Mortgage payments and rental interest

Canadian rates compound twice a year

The Interest Act requires a mortgage with blended payments to state its rate compounded yearly or half-yearly, and fixed-rate mortgages in Canada are quoted half-yearly. A 5% rate is 2.5% for each half-year, and the rate for each payment is the one that grows to 2.5% over six months. Dividing 5% by twelve, as many US calculators do, overstates the payment.

On a $350,000 mortgage at 5% over 25 years, the monthly payment is $2,035.62. Compounding monthly instead would give $2,046.07.

Only the interest is a rental expense

Each payment is part interest and part principal. Interest on money borrowed to buy or improve a rental property goes on line 8710. The principal repays the loan. It is not an expense and does not appear on the T776.

What counts is how the borrowed money was used. If you live in part of the property, only the rental share of the interest is deductible. Money taken out later for a personal purpose, such as refinancing to buy a car, does not become rental interest because the rental property secures it.

The first year is mostly interest

Interest is charged on what is still owed, so early payments are mostly interest. In the example above, the first twelve payments include $17,157.01 of interest and repay $7,270.43 of principal.

A return uses the interest paid in the calendar year, which rarely lines up with the first twelve payments. Your lender’s annual mortgage statement shows the figure for each year.

Accelerated payments

An accelerated bi-weekly payment is half the monthly payment, paid every two weeks. Twenty-six halves make thirteen monthly payments a year, and the extra one goes to principal. In the example, the first year’s interest falls to $17,080.19 and the principal repaid rises to $9,382.87.