Case Study - A Toronto young family plans and executes a strategy to switch from a townhouse to a detached house during the pandemic.

This is an in-depth study on how a family in Canada utilized different types or mortgage in the process of selling a townhouse and buying a detached house during the pandemic. We hope this case study will help families, who are planning to upgrade/switch their residential properties, create and execute a strategy utilizing different types of mortgage.

The Toronto family is a young family of 4, with two kids aged 3 and 5. In January 2020, they decided it was time for them to upgrade their residential property in order to provide their children a better place to grow up in. Here is some background on the family:

  • They purchased a townhouse in 2013 for the amount of $420,000.
  • Their mortgage (we’ll referred to this as Mortgage A) on the townhouse was with a prime lender - RBC, for the amount of $380,000 with a fixed rate 5-year term contract at 2.89% interest rate. Their down payment on the property was $40,000.
  • They had utilized various pre-payment options such as annual lump-sum payments and increased monthly double-up payments. By January 2020, their mortgage was down by about 58%, to $160,000, within less than 6 full years. If they did not utilize those payment options, the mortgage would be about $250,000 instead.
  • They had a HELOC with their mortgage with RBC.
  • They only had about $25,000 in cash savings in January 2020. They had about $80,000 invested in RRSP and $10,000 in RESP at the time, but didn’t intend to touch these investment funds.
  • Their annual household income in 2020 was $150,000 before tax.
  • Their household expense was $5,000/month.
  • By 2020, the value of their property (townhouse) was around $780,000.

In January 2020, They decided to purchase a detached property with at least 5 bed rooms, such property was at least $1.25M in the Greater Toronto Area (GTA). Their ultimate goal is to settle with a prime lender for the lowest rates and with HELOC on the mortgage. They set the target on the new property valued at $1.25M. To obtain a mortgage with a prime lender, they needed about $437,500 in down payment. They didn’t have that much cash available but they knew the value of their townhouse was increased enough to cover the down payment, which means they had to sell their townhouse.

Because the real estate market was hot in the Toronto area in 2020, the family had decided that they needed to settle on buying a new property before putting the existing property up on sale. For example, they did not want to run into the situation where they have sold their current property but have not been able to buy a new property with a good price. They had considered the option to sell their townhouse first and utilize a bridge loan to cover the cost of setting up a new mortgage on the new property. In the end, they decided to go with the following overall plan:

  1. Buy the new property first at their ideal price range.
  2. Renovate the new property (if needed) while the current property is being listed for sale.
  3. Sell the current property and move into the new property at approximately the same time. (e.g. set the closing date of existing property and the move-in date of the new property at around the same time)

Utilizing HELOC to obtain the deposit for the purchase of new property

They took a few months and found a property for exactly $1.25M in early April 2020. The closing date on the new property was set to end of May 2020. The deposit on a $1.25M property is $60,000. Since the family only had $25,000 in cash savings and they did not want to use that since their monthly household expense was $5,000 so they wanted to make sure they have enough cash for their family to survive for 5-6 months in the unexpected event of lost income. So they took $60,000 out using the HELOC on their mortgage on the townhouse (Mortgage A). The outstanding balance on Mortgage A was increased to $220,000 as a result.

Refinance the existing property to obtain enough down payment towards the mortgage on the new property

The family did not qualify to obtain mortgage with a prime lender while their current residential property is not sold, and they needed to get mortgage approval to purchase the new property. They got in touch with a mortgage broker and obtained a $1M mortgage with a sub-prime lender. This mortgage (Mortgage B) had a 1-year term.

The $1M mortgage on a $1.25M property required $250,000 in down payment. The family refinanced their mortgage with RBC and obtained a new $600,000 open mortgage (Mortgage C) on their townhouse. This resulting in closing the original mortgage on the townhouse (Mortgage A) that had $220,000 in outstanding balance and $380,000 cash available. The family put $250,000 as the down payment of the mortgage on the new property (Mortgage B). With $130,000 remaining cash, the family had enough left over to cover the cost on realtor commission and land transfer tax. The land transfer tax in Ontario on a $1.25M property is $42,950 and the realtor commission on a $1.25M property is $31,250. The family also had to pay about $6,000 in legal/administrative fees for selling/buying properties, as well as $10,000 in mortgage broker commission.

By refinancing the existing property, the family was able to obtain enough to cover the cost of paying down Mortgage A, the down payment on the new mortgage, land transfer tax and realtor commission for purchasing the new property, mortgage broker commission from obtaining a mortgage with sub-prime lenders, as well as all of the legal and administrative fees involved. And was left with $40,000 cash.

So before the existing property (townhouse) was sold, they had:

  • Mortgage on the new property, with sub-prime lender, at $1M with 1-year term. (Mortgage B)
  • Mortgage on the existing property, with prime lender, at $600,000 (Mortgage C)
  • $40,000 cash

They ended up spending $30,000 in renovation on the new property and was left with $10,000. After they have obtained possession of the new property, they started renovation right away and started to pack and move things from the existing property to the new property to prepare the existing property for sale and save some money on moving services.

In July 2020, they sold their townhouse for $787,000 and the closing date was end of August 2020. After paying down the mortgage on the townhouse (Mortgage C) they had:

  • Mortgage on the new property, with sub-prime lender, at $1M with 1-year term. (Mortgage B)
  • $190,000 cash

Renovation finished before the end of August 2020 and the family moved into the new property without a hassle and paying only $500 in moving fees (they moved most of their belongings themselves, leaving only the large furniture for the movers) before the end of August 2020.

In May 2021, the family saved up an additional $30,000 and the total cash available was $220,000. After the term expired with Mortgage B, they closed Mortgage B with all the cash available, switched and obtained a new mortgage (Mortgage D) with RBC - $780,000 principal with fixed rate at 1.69% on 5-year terms. With $220,000 HELOC available to start. There were no pre-payment penalties with Mortgage B because it was only on 1-year terms.

In a nutshell, the different strategies this Toronto family used were:

  • Pay down mortgage faster and save on interest with annual lump-sum and monthly double-up payment options.
  • Use HELOC to obtain the deposit for a mortgage
  • Refinance a mortgage to obtain the cash needed on down payment, land transfer tax, realtor commissions, and legal fees
  • Utilize mortgage products from sub-prime lenders as temporarily/short-term financial instruments in the process of buying a new property and selling the existing property
  • Utilize open mortgage to avoid pre-payment penalties on short-term plans

The value of the new detached property was appraised at $1.65M as of October 2021. Back in January 2020, the family had $620,000 in the equity of their residential property (townhouse, $780,000 in value with $160,000 outstanding mortgage balance). Less than 2 years later, the family had $870,000 in the equity of their new residential property (detached house, $1.65M in value with $780,000 outstanding mortgage balance). A growth of $250,000 in net worth with a better place for the family to grow up in.

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Read next: Don't get fooled by interest rates that appear to be lower - you might be paying more on interest.

or back to previous: Common types of mortgage in Canada.