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What is a Rental Property? (Investment Property, Income Property)

A rental property is a type of real property like a home or apartment complex that you own, but do not live in. Instead of living in the property, you allow an occupant known as a tenant to stay there and pay you a monthly fee, or rent.

For Canadians looking to invest, buying a rental property in Canada can be an excellent idea, but financing a property of this nature can be quite complex.

How to Get a Mortgage for Rental Property in Canada

Securing financing for an investment property in Canada will depend on how many units are in the property, and if you’ll be living in one of the units. If you’ll be living in one of the units, the property is considered “owner-occupied.” An owner-occupied property and a non-owner occupied property have different down payment requirements. It is important to note, that some lenders will not grant you a mortgage unless it is an owner-occupied property. Working with a mortgage broker is key in identifying, and securing the best possible lender and mortgage product.

To start the approval process, you’ll need to provide the lender with the following documentation.

  • Agreement of purchase and sale
  • Proof of your down payment
  • Proof of your income
  • Proof of current renters (if any)
  • Zoning documents to ensure the property is residential (and not commercial)

Just like a standard residential mortgage, the lender will do a credit check and review your debt ratios.

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Income Property in Canada Debt Ratios for Mortgages

Before giving you a loan, the lender will need to determine if you will actually be able to afford the mortgage payments and expenses that come with owning a rental property. To do this, they use various debt ratios. The three ratios that are used are: two variations of the Total Debt Service (TDS), and the Debt Service Coverage Ratio (DSCR).

Total Debt Service: Rental Offset & Rental Inclusion for Rental Properties

The total debt service ratio is the percentage of your income required to pay your mortgage, housing expenses (property taxes, heating) and all other debts (credit card payments, auto loans).

Rental Offset
For an investment property, lenders will often allow a rental offset of 50-70% This means that 50-70% of the rental income for the year will be calculated to offset your expenses like mortgage payments and other housing costs.

Rental Inclusion
This method essentially “includes” income from the rental property as your income when qualifying you. 50% of the annual rental income gets added to the gross income portion of the total debt service calculation.

Debt Service Coverage Ratio for Rental Properties in Canada

The debt service coverage ratio is the property’s net operating income (total income minus operating expenses) divided by the annual mortgage payments. This ratio should be over 1. The higher the debt service coverage ratio, the higher your chances are for getting your mortgage approved.

mortgage for rental property in Canada

Some rental properties will qualify for a 30-35 year amortization schedule, which translates to lower monthly mortgage payments for you.

Required Mortgage Down Payment for Rental Property in Canada

The amount of down payment required for an investment property will depend on how many units the property has, and whether or not it will be owner-occupied.

There are 4 scenarios for a standard rental property:

  • Owner-occupied with 1-2 units = 5% down payment required
  • Owner-occupied with 3-4 units = 10% down payment required
  • Non-owner occupied with 1-2 units = 20% down payment required
  • Non-owner occupied with 3-4 units = 20% down payment required

It is important to note that a 5% down payment applies only to the first $500 000. Anything over that threshold will be subject to a down payment of 10%. Currently you are not able to buy rental property with no down payment. Fortunately, if you have a lot of equity in your existing home, you can usually buy an investment property with a home equity loan.

Down payments of less than 20% will require insurance. The premiums can usually be lumped in with the mortgage amount. Occasionally a lender will require insurance even if the borrower does put down more than 20%. This depends on finances and will be at the lender’s discretion.

What is the Interest Rate for Investment Property in Canada?

If you have an appropriate down payment, meet the lender’s requirements, and have a good credit score, owner-occupied financing will be the same competitive rates you’d typically receive for a standard residential mortgage. This includes fixed, variable, and adjustable rental property mortgage rates. Mortgage rates for non-owner occupied properties are often just slightly higher.

In addition to qualifying for the mortgage rate, potential borrowers will also need to be able to pass the Stress Test, introduced in January of 2018. The stress test determines if you would be able to pay your mortgage in a worst case scenario (like if rates were to suddenly rise).

The stress test is calculated using either the Bank of Canada’s 5-year benchmark rate, or at the current contract rate plus 2% – whichever is higher. So if you were pre-approved at 3.25% and the current benchmark rate is set at 5.14%, you would actually need to qualify for a 5.25% interest rate. Qualifying for a higher rate ensures lenders that the borrower won’t default on their loan.

Need a Mortgage for Rental Property? How a Mortgage Broker Can Help

Rental property financing is considered a specialty product, so it can be very difficult to find a suitable lender. Anyone in the market for a mortgage can either go to a bank, or to a mortgage broker. The downside of working with a bank, is that they only have access to their own products. Even if your local bank does offer investment property mortgages, it is very likely that their product is not the most ideal fit for you (too specific restrictions, etc.).

The absolute best way to achieve financing for a rental property in Canada is to work with a mortgage broker. A mortgage broker routinely gets rental properties approved. They can review your unique situation, and match you up with one of their many lenders, who is most likely to approve your application and give you a great rate. In addition to taking the work off your hands by finding you the best lender, their services are also free. A mortgage broker gets paid by the lender, but not until your mortgage has been approved and funded.

Pros and Cons of Buying Rental Property in Canada

For people who have some extra cash and would like to start investing, “should I be investing in rental properties?” is often a question that comes to mind. Below are the top pros and cons of rental property to consider before purchasing.

Pros of Buying Investment Property in Canada

  • Pay Less TaxWith a rental property, you’re permitted to deduct expenses from your income like mortgage interest, property taxes, insurance, management, maintenance, and sometimes losses. This lowers your total income, reducing the amount of taxes you owe.
  • Receive Steady Income Each MonthWith tenants occupying your rental property, you can rely on that cheque arriving every single month. The income from this type of investment is usually considered quite predictable compared to other forms of investments, like stocks.
  • Benefit from Increase in Property ValueBecause you own the property, you will directly benefit if its value rises each year.

Cons of Buying Rental Property in Canada

  • Tenant RiskBeing a landlord is not enjoyable for everyone. You are the one that gets called when something breaks, and having tenants can be frustrating, especially if they do not make their payments on time. You can hire a management company to deal with tenants on your behalf, but it will cost you.
  • The Investment is Not LiquidSelling real estate can be expensive and takes a very long time, compared to an investment like stocks which are liquid, meaning they can be bought and sold relatively quickly.
  • Plenty of ExpensesAs the property owner you’ll be responsible for all the standard residential household fees that come up like insurance, property taxes, etc. These fees can be very detrimental if the property is vacant for some time, because you still have to pay them, even if no one is paying you rent.
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