3 Practical Strategies for Active Management of Canadian Mortgage Debt

16% of Canadian mortgages are set to expire in 2024, requiring a reset of interest rates and monthly payments. Families with significant debt or facing mortgage renewals this year can do more than wait helplessly for rate cuts—they can actively manage their debt. Over the past six years, I’ve shared many active debt management strategies through this blog, and attentive readers may already have drawn insights from previous posts. In this article, I’ll summarize three of the most commonly used active debt management strategies.

01 Use Cash Wisely

Using available cash to reduce debt is a very instinctive approach and shouldn’t really be considered a debt management "technique." However, in practice, many families do not manage their cash effectively.

The primary rule for using available cash to reduce leverage is: prioritize paying down the mortgage on your primary residence, rather than on rental properties. The core of family debt management is to steadily work towards reducing consumer debt, including student loans, car loans, credit card debt, and your primary residence mortgage. There is no need to accelerate the repayment of rental property mortgages, as they are investment loans and the interest can be tax-deductible. As long as the cash flow is manageable, even if all consumer debt is paid off and there is still surplus cash, there’s no need to rush the repayment of rental property mortgages—unless a serious cash flow crisis arises.

For families with cash on hand, if you’ve already reached the prepayment limit on your primary residence mortgage and face penalties for further payments, you might consider accelerating the repayment of your investment property mortgage, particularly the one with the highest monthly payment pressure, if doing so can lower your monthly payments. The reason I bring this up is that some banks, while offering negative amortization variable-rate repayment options, are also persistently encouraging borrowers to “voluntarily” give up this convenience. These repeated reminders often highlight the perceived downsides of using such options.

Families with cash on hand may give in to this pressure and use their valuable cash to accelerate repayments on their investment property mortgages. This might reduce interest payments, but it also indirectly increases the net income from the investment property, which in turn increases taxable income. Even if you use cash to accelerate repayment on a loan with negative amortization, the monthly payments may not necessarily decrease, so it’s not advisable to accelerate repayments on such loans. Accelerating investment property mortgage payments is always the least favourable option, unless you face a serious cash flow crisis. Otherwise, there is no need to hastily pay off investment property debt, no matter how urgently the bank tries to persuade you.

For families without cash on hand facing a debt crisis, the first option should be to sell financial assets, not property. Selling property can result in significant capital gains taxes if the property has appreciated substantially, which could solve this year’s cash flow problem but create a major tax liability for next year. If the property hasn’t appreciated much, potential buyers might sense a cash flow crisis and offer deep discounts, making it hard to sell the property. Liquidating property is akin to "killing the goose that lays the golden eggs" and should be a last resort.

For many Canadian families, most liquid financial assets are held in U.S. stocks or bonds. If you face a debt crisis and need to liquidate financial assets, the first choice should be assets in your TFSA that have appreciated. For example, borrowers who renewed their mortgages between August and November of last year may be looking at fixed rates over 7%. If your loan balance is significant and your monthly payments have risen sharply, you might consider selling profitable financial assets in your TFSA to pay down the principal when it’s time to renew, helping you avoid high monthly payments that could affect your overall debt level. Thanks to the U.S. stock market’s steady rise over the past two years, families in debt crises may find a glimmer of hope.

For families with excess cash, though not the main focus of this discussion, I want to remind readers of one important point: given the current state of the pre-construction market, avoid using your cash to buy pre-construction condos. In certain circumstances, cash deposited into pre-construction projects can effectively hold your funds hostage. As Hongyu Wang says, "The final payment on a pre-construction condo is the ransom for your initial deposit." The cash you invest today may require an additional payment at closing just to release that deposit. So, don’t let your cash get tied up.

The current situation with pre-construction closings is alarming. Take, for example, a condo bought for $900,000 a few years ago, now appraised at $700,000 at the time of closing. The bank is only willing to provide a $560,000 loan, meaning the buyer would need to come up with an additional $160,000 to close the deal. Here’s the calculation for the final payment, or "ransom," for the pre-construction deposit: Purchase price of $900,000 – mortgage loan of $560,000 – deposit of $180,000 = $160,000. If the buyer can’t come up with this $160,000 at closing, the transaction cannot proceed.

Since 2018, construction costs have risen dramatically and continue to worsen as construction loan interest rates have doubled. Pre-construction condo prices remain high, increasingly out of sync with resale market prices, which is why buyers are now facing these "ransom" payments to finalize their purchases. This issue is expected to persist for several years to come.

02 Make the Most of Loan Policies

Variable-rate borrowers can switch to a fixed-rate mortgage without penalties, provided that the remaining term of the variable-rate contract is shorter than the new fixed-rate term. For example, if you have a 5-year variable-rate contract with 2.5 years left, you can switch to a fixed-rate contract of 3 years or more at no cost.

Last year, I had a mortgage up for renewal and chose a 5-year variable-rate term. This year, I switched to a 5-year fixed-rate term with no penalties and successfully lowered my interest rate by 2%.

Variable-rate borrowers experience different levels of hardship depending on the bank they’re with. Some banks, like Scotiabank (BNS) and National Bank of Canada (NBC), increase monthly payments whenever variable rates go up, which has been a struggle during the interest rate hikes of the past two years. Borrowers with such mortgages should check how much time is left on their original contract and compare it with the current fixed-rate options their bank is offering. If switching to a fixed rate can lower your monthly payments, it might be a good option. Since we still don’t know when or by how much the Bank of Canada will cut rates, being able to lower your rate by even 1% right now would be equivalent to the Bank lowering rates four times by 0.25% each, which could immediately relieve payment pressure.

Other banks, like TD and BMO, allow for negative amortization, meaning the interest rate rises but the monthly payment stays the same, with any unpaid interest being added back to the loan principal. If you switch to a fixed-rate mortgage in this situation, it might actually increase your monthly payments, so it’s not always an obvious advantage. For example, if your current payment is $1,000 in a negative amortization scenario, switching to a fixed rate might reset your payment to $1,800. While this would save on interest costs, the monthly payment would permanently increase, and you wouldn’t be able to lower it back to $1,000.

If you have variable-rate loans with both BNS and BMO, you could consider switching the BNS loan to a fixed rate while leaving the BMO loan as-is, waiting for the Bank of Canada to cut rates.

There are three key factors to consider when deciding whether to switch from a variable to a fixed rate, and they should be evaluated in order of priority. First, if switching to a fixed rate would increase your monthly payment, it’s not recommended to switch. Second, if your original variable rate is relatively high, for example, Prime minus 0.4%, meaning your current rate is 6.8%, and switching to a fixed rate would lower your interest rate by more than 1% without increasing your monthly payment, it’s worth considering. Third, if your variable rate is favourable, for example, Prime minus 1%, with a current rate of 6.2%, and your loan has a HELOC with available credit, and switching to a fixed rate wouldn’t increase your payment, it’s worth considering the switch.

03 Make the Most of Your Investment Property HELOC

A Home Equity Line of Credit (HELOC) secured against your property’s equity is one of the best tools for debt management. A HELOC on your primary residence is usually used for emergencies and is not recommended for debt restructuring. Therefore, the HELOC strategies discussed here specifically refer to those on investment properties, not on primary residences.

Let’s say the mortgage on Property A is due for renewal in March this year, and the renewal rate from the current lender is around 5.5%. Since it’s a renewal, many banks do not allow changes to the amortization period, meaning the monthly payment will be reset based on the remaining term and the current interest rate. For example, if the outstanding loan balance on Property A is $500,000, with an original amortization period of 30 years and a 3-year term that is now ending, the remaining amortization period would be 27 years. At a 5.5% renewal rate, the monthly payment would increase from $1,900 to $2,946.

In this case, if Property B is an investment property and has a $100,000 available HELOC, and the interest rate at the bank holding the mortgage on Property B is also 5.5%, and they allow you to convert the $100,000 HELOC withdrawal into an installment loan with a repayment period of up to 30 years, you could withdraw $100,000 from Property B’s HELOC to accelerate the repayment of Property A’s mortgage. This would ultimately reduce your overall monthly payments.

If you have a pre-construction condo closing in 2024, with an existing mortgage on your primary residence, and available credit in the HELOC on your investment property, you could use your cash to pay down your primary residence mortgage and increase your borrowing capacity. Then, when it comes time to close on the pre-construction condo, you could draw on the investment property’s HELOC to cover the closing costs.

If the interest rates at different banks vary and the bank holding your investment property HELOC offers a lower rate, you could withdraw funds from the HELOC to accelerate the repayment of higher-interest loans elsewhere, thereby reducing your overall monthly payments and saving on interest costs.

04 Combining Strategies

After years of preparation, now is the time to apply financial intelligence to actively reduce monthly payments and interest expenses. All the debt management experience you’ve built and the cash reserves you’ve saved to avoid debt and liquidity crises are now ready to serve their purpose. Currently, Canadian homeowners face the heaviest debt burden in recent memory, with many hoping for interest rate cuts from the Bank of Canada. But instead of waiting passively for rate cuts, homeowners can take action now to manage their debts proactively.

Between August and November last year, fixed interest rates were over 7%, and families whose mortgages were up for renewal found these high rates hard to afford, causing significant damage to their balance sheets. The reason is that, under previous mortgage approvals, the stress test rate was around 5.25%, meaning 5.25% was the maximum mortgage rate most families could afford. If renewal rates were higher than that, borrowers found themselves struggling.

This year, however, many banks are offering 4- to 5-year fixed rates around 5.5%, which is much closer to the stress test rate. Now is the time to combine available cash, mortgage policies, and funds from an investment property HELOC to quickly and effectively repair the family balance sheet.

Recently, I met a former client at an event. She told me her family’s finances had changed, and she wanted my help to reassess their overall debt situation. After the event, she sent me a chart of their liabilities. After our discussion, I recommended that she continue using cash to accelerate paying off her primary residence’s mortgage, regardless of the interest rate. Then, she could use her available investment property HELOC to pay down the higher-interest loans on other properties. We also identified investment property loans that were maturing this year, and I advised her to prepare the necessary documents to refinance these loans, extending the amortization back to 30 years and extracting equity for financial asset investment to replenish cash reserves. Combining these strategies under the guidance of a professional is ideal, considering current resources and future plans.

Conclusion

Debt management is a lifelong skill for real estate investors. During the ultra-low interest rates after the pandemic, it was the best time to build wealth. Now, with higher interest rates damaging balance sheets, it’s time to test your debt management skills. Whether through favourable conditions or challenging ones, real estate investors must navigate an ever-changing environment—it’s not advisable to rely on rate cuts alone. In January 2024, Canada's inflation rate dropped to 2.9%, prompting excitement and celebration in many circles, with people anticipating interest rate cuts. However, it’s worth remembering that inflation fell to 2.8% in June 2023, only to rise again shortly after. Therefore, I encourage all readers to actively manage their debts instead of waiting on rate cuts.

The debt management strategies outlined above—avoiding property sales, combining financial assets with real estate, and leveraging mortgage policies and tools—are just a few examples of how to proactively repair your balance sheet. Over the past six years, I’ve proposed many more debt management strategies beyond what is discussed here.

Recently, I’ve been working with the Landlord Network AI team to train an AI assistant. I asked my AI assistant how to choose mortgage rates, and in just a few seconds, it summarized the key points from my previous articles. The AI assistant allows us to access knowledge more quickly. By combining AI-driven insights with local experience, our AI-powered community will dramatically improve the efficiency and accuracy of information searches. In this community, an AI assistant will instantly provide answers, followed by local moderators who will evaluate and refine the responses. If the AI’s answers are incorrect or incomplete, the moderators will correct and supplement them. The AI community I am moderating will launch within the next six months, and together we will step into the new world AI has to offer.