed-income investment.
A MIC will borrow from the bank as well as from other lenders, involving the shareholder’s capital and the loan proceeds to fund its mortgage portfolio.
The mortgage pool is supervised and adjusted constantly with newly invested share capital while the proceeds of repaid and discharged mortgages are utilized to fund additional incoming mortgages.
A Mortgage Investment Corporation’s management is in charge of every operational aspect of the company, including sourcing eligible mortgage investments, analyzing mortgage applications, negotiating applicable interest rates, regularizing terms and conditions, instructing solicitors, establishing the mortgage portfolio and other administrative deeds.
Just like any other investment fund, the MIC’s manager receives a percentage fee, usually calculated in relation to the total value of the assets found under administration.
This federal statute requires that, once it’s verified by external audit, the annual net income belonging to the MIC is distributed among its shareholders as a dividend. The dividend is taxed only as interest income, which means the MIC itself is not taxed. This represents a significant advantage for MIC shareholders, who can now avoid paying the double-level tax applied to regular corporations.
Rules Regarding Income Tax Act, Section 130.1
- A MIC requires at least 20 shareholders.
- The shares should be widely distributed. No shareholder may hold more than 25% of the total capital.
- Residential Mortgages, insured deposits and/or cash should comprise at least 50% of the company’s asset portfolio.
- A MIC may invest up to 25% of its assets directly into real estate. However, land development or construction would be off-limits as it involves a whole different tax bracket.
- MIC investments are to take place exclusively on Canadian soil, but MIcs may accept investment capital from abroad.
- MICs are tax-exempt.
- Dividends are taxed as interest income, and they can be received as cash or additional shares.
- MIC shares are categorized as RRSP and RRIF investments.
- Keep in mind that MIC’s annual financial statements must be audited.
- A MIC may partially fund assets by using debt as a means to employ financial leverage.
Unlike Mortgage Investment Corporations — which distribute your money over a pool of several properties — when it comes to private lending, the loan is set against just one.
A private lender may lend for one year and then wait for 3-5 months to find an eligible mortgage to lend their money on.
One risk is that smaller investors may find it more difficult to find smaller mortgages. On the other hand, Mortgage Investment Corporations have the resources to lend on various mortgages of different sizes, and usually have a Line of Credit with a bank, staying fully invested all along.
This means that even after paying the administrative cost, a private lender can provide better returns down the road at a lesser risk.
Another advantage of working with a private lender is approachability. Private lenders are more inclined to take your business even if you are recovering from a bad credit score. A hard money lender is also more prone to build a lasting professional relationship with the buyer. Respect your contract, and your lender will provide you great future investment opportunities.
Time is a commodity, especially for real estate deals. And since private lenders have to deal with much less red tape than larger institutions, this can give you a head start against your competition in buying the desired property.
Another factor to bear in mind is that traditional mortgages have a minimum 5% required put-down of the property’s purchase price. Still, banks may require up to 20% to secure a better-termed contract.
Although many private lenders might still require 25% down payment for a hard money loan, unlike banks, they look at the potential your property has, and tend to ignore past credit and income issues.
Things To Consider Before Before Getting Into a Mortgage Investment Corporation
- High and increasing rates for non-performing mortgage loans.
- The current state of the Canadian housing market and the public opinion around it.
- The Domino Effect – If some Mortgage Investment Corporations decide to disallow redemptions, the other investors in similar capital pools may try to liquidate their own holdings.
- Loans on average remain repayable at any time, a quality ensured by the short-term nature of the loans.
- Fraud – Watch out for lenders that provide bubble-era type loans, i.e., doing business with unemployed individuals without income or other sustainable means to pay back the loan.
- Shell games – Suspicions have been raised in the past that some MICs are not transparent enough and do not recognize some existing loans as non-performing.
Reaching for yield can be a risky endeavour, and investors should be aware. When rates go down under a certain margin as they have recently, some investors might feel tempted to reach for yield.
This means they chose to abandon caution in pursuit of the highest return points per year. With the market being notoriously volatile, buyers may find themselves in serious debt without a strong financial safety net.
Research, caution, and recommendations will minimize the risk when deciding between a Mortgage Investment Corporation or going forward with a private lender for any type of mortgage, including home equity loans, second mortgages, or spousal buyouts.
If you are not sure whether a Mortgage Investment Corporation is the right choice for you or not, working with an expert broker in BC will help you find the best mortgage option for your specific financial situation. A professional broker will also negotiate with mortgage lenders and submit documents on your behalf.
Mortgage brokers also have regular contact with a wide variety of lenders, not to mention that some lenders work exclusively with mortgage brokers. Your broker may also be able to get special rates from these lenders due to the volume of business generated.
Contact us today to get a quick assessment of your financial situation.
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