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August 30, 2012
As published in Canadian Mortgage Professional Magazine
Mortgages can be a useful tool when a client is looking to increase his or her net worth, but how far can a broker go when offering advice? CMP finds out
As stock markets become more volatile – and interest rates remain low – real estate investments are becoming increasingly popular among savvy homebuyers looking to make some extra cash.
And with a variety of innovative mortgage products leading the way, mortgage brokers/agents have a unique opportunity to offer value-added services to their clients – and keep them around for life.
But let's face it – mortgage brokers aren't financial planners. And while assisting clients with their real estate-focused investments might sound simple enough, the truth is it's not.
"I've noticed more and more brokers are trying to do the Smith Manoeuvre with little understanding of what it is. And a little knowledge is a dangerous thing," says Peter Kinch, a mortgage broker with Mortgage Centre Canada franchise Canadian Mortgage Team in Port Moody, British Columbia.
Kinch specializes in offering mortgages to real estate investors – 90% of his business involves helping individuals purchase rental properties. And while he has afforded the time to learn the ins and outs of this often-complicated business, he says the majority of mortgage brokers that dabble in this field have not.
"We spend a lot of our time fixing other people's messes," he says. "The reason I decided to treat this as a niche was because: A) It was underserviced and B) Both mortgage brokers and consumers were undereducated."
Kinch adds that of the four per cent of mortgage holders who opt to invest in real estate, more than half jump in without a proper education – often relying on information they heard on late-night television.
Misinformation leads to misconceptions – and plenty of those are abound when it comes to mortgage investment products.
While most mortgage brokers aim to help their clients on their investment journeys, a lack of education can leave clients with limited options – and potentially end in mortgage fraud as they're forced to misrepresent the file.
Kinch says the most common situation he has seen results from a 'transactional lending' approach. It usually occurs when a broker sets a client up with one investment property – purchased using a high-ratio mortgage. While this is simple in itself, problems arise when the client wants to purchase additional properties.
"Most brokers believe that clients should put down as little money as possible so they can finance as many properties as possible," he says. "They think the less money down, the lower the cash flow – but in actuality, it handcuffs the client's ability to get an additional mortgage."
Despite the fact real estate investors make up only four per cent of mortgage holders in Canada, this market has the highest probability of fraud, bankruptcy and foreclosure – making it unappealing to lenders. Factor high-ratio mortgages into the equation and nobody will want to touch your investments.
The problem is, many mortgage brokers don't recognize this until it's too late – and end up fudging the truth. Kinch says he's encountered clients who are pretending that their rental property is their primary residence, under their broker's counsel.
"Most brokers don't know how to handle a real estate portfolio, so they resort to fraud. This means misrepresenting the file – in any way," he says.
Samantha Gale, manager of mortgage broker regulation at the Financial Institutions Commission of British Columbia (FICOM), adds that misrepresentation and a lack of disclosure are often two factors that lead mortgage clients into trouble.
"Mortgage brokers are soliciting business – they're not doing this out of the goodness of their hearts," she says. "They're encouraging clients to make investments with equity take-outs, promising the client that they'll make money. The thing is, not everyone makes money – we've heard of a lot of people who've lost money."
Gale offers the example of an individual who bought a rental property with the help of his mortgage broker, and the going rent was less than the monthly mortgage payment. Situations like these could be avoided if brokers offered full disclosure and educated their clients – and themselves – of the potential risks involved.
"In the case of tax deductible mortgage products, the broker should ensure the client contacts Revenue Canada to make sure their investments are legitimate. A broker can't guarantee that it's always tax-deductible," Gale says.
This type of due diligence is as much for the benefit of the mortgage broker as it is for the mortgage client. If brokers are seen to be overstepping their boundaries – or forging information – they could lose their licence, find themselves subject to a criminal investigation or sued civilly for negligence. If they are found to be offering incorrect investment or tax information they can also be fined up to $50,000 in some provinces, such as British Columbia.
So how far can a broker go when offering mortgage investment advice? Ellisseos Iriotakis, a mortgage agent/owner of TMG SAFEBRIDGE Mortgage Solutions in Toronto, says the answer is simple.
"You should probe – not advise," he says. "I offer my clients a high level of understanding regarding the different mortgage and investment products out there, but I don't go into product offerings."
Iriotakis obtained his Certified Financial Planner (CFP) designation before becoming a mortgage agent, but says he only uses it for creditability. While he could get his financial advisor's licence, he's chosen not to – and instead sends his clients to his partner, Chris Karram, who is a licensed financial planner.
"I want to keep the lines clean," he says. "I have a good understanding of financial planning and key products. But, for me, it's about finding opportunities on behalf of the client. I want to understand the situation and find ways to enhance their net worth."
Kinch, in a similar fashion, focuses on partnering the right mortgage with the right individual. He examines the big picture before coming up with a mortgage-related plan.
"I focus on portfolio-based lending – it's more of a bird's eye view. The approach looks at the investor's goals today as well as those tomorrow," he says, comparing his strategy to the aforementioned 'transactional' approach. "I make sure I understand how many rental properties will be required for clients to reach their financial goals. I analyze any potential roadblocks the bank may face when dealing with them and we tackle it ahead of time so it doesn't happen during the transaction."
This is exactly the approach mortgage brokers/agents should be taking. According to FICOM, mortgage brokers "should be careful to provide only general information about investment strategies and to refer individuals to qualified investment advisors, tax experts or licensed real estate sales people. They should not recommend specific investment vehicles to invest in."
The reason for this – and where many brokers/agents run into trouble – is that, without a full, in-depth knowledge of investment-related legislation, a broker/agent can do something illegal without fully being aware. That's why many brokers/agents who are opting to partake in tax-deductible mortgage plans or similar investment-focused services have partnered with a credible professional.
When most mortgage brokers/agents venture into the world of mortgage investments, they partner with a financial planner to supplement the service.
Iriotakis used this partnership to create a one-stop shop – offering clients a solution to all their financial needs.
"The mortgage is our lead product, but we also keep an eye out for other opportunities that might benefit a client's situation," he says, adding that every client is asked to fill out a 20-question checklist before meeting with an advisor. The questions are both mortgage-specific and financial planning focused.
While the Personal Information Protection and Electronic Documents Act (PIPEDA) prevents sister companies, acting as separate organizations, from sharing personal information without consent, usually all that is needed to share basic information is a clear opt-out consent form.
Iriotakis finds that, most of the time, clients benefit from meeting with a financial planner after sorting out their mortgage because it allows them to take care of insurance-related matters as well as leverage their existing investments and RRSPs. Occasionally, if the client requires assistance with family trusts or investments related to Canadian Controlled Private Corporations, the company will forward them to an accountant.
Kinch, on the other hand, has developed an exclusive referral relationship with a tax accountant.
"Financial planners have another slate of problems – they can't offer advice on real estate and they don't get compensation for real estate," he says. "They often try to push clients into products that they get commission from. Instead, the clients should be getting good tax advice from an accountant that understands real estate."
Kinch frequently runs his client files by his accountant – just to get a fresh set of eyes on the file and to spot any red flags.
"He's the top authority on tax implications for real estate investors," he says.
Brokers who are thinking about dabbling in mortgage-focused investment strategies should make sure they know what they're getting into before diving in. While assisting a client in the purchase of a single rental property or small commercial property is likely doable, if they're planning to invest in more down the road – or would like to test out a tax-deductible mortgage strategy – it makes sense to forward them to a more specialized broker.
"Many brokers think offering tax-deductible mortgage strategies make sense. So they try it out and quickly go back to their regular business," says Boris Bozic, president of Merix Financial. "It's not easy."
Even if a broker understands the fundamentals of these practices, there is a lot of back-end work involved. And while some lenders are offering assistance in this area – namely, managing the back-end work, free of charge – others, like Merix, shy away from it.
"We don't manage funds when it comes to tax-deductible mortgage plans because we're concerned with a conflict of interest," says Bozic. "We wanted to take a step back – we're not a bank. We defer to the mortgage originator – the financial planner manages the money and investments."
1. Partake in portfolio-based lending rather than transactional-based. This means taking the client's complete portfolio into consideration – including rental properties or investments they aspire to purchase down the road.
2. Find a reputable partner. It always helps to have a second set of eyes look over complex transactions. Establish a relationship with someone who has proven experience in your chosen area – whether it's a chartered accountant, financial planner or fellow mortgage broker.
3. Make sure you're 'probing' not 'advising'. Overstepping your boundaries can cost you your mortgage licence, lead to a law suit – or worse.
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