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How To Finance A Rental Property
In the wake of a hot, real estate market and a less than robust stock market, many investors are considering purchasing rental real estate as an additional option for wealth creation. The qualifications for rental property mortgaging changed drastically since the recession of the early '90s. During the recession, many landlords either declared bankruptcy or walked away from devalued real estate leaving the lenders "holding the bag" on run down rental properties with non-cooperating tenants. During this period, the majority of the power of sale, properties were rentals. The expensive lessons learned by the lenders and Canada Mortgage & Housing Corporation (CMHC) translated into tougher criteria for rental property financing including amongst other things, higher rates. Since this may be your first foray in to rental real estate here's a tip on financing a rental property.
The minimum down payment required to purchase a rental property is 15% of the value. The remaining 85% of the value required can be financed in one of two ways. Since the Bank Act will only allow up to 75% of the property value in un-insured financing, this mortgage needs to be either insured through CMHC or a first and second mortgage combination must be used to come up with the total financing required.
CMHC guidelines for financing rental properties insist that the borrower must have a net worth of $100K (not including the down payment) to begin the qualification process. Then you must demonstrate that you can carry the mortgage payments on the rental property with your own income in addition to all of your other debts. The rental income that you would collect is not used as an offset of the rental mortgage payments, as you would assume. A rental offset suggests that the rental income you earn goes directly to paying your monthly mortgage costs. Essentially, money in equals money out. In the insured mortgage qualification process, 50% of the rental income is, actually, added to your regular income, to assess your ability to service all your debts. If you currently have a mortgage on your principal residence, this is similar to trying to qualify for two mortgages with a small raise in your income! Not an easy task. However, If you're successful in meeting the above criteria and a few others and the property meets with the lender and CMHC guidelines, you will be approved for an insured mortgage on the rental property. Of course, you then incur the cost of the insurance premium, which amounts to a staggering 4.5% of the mortgage amount. That means a $200K mortgage will have an insurance premium of $9000.
Since most rental property buyers own their principal residence, probably a more acceptable scenario would be to consider leveraging the equity available in your home to facilitate the purchase. Place a line of credit on your home to extract an amount equal to a minimum of 25% of the value of the rental property. Use that money for the down payment and finance the rest eliminating the need for an insured mortgage and the hefty 4.5% insurance premium. For qualifying purposes, many lenders will also consider the rental income as a direct offset against the mortgage payments. This is a tremendous advantage as it has little or no effect on your debt serviceability. Qualifying for the financing just got a whole lot easier.
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