Whether you already own your home and are thinking of getting into real estate as an investment, or if you want to start with an investment property, this information will help with your planning.
The points below apply to rental properties that are single homes or condos, or multi-unit properties up to 4 units. These fall under regular residential lending rules. Five units and up, or commercial properties are treated differently for financing.
Down Payment – To purchase an investment property (which you are not going to live in) up to 4 units, you need to have a minimum of 20% of the purchase price for the down payment. If you have equity in your home, consider a home equity line of credit to provide the down payment. If you are purchasing a duplex, triplex or 4-plex and you plan to occupy one of the units, you can purchase with a smaller down payment. For an owner-occupied duplex, you need a 5% down payment, and for a triplex or 4-plex, you need 10%. Mortgage insurance premiums apply with less than 20% down.
Cash Flow – When calculating your cash flow, you want your rental income to cover your mortgage payment, property taxes, condo fees (if applicable), insurance and utilities. You should also make allowances for vacancies and maintenance when working out the numbers for a property. Lenders will qualify you based on a combination of the rental property income and expenses along with your personal income and expenses.
Fire Code Requirements – Each municipality has fire code requirements. Some lenders may require a fire retrofit certificate for multi-unit properties to ensure the property meets the fire code.
Tax implications – don’t forget that your net rental income is taxable. You can deduct costs such as your mortgage interest and property taxes, which will reduce your taxable rental income. When you sell your investment property down the road, the profit on the sale is subject to capital gains tax. It’s a good idea to talk to your accountant to ensure you’re aware of all of the tax advantages and implications of buying an investment property.
Qualifying – Qualifying for a mortgage for an investment property is similar to qualifying for purchasing your own home with some additional factors to consider. The approval is based on your personal financial situation in conjunction with the subject property details. An appraisal is always required by the lender to confirm the value of a rental property. Lenders will include rental income in the calculations. Depending on the lender, the amount or rental income included in the calculations varies from 50% to 100%. Most lenders require current leases to confirm rental income.
Interest Rates – If you’re purchasing a non-owner-occupied property, expect your interest rate to be slightly higher than the rate for an owner-occupied property. Most lenders charge a rate premium for investment properties.
Paperwork – Verification of your personal income is required along with verification of the rental income for the subject property and any other properties that you own. Verification of your down payment and other expenses such as existing mortgages and property taxes on any properties already owned is also required. An appraisal is required for all investment properties.
Costs – Appraisal fee, mortgage insurance premium (if applicable), plus legal fees. Properties that are 5 units or more are considered under commercial lending with most lenders.
Qualifying for the purchase of a property of 5 units or more is based primarily on the subject property cash flow (rather than your personal financial cash flow). Here are some points to consider for properties with 5+ units…
Down Payment – The down payment required by most lenders for 5 units and up is 35% for an uninsured mortgage. With CMHC insurance, you can purchase with as little as 15% down. CMHC fees and insurance premium will apply.
Cash Flow – Lenders will qualify the mortgage based on the cash flow for the subject property, including rental income, expenses and allowances for vacancies, maintenance and management.
Fire Code and other Requirements – most lenders will require a fire inspection or certificate and may require a Phase 1 environmental assessment and/or a structural engineering report and/or other information depending on the type of property.
Tax Implications – Net rental income is taxable and capital gains may apply down the road when you sell. Talk to your accountant about the option of registering the property in a company name, which may or may not be advantageous from a tax perspective.
Qualifying – Most lenders use the cash flow for the subject property to qualify for a mortgage. The property must meet certain Debt Coverage Ratios, usually around 1.2. This means that the income must be 1.2 times as much as all of the expenses including the mortgage, property taxes, utilities, maintenance, vacancy allowance, etc..
Interest Rates – Rates vary and are not usually posted. Each application is assessed and priced on risk. Rates are generally slightly higher than regular residential rates.
Paperwork – Rent roll for the subject property, along with a property tax bill, income and expense statement. If currently held in a company name, financial statements may be requested.Verification of personal income may also be requested. An appraisal is always required.
Costs – Fees apply for appraisal and other inspections (eg Phase 1) if required. CMHC fees will apply if insured. Lender and broker fees may apply plus legal fees.
Article by Cathy Macdonald, Mortgage Brokers Ottawa