Your mortgage is likely the biggest bill you have to pay every month. In an effort to help with mortgage payments, many Canadian homeowners choose to outfit their homes with a separate rental unit to collect extra income. The money charged in rent can then be used to offset the cost of a mortgage.
But building a tenant apartment in your home is expensive and requires you to adhere to local bylaws and building codes.
Luckily, you don’t need the money upfront to cover the cost of renovating your home to include a tenant apartment. With a home renovation loan, you can add a rental unit in your home and start collecting monthly rent cheques that can be used towards paying down your mortgage, or any other expense you may have.
What Is A Tenant Apartment?
Creating a suite in your home that you can then rent out to a tenant involves a lot more than just setting up a bed and adding a little bathroom and kitchenette. While that may be enough for someone to live in, it can’t really be classified as a legal tenant apartment until it’s met the building codes in your municipality to be considered a legal separate apartment.
Back in the day, homeowners could build second suites in their homes and rent them out without many restrictions. But these days, there are plenty of bylaws and building codes that govern legal tenant apartments in Canada.
For example, here are some criteria you must meet in order for your secondary suite to be considered legal in Toronto:
- Be self-contained with a separate kitchen, bathroom, and living area
- Have a minimum ceiling clearance of 6′ 5″
- Have a minimum of two unobstructed escape routes, including a door that leads directly outdoors.
- Comply with residential zoning requirements, bylaws, health and safety regulations, occupancy standards, and fire and electrical codes.
- Have drywall, flooring, and properly maintained fire alarms.
Keep in mind that the rules and regulations surrounding legal second suites will differ from province to province, and from city to city. Be sure to check the bylaws where you live before transforming the space in your home as a tenant apartment.
Rental Income vs. Business Income
Understanding whether the rent you collect from your tenant is classified as rental income or business income is important as it will affect the way you calculate your gross income as well as the type of expenses you can deduct. To distinguish between the two, consider how many services you will be providing your tenants, as well as the type of services provided.
If you simply offer rental space for a tenant to live in and provide basic services such as heat, light, laundry, and parking, you’d be considered to be collecting rental income. But if you provide other services to your tenant, such as meals, security, and cleaning services, you may be running a business.
How Do You Finance A Tenant Apartment?
Renovating a space in your home to create a separate apartment is usually a very expensive endeavour. Luckily, you don’t need a lump sum of cash sitting in your bank account to cover the cost. Instead, there are numerous home renovation loan options available that you may qualify for to help pay for this large expense.
More specifically, a home equity loan or second mortgage may be a financial product to consider. If you own your home and have some equity built up in it, you may qualify for this type of loan.
Second Mortgages
Second mortgages are home loans that are taken out using the equity in your home. When you first take out a mortgage to buy a home, that would be considered a “first mortgage”. Naturally, a second mortgage would come in after a first mortgage, and is usually for a smaller amount.
If you ever default on your mortgage, the first mortgage would be paid off first, followed by the second mortgage. And if there is a third mortgage involved, that loan would then be paid off after the second mortgage.
Interest rates for second mortgages tend to be a bit higher than they are for first mortgages because of the added risk involved. As mentioned, the second mortgage would be second in line to be repaid in the event of mortgage default. If there is not enough money left in the pot, the lender holding the second mortgage may risk not recouping all the money loaned.
There are two commonly-used second mortgages:
Home Equity Loan
If you have equity in your home, you may be able to borrow against it to cover a large expense, such as a home renovation. Like a traditional personal loan, you’ll receive a lump sum of money to be used as you wish. The loan will need to be paid back in regular installment payments, plus interest, over a certain period of time. Interest rates on these loan types are usually fixed.
Home Equity Line Of Credit (HELOC)
Like a home equity loan, a HELOC allows you to borrow money against your home’s equity. But that’s where the similarities end. Unlike a home equity loan, a HELOC is revolving credit. You’ll be approved for a certain credit limit which you’re free to withdraw as much or as little as you like, as long as it’s not any more than your credit limit.
With a HELOC, you are charged interest only on the amount of money you withdraw. Once you repay that amount, you will no longer be charged interest, and you can re-use the HELOC on an as-needed basis. Interest rates on HELOCs are usually variable.
With both home equity loans and HELOCs, you’ll need to have at least 20% equity in your home to qualify.
Why Use A Home Renovation Loan To Finance A Tenant Apartment?
A home renovation loan comes with several perks that might make it a great option to help you pay for the cost of your home improvement project:
Good for cash flow – Rather than draining your bank account to pay for your home renovation project in one lump sum, you can keep much of that money as is and just make much smaller installment payments towards your home renovation loan. All that money that remains in your account can accumulate interest in the meantime. Or, you can invest that capital for even bigger gains.
Regardless of where you leave that money, it will be available for cash flow without leaving you financially strapped if you put all your funds towards improving your home.
Bad credit accepted – If your credit score is a little on the lower end of the spectrum, you may still be able to qualify for a home renovation loan. That’s because the loan is secured against your home, which makes this type of loan less of a risk for your lender. In turn, your lender may be more willing to work with you even if your credit score is not as high as it would need to be to get approved for a personal loan.
No early mortgage repayment penalties -There’s no need to discharge your first mortgage in order to take out a second mortgage. For this reason, you won’t be subject to any early mortgage prepayment penalty fees, nor will you have to sacrifice a low-interest rate that you may have on your first mortgage.
Lower interest rates – Second mortgages come with lower interest rates compared to credit cards and personal loans.
Build the equity in your home – By improving your home, you can add more value to it, and therefore build more equity. With more equity, you’ll be able to borrow even more money against your home in the future if need be.
Pros And Cons Of A Tenant Apartment
Is having a tenant apartment in your home worth it? Here are some pros and cons of tenant apartments to help you determine if renovating your home is something you should consider.
Pros
- Rental income – The biggest advantage of a tenant apartment is the extra money you’ll collect every month. You can either put this towards paying down your mortgage or for some other expense you may have.
- Extra security – Anytime you’re ever away from home, there will be someone there to watch the house. Thieves usually target homes that are vacant for a period of time. But if your tenant is home while you’re away, this could act as a deterrent against break-ins.
Cons
- Privacy – You’ll be giving up a little bit of privacy since someone else will be living in your home.
- Expensive – Renovating your home to create a rental suite that is up to code can cost thousands of dollars. That said, you can use a home renovation loan to help accommodate the costs.
- Your electricity is being used by the tenant – If you include the cost of electricity in the rent, you’ll be on the hook for paying for the extra energy used by your tenant. If you choose not to include electricity in the rent, you may have a more difficult time trying to find a tenant willing to agree to this arrangement.
Final Thoughts
If you’re looking for a way to reduce your financial burdens, having a separate apartment in your home can help you bring in extra cash in the form of rent payments. This can not only help you with your mortgage payments, but it can also help add more equity to your home by adding more value. And with a home renovation loan, you won’t have to come up with a lump sum of money on your own to cover the cost of your project.
