*This post was created in collaboration with Alpine Credits
Real estate has consistently proven itself as one of the most effective methods for Canadians to accumulate wealth. Housing demand in Canada has continually risen over the years and serves as a safeguard for your investment, even if local housing prices dip. Those considering investing in a rental property should explore financing options like a landlord mortgage.
Key Points
- Landlord mortgages help buyers finance the purchase of rental or investment properties.
- Down payment requirements are usually higher for landlord mortgages compared to home loans on primary residences.
- Mortgage interest rates also tend to be a little higher for landlord mortgages than for standard mortgages.
What Are Landlord Mortgages?
A landlord mortgage is a loan that you can take out to finance the purchase of a rental property. These mortgages differ in a few ways from standard mortgages for primary residences that you live in with no tenants
Types Of Rental Properties Mortgages
There are two different scenarios in which you can earn rental income with your rental property:
Owner-Occupied Landlord Mortgage
This type of mortgage is meant for a rental property that you live in, but that also has either a suite, basement, or room that you rent out. It’s similar to a mortgage for a primary residence that only you would reside in.
Since you live in the home and consider it your primary residence, banks will allow you to put as little as 5% as a down payment. Declaring your intention to rent out part of your future home could be a good strategy to qualify for a higher loan amount as the projected rental income would strengthen your mortgage application. This can help you obtain mortgage approval on a bigger property, or help you pay for renovation costs for your new home.
Non-Owner Occupied Landlord Mortgage
Non-owner-occupied rental properties are a bit different. These properties are not lived in by the homeowner and are rented entirely to tenants.
When applying for a mortgage for a non-owner-occupied rental property, you must put down at least 20%. Banks will not lend to you if you only have a 5% down payment, since it’s not your primary residence.
How Do You Qualify For A Landlord Mortgage?
A landlord mortgage comes with roughly the same requirements as a standard mortgage for a primary residence, along with a few extra criteria.
Low Debt Service Ratio
Lenders will assess your financial ability to meet your monthly debts and expenses. You’ll need a strong income that’s enough to cover not only your mortgage payments but also your debts. As such, your lender will look at your income level and debt load when assessing your ability to secure a landlord mortgage.
More specifically, your lender will calculate your debt service ratio. This ratio measures how much of your income is dedicated to paying your existing debt and is calculated by dividing your debt by your gross income.
Your debt service ratio can be broken down into the following:
- Gross Debt Service (GDS). Your GDS ratio is the percentage of your gross income that goes towards paying all housing costs. It should not exceed 39%, according to the Canada Mortgage and Housing Corporation (CMHC).
- Total Debt Service (TDS). Your TDS ratio is the percentage of your gross income that goes towards paying all housing costs, plus all other debts you have. It should not exceed 44%.
These ratios together calculate the maximum debt you can carry as a percentage of your income.
Large Down Payment
Landlord mortgages in Canada require a larger down payment amount compared to mortgages for primary residences. A bigger down patent reduces the risk for the lender since the borrower has more equity in the property. Most lenders require a minimum 20% down payment for a landlord mortgage.
If you already have a property as your primary residence, for example, you could use its equity to pay for your down payment.
Good Credit Score
Like a regular mortgage, a landlord mortgage requires that you have good credit to qualify. Your creditworthiness determines how likely you are to keep up with your mortgage payments.
In Canada, a ‘good’ credit score is one that falls within the 660 to 724 range. The higher your score, the better your chances of loan approval at an affordable rate.
Documents Required
You’ll need to provide a variety of financial documents to your lender, including:
- Tax returns
- Proof of income
- Bank statements
- Paystubs
- Letter of employment
- Sales records if you own a business
Benefits Of Owning An Investment/Rental Property
Investment properties can be lucrative investments and offer several benefits, including the following:
Extra Income
Investment properties can offer you extra income through regular rent payments. You can use these payments to pay your mortgage or to boost cash flow to be used for a variety of other purposes.
Build Long-Term Wealth
Real estate tends to increase in value over time. As you pay down your mortgage and allow your property to naturally appreciate in value, you can build equity in the home. This long-term investment will help you achieve a higher net worth in the future and provide you with an asset that you can borrow from or pass down to future generations.
Tax Incentives
Talk to your accountant to find out all of the different tax deductions you can take advantage of on your rental property. Although being a landlord can be an expensive endeavour, (repairs, maintenance, mortgage payments, etc.), there are several expenses you will be able to deduct from your income, such as:
- Repairs and maintenance
- Property taxes
- Utilities
- Management fees
- Insurance
- Mortgage interest
Increased Sense Of Control
Landlord properties allow you to take control of many aspects surrounding the property, including renovations, rentals, financing, or even repurposing the property into a commercial business.
Drawbacks Of Owning An Investment/Rental Property
Like all investments, buying a rental property is not always 100% secure. Owning an investment property can pose various risks, such as:
High Costs
Mortgage payments, interest, and down payments are far from all you need to cover the costs of owning a rental property. Be prepared to shell out money for closing costs, property and pest inspections and treatments, and legal fees. Don’t forget that as a landlord, you are responsible for repairs and maintenance costs, property taxes, insurance, and other ongoing costs.
Time Commitment
Rental properties are not quick returns on investment. You’ll need to take time to advertise the property, find and screen suitable tenants, collect rent cheques, and maintain the property. Alternatively, you can hire a property manager to tackle these chores for you, but you’ll be paying extra for these services.
Vacancies
Be prepared to have your property vacant for some months, and be patient during that time. While the place is vacant, you won’t be collecting rent, so make sure you can handle that financially.
Dealing With Unruly Tenants
Properly screening tenants is a crucial step to becoming a landlord. It’s better to have your property empty for a while as you find the right tenant than to fill the vacancy right away with a difficult renter. If you land a bad apple, you could find yourself dealing with headaches until you can replace them.
Factors To Consider When Getting A Landlord Mortgage
When looking for a landlord mortgage, there are many factors to consider before making a decision. Let’s take a look at everything you will need to account for before jumping into a landlord mortgage:
Interest Rates
Some lenders might assume that, if given the option, you are more likely to default on a property that you do not reside in than on a property you do reside in. Because of this, mortgage rates for investment properties might have a slight premium or higher interest rates than for primary residences.
Fees
Applying for a landlord mortgage comes with many fees that may not be obvious when you first start looking. Be sure to consider the following:
- Application fees
- Appraisal fees
- Closing costs
- Fees for late mortgage payments
- Prepayment fees
Make sure to ask your lender or examine your contract in great detail to learn about any prepayment fees.
Eligibility
Make sure to research and consult with your bank or broker to ensure that you meet all the eligibility requirements for a landlord mortgage, as discussed above.
Amortization Period
The amortization period refers to the amount of time it would take for you to pay off a mortgage, including interest. Most mortgages have an amortization period of 25 or 30 years, though it may be much shorter.
A longer amortization period means lower mortgage payments, but it also means more interest paid over the life of the loan. A shorter amortization means bigger payments, but less paid in interest overall.
Where To Get A Landlord Mortgage
Various types of lenders offer landlord mortgages, including the following:
Traditional Lenders
Conventional lenders, like banks and federally regulated credit unions, offer landlord mortgages. These loans typically come with the lowest interest rates, though they may be more difficult to get approved for because of the more stringent financial and credit score criteria.
B Lenders
Also referred to as ‘subprime lenders’, B lenders provide borrowers with an alternative to traditional banks if they can’t meet the income and credit criteria demanded by prime lenders. Borrowers with lower credit scores, non-traditional income, newcomers to Canada, or self-employed individuals may have better luck securing a landlord mortgage with a B lender.
Private Lenders
Private lenders include individuals or companies that provide mortgages for the purpose of earning a profit. Since private lenders are not federally regulated, they don’t have to impose the same level of loan criteria on borrowers as A lenders.
That means loans from private lenders are much easier to get approved for and don’t require a mortgage stress test. However, in exchange for this leniency, private lenders tend to charge much higher interest rates.
Final Thoughts
Landlord mortgages are the first step in bringing in rental income. Although rental properties are usually great investments, it’s important to conduct enough research, compare rates and loans from different lenders, and familiarize yourself with all factors associated with acquiring a landlord mortgage before making a decision.
Landlord Mortgage FAQs
Do I need to undergo the mortgage stress test for a landlord mortgage?
Will I be charged a higher interest rate on a landlord mortgage?
Do I need mortgage default insurance on a landlord mortgage?
Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.
