Many people in Toronto are intrigued at the possibilities associated with rental properties but aren’t quite sure how to finance their plans. There are several different reasons why Canadians are interested in purchasing a rental property such as using the income to pay off their mortgage or to build up a retirement nest egg. Some investors even sell the property for a profit after fixing it up. To make things a little clearer, we must understand what the difference is between a second home and a rental property. Basically, a rental property is there for the sole purpose of generating income and a second home is for living in or recreational purposes.
Financing Rental Properties
When it comes to financing a rental property, some traditional financial institutions may lend up to 80 percent of the appraised value of the building or the purchase price. They usually lend the money for the lower amount of those two options. For loans higher than 80 percent on residential properties, the financial institution will likely require you to insure the mortgage with CMHC (Canada Mortgage and Housing Corporation) or Genworth MI Canada.
The lender will require that the majority of the property’s operating expenses, including the mortgage payments and property taxes, are covered by legal income. If the property isn’t self-sufficient in this regard, then you’ll need to show that you can personally handle any financial shortfall. Some potential buyers prefer to place a larger down payment while others would rather borrow as much money as possible. To come to the right decision regarding this, it’s recommended that you discuss all of your options with a professional, licensed mortgage broker.
You’ll also need to understand how cash flow works. This term represents the total rental income minus all of your allowable expenses such as mortgage interest, general maintenance, possible vacancy, and property taxes. In many instances, the rental income will be exceeded by the expenses and create a monthly negative cash flow. A negative cash flow allows an investor to reduce their income tax since it can be deducted from their earned income.
As with most types of mortgages, you’ll need to have a good credit rating of at least 680 to be considered a lower risk for a rental property and to receive more favourable interest rates. You can always check your credit score before applying for a mortgage to know exactly where you stand. The key in any mortgage financing is to show you’re a low-risk borrower. It’s a good idea to have a game plan when it comes to rental properties. For instance, are you interested in a single property or several of them and are they located in different areas? You also need to know how long you need the financing for.
You’ll need to prove your income to potential lenders via pay stubs and/or a letter of employment. You can also use a notice of assessment and income tax returns. If you work for commission or are self-employed, it’s likely that notice of assessments, income tax returns and other financial documents related to your business will be required. You may also be asked for your business registration or the company’s website address.
Most lenders will ask for a minimum down payment of 20 percent of the rental property’s purchase price. In addition, the lender will need to know that you haven’t borrowed the money for the down payment. You can prove this by showing the money was in your account for 90 days before the down payment was due. Your down payment can come from selling another property as long as you can show the agreement of purchase and sale, in order to prove how much you’ve made from the sale.
As well as having a down payment, the lender will likely want to see a minimum of 1.5 percent of the purchase price to cover the closing costs. It’s also recommended to have some kind of contingency fund available in case of an emergency. If you already own other properties, the lender will want to see property tax and mortgage statements for them along with lease agreements if they’ve been rented out. If the properties have a negative cash flow, you’ll need to show you can cover it each month.
Work with a professional
To be sure that your investment efforts get the best results, you’ll want to work hand in hand with a good, experienced, mortgage professional, home inspector, real estate agent, property insurance broker, and real estate lawyer. At MortgageMeister.com, we’ll be able to assist you every step of the way when applying for financing for a rental property. We’ll be able to fully explain and simplify what can be a complicated process and help you find the best terms and rates for your investment. Please feel free to contact us at your convenience for more information and assistance on any mortgage-related matters.