Real estate has continued to reign as one of the best investment opportunities for Canadians. There will always be a demand for housing in Canada, which will protect your investment even in the event that the price of houses decreases in your area. Experts say that even during the COVID-19 pandemic, houses are still a good investment, especially since interest rates are lower for most mortgages right now. While any real estate can be a solid investment, let’s take a look at property investments where you do not dwell on site.
What Are Landlord Mortgages?
Landlord mortgages refer to mortgages that you acquire for properties that you plan to rent out for income. These mortgages differ in a few ways from mortgages for properties that you reside on with no other tenants. The profit obtained from these properties, specifically from the rental income, is added to your personal income when you do your taxes.
There are two different scenarios in which you can earn rental income:
Owner-Occupied Landlord Mortgage
This type of mortgage is meant for a rental property that you live on, but that also has either a suite, basement, or room that you would rent to another person. It’s similar to acquiring a mortgage for a property that only you would reside in. Since you will be living on the property, banks will allow you to buy the home with at least a 5% down payment, though experts recommend saving up to 20% if possible regardless. Declaring your intention to rent out part of your future home could be a good way to encourage a greater amount of lending from banks, 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, the buyer must put down 20%. Banks will not lend to you if you only have a 5% down payment, as this property will not be one that you reside on.
How Do You Qualify For a Landlord Mortgage?
Obtaining a landlord mortgage will demand a few requirements from you, often more than usually required from a mortgage for a primary residence.
Debt Ratio
Lenders will often assess your financial ability to meet your monthly debts and expenses. To do this, lenders will calculate your debt service ratio.
- Gross Debt Service (GDS) – which is the percentage of your gross income required to pay for housing expenses
- Total Debt Service (TDS)- which is the percentage of your gross income needed to pay for housing expenses and other debts.
These ratios together calculate the maximum debt you can carry as a percentage of your income. According to the CMHC, borrowers must have a debt service ratio of no more than 35% for GDS and 42% for TDS to be eligible.
Minimum Down Payment
Landlord mortgages in Canada require a minimum 20% down payment in order to qualify. If you already have a property as your primary residence, for example, you could use its equity to pay for your down payment. For more information about second mortgages, check out our article on second mortgages.
Documents You Need to Provide Your Lender
You’ll need to provide a variety of financial documents to your lender, including:
- Tax returns
- Proof of income
- Credit score
- Sales records if you own a business
Benefits of Owning an Investment/Rental Property?
Investment properties can be quite lucrative investments if you are careful and determined. Here are some of the benefits:
- Extra income: Investment properties can offer you extra income. Even if you don’t make enough off of a rental to make a profit, having someone else pay your mortgages is a long-term investment that will help you achieve a higher net worth in future.
- Tax Incentives: Talk to your accountant to find out all of the different incentives there are for people who own rental properties. Although being a landlord can be an expensive endeavour, (repairs, maintenance, mortgage payments, etc.), there are some expenses you will be able to deduct from your income.
- 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, as well as legal fees. Don’t forget that as a landlord, you are responsible for repairs and maintenance costs for the property, and can face legal trouble if you do not uphold the property.
Time Commitment
Rental properties are not quick returns on investment. Selling property takes months sometimes, and so does finding suitable tenants. Be prepared to have your property vacant for some months, and to be patient during that time.
Inconsistent Cash Flow
As noted above, sometimes finding a tenant can take some time. This can result in inconsistent cash flow, as your property is bound to be vacant at some point. It’s important to budget for this before buying a rental property.
Factors to Consider When Getting Landlord Mortgages
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 application fees, appraisal fees, closing costs for your lawyer and lender, fees for late mortgage payments, and prepayment fees, which are incurred if you pay for too much of your mortgage in a short period of time, as the lender loses out on potential interest payments that were already agreed upon. 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 your rental property is eligible for a mortgage. Some mortgages aren’t available to specific property types, such as cottages for example.
Amortization Period
The amortization period, or the amount of time it would take for a borrower to pay off a mortgage loan, including interest, can be decided in consultation with your bank. Most mortgages have an amortization period of 25 or 30 years. Although having more time in your amortization period might lower your principal payments, keep in mind that a longer period means more interest paid overtime and that most lenders will require you to have a 20% down payment if you want a 30-year amortization term.
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.
Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.
Glossary
| TERM | DEFINITION |
|---|---|
| Appraisal | An appraisal involves assessing the value of a property based on current market values and is conducted by an appraiser that is typically assigned by a lender. The appraisal is then used by the lender to determine whether or not to extend a mortgage to a borrower. |
| Bridge Loan | A bridge loan is a type of short-term loan that may be used to “bridge” the gap between carrying a mortgage on an existing home and covering the mortgage for a new home. These are usually obtained when the closing dates of a home sale and purchase overlap, requiring the seller to continue paying the mortgage on the existing home before it closes while paying the mortgage on a new home. |
| Canadian Housing and Mortgage Corporation (CMHC) | A governing body in Canada that oversees and executes several federal housing projects in relation to the National Housing Act. |
| Cash-Back Mortgage | A cash-back mortgage allows borrowers to obtain the mortgage principal and a percentage of the loan amount in cash, which can come in handy to cover the cost of certain expenses, such as making home improvements or paying for car repairs. Rates on these types of mortgages tend to be higher compared to other home loans. |
| Closed Mortgage | A closed mortgage allows borrowers to prepay only a certain amount of the principal without being charged a prepayment penalty fee. Fixed-rate closed mortgage prepayment penalties are usually 3-months’ worth of interest or the interest rate differential, whichever of the two is greater. |
| Closing Costs | Before a real estate transaction closes, certain closing costs will need to be paid, which can include real estate commissions, lawyer fees, land transfer taxes, appraisal fees, home inspection fees, adjustments, and others. |
| Conditional Offer | A conditional offer is not yet final and means that there are certain conditions that must be fulfilled by the buyer, seller, or both before the sale is considered “firm.” For instance, an offer could be conditional on the home being inspected, which the buyer must be satisfied with. |
| Construction Mortgage | A construction mortgage allows borrowers to finance the cost of construction of a new home or major renovations. |
| Debt Ratio | Your debt ratio determines your ability to pay off a mortgage by measuring your debt relative to your income. Lenders look at debt ratios to assess a borrower’s ability to make mortgage payments. A high debt ratio means your debt load is too high relative to your income. Gross debt service ratio refers to your debt that does not include a mortgage payment, and total debt service ratio refers to your total debt including mortgage payments. |
| Deed | A deed is a document signed by the seller that transfers ownership from the seller to the buyer. |
| Down Payment | A down payment is the money that is put toward the purchase price of a home. The required down payment will depend on a number of things, such as the type of mortgage being taken out and the cost of the house. |
| TERM | DEFINITION |
|---|---|
| Firm Offer | An offer goes “firm” after all conditions have been satisfied and signed off by all parties. A sale can also be immediately firm if no conditions are included. |
| Fixed-Rate Mortgage | A fixed-rate mortgage means that the interest rate does not change throughout the entire mortgage term. Even if posted interest rates go up or down during the term, your rate will be locked in and stay the same until the term ends. |
| Foreclosure | Foreclosure is an unfortunate situation in which a homeowner loses possession of the title of their home as a result of mortgage payment defaults. When mortgage payments are missed, the foreclosure process may begin after a certain number of days have passed. In this case, the lender can take over the home under a “power of sale,” after which the homeowner may still have a chance to make good on their mortgage payments and bring their debt up to par. Otherwise, the lender may make efforts to sell the property to recover any money they are owed. |
| Gross Debt Service Ratio | A gross debt service ratio is the measure of housing-related debt relative to a borrower’s income. GDSR is a factor that lenders consider when determining whether or not to approve a mortgage application. |
| High-Ratio Mortgage | A high-ratio mortgage refers to a mortgage in which the principal is greater than 80% of the property’s value. That means more than 80% of the home’s value must be borrowed in order to buy a home, while the down payment is less than 20% of the property value. High-ratio mortgages require mortgage default insurance to be paid. |
| Home Buyers’ Plan (HBP) | The First-Time Home Buyers’ Plan (HBP) is a government incentive program that allows first-time homebuyers to withdraw up to $25,000 from their Registered Retirement Savings Plan (RRSP) – or $50,000 in total for first-time home buyers and their partner – to buy or build a home. The full amount withdrawn must be repaid within 15 years. |
| Home Equity | The equity in a home represents the value of the property, less total outstanding debt, that the owner actually owns outright. It is calculated by subtracting the total mortgage loan amount still owed by the property’s value. |
| Home Equity Line of Credit (HELOC) | Using the equity in your home, you can secure a line of credit that uses the equity as collateral. The credit limit is usually equivalent to a particular percentage of your home’s value and there is a set date when the loan must be repaid. If you default on this kind of loan, the lender can repossess your home and sell it to cover the owed debt. Since there is a high risk with this type of financing, it is typically used to finance big purchases such as home improvements, education, or medical expenses. |
| Home Inspection | Many conditions can be inserted into a purchase agreement, including a home inspection. The home inspection allows buyers some time to have the property assessed by a professional to uncover any potential issues with the home before the buyer is obligated to complete the purchase. |
| TERM | DEFINITION |
|---|---|
| Interest | Interest is added to the principal amount of the mortgage and is paid to the lender in exchange for access to the funds needed to complete a real estate purchase. Interest is charged from the moment the money is received to the moment the term expires. |
| Land Transfer Tax | Land transfer taxes are charged by the province in which the property is being purchased, as well as in certain municipalities. It is a type of tax that is based on the purchase price of the property, though these taxes vary by province. First-time homebuyers are sometimes exempt from paying the entire land transfer tax amount and may be eligible for a rebate. |
| TERM | DEFINITION |
|---|---|
| Maturity Date | The maturity date is the date when the mortgage term ends. It is at this point that the mortgage must either be paid in full, refinanced, or renewed for a new term. |
| Mortgage | A mortgage is a loan that is provided by a lender to help a homebuyer complete a home purchase. Lenders provide a certain amount of money required to cover the cost of a home’s purchase price while charging interest on the principal amount. The loan is collateralized by the property itself. The mortgage must be repaid according to the terms of the contract. If the loan amount cannot be repaid according to the terms, the lender has the right to repossess the property and sell it to recoup any losses. |
| Mortgage Broker | A mortgage broker is a professional who works on behalf of the borrower and finds the best mortgage product and lender among their network of lenders. |
| Mortgage Default Insurance | Mortgage default insurance is designed to protect the lenders when a borrower is unable or unwilling to repay their mortgage. This is applicable to high-ratio mortgages where the down payment amount is less than 20% of the purchase price of the property and does not apply to conventional mortgages. Borrowers are responsible for this payment. |
| Mortgage Discharge | A mortgage discharge is issued by the lender when the mortgage is paid off in full by the borrower. When the mortgage is fully repaid, it is discharged from the title to the property and certifies that the property is completely free from the mortgage debt |
| Mortgage Life Insurance | Mortgage life insurance is an optional policy that borrowers may take out. It is designed to reduce or pay off the mortgage amount (up to a certain amount) in the event of the borrower’s death. |
| Mortgage Payment | A mortgage payment is the regular payment borrowers are required to make to pay off their home loan. These payments can be made monthly, semi-monthly, biweekly, or weekly, and include both principal and interest. |
| Mortgage Pre-Approval | A mortgage pre-approval involves having your credit and finances checked out before you formally apply for a mortgage once you agree to purchase a particular home. It allows you to find out how much can be afforded, how much the lender is willing to lend, and the interest rate that may be charged. Pre-approvals expire within 90 to 120 days after they are issued and are not a guarantee of final mortgage approval. |
| Mortgage Principal | The mortgage principal represents the amount of money borrowed from a lender and does not include the interest portion. |
| Mortgage Statement | Lenders typically submit a mortgage statement to borrowers on a yearly basis that details the status of the mortgage, including how much has been paid and the principal on the mortgage that still remains. |
| Mortgagee | The mortgagee is a mortgage lender. |
| Mortgagor | The mortgagor is the borrower. |
| Multiple Listing Service (MLS) | The Multiple Listing Service (MLS) is a database of listings where real estate professionals market properties they have for sale and search for properties for sale for their clients. |
| Offer | The offer represents the purchase agreement that the buyer submits to the seller and that the seller can either accept, reject, or negotiate with the buyer. The offer includes the offer price, deposit amount, closing date, conditions, and other items pertinent to the transaction. |
| Open Mortgage | An open mortgage allows borrowers to repay their loan amount in part or in full without incurring any prepayment penalty fees. Open mortgages tend to have higher interest rates compared to closed mortgages but are more flexible. |
| Posted Rate | The posted rate is the lender’s benchmark advertised interest rate for mortgage products offered. These are not necessarily set in stone, but may be negotiated with the lender. |
| Prepayment | Prepayment is made when some or all of the loan amount is paid off before the end of the mortgage term. Most open mortgages can be paid off early without any prepayment penalty charges, but prepaying a closed mortgage typically comes with a prepayment charge. However, most closed mortgages allow an annual prepayment of anywhere between 10% to 20% without any penalty. |
| Prepayment Charge | When all or part of a closed mortgage is paid off before the end of the mortgage term, a prepayment charge may have to be paid to the lender. |
| Prime Rate | The prime rate advertised by a lender is typically based on the Bank of Canada’s interest rate that is set each night, which may change at any time. |
| Property Insurance | Property insurance must be paid on a home throughout the mortgage term. Lenders require a policy to be held on a property before they agree to extend a mortgage, and the lender must be named on the policy. This type of insurance covers the cost of any repair or replacement as a result of damage to the home from fire or other disasters. |
| Property Tax | Property taxes are paid by homeowners to their respective municipalities to cover the cost of things such as police, garbage collection, policing, schools, and fire protection. The property tax amount paid is based on the property’s value and the rate charged by the municipality. |
| TERM | DEFINITION |
|---|---|
| Qualifying Rate | A qualifying rate is the interest rate that a lender uses to assess a borrower’s eligibility for a mortgage and to calculate your debt-service ratio. |
| Renewal | When the term of a mortgage expires, another term may be negotiated with the lender. If the mortgage is not renewed, it must be paid off in full. |
| Reverse Mortgage | Homeowners over the age of 55 can use a reverse mortgage to borrow as much as 50% of the home’s value to be used to pay for other expenses. Payments are not made on a reverse mortgage, but interest can accrue on the loan amount until the property is sold or until the homeowner passes away. |
| Second Mortgage | A second mortgage may be taken out on a home that already has a mortgage on it. The funds accessed through a second mortgage from the home’s growing equity may be used to cover other expenses, such as home renovations, but they carry more risk than first mortgages. |
| Statement of Adjustments | The statement of adjustments outlines the purchase price, deposit, and any financial adjustments that are required for taxes, utilities, or condo fees that have been prepaid by the seller and payable by the buyer to compensate the seller for fees already covered on the home. |
| Survey | A survey is a plan of the property’s lot that shows the lot size and where the property boundaries and building structures lie. It will also show where any easements, right-of-ways, or overhanging structures from adjacent properties that could impact the value of the home. |
| Term | The mortgage term is the period of time that you are committed to your mortgage with your lender, including the interest rate. When the term expires, the mortgage either needs to be paid off in full, refinanced, or renewed, either with the same lender or a new one. The average term is 5 years, though it can range anywhere from 1 to 10 years. |
| Title | Title is the ownership provided to a homeowner when a property is purchased. A clear title is required by lenders before a mortgage is extended. If there are any issues with the property’s title, they must be resolved before the transaction closes. |
| Title Insurance | Title insurance is meant to protect lenders and buyers from issues on the title that are discovered after the transaction closes. Title issues can include title fraud, encroachments, municipal work orders, or zoning violations. If title insurance is purchased, it will be added to the closing costs. |
| Total Debt Service Ratio | The total debt service ratio refers to the percentage of gross annual income needed to cover all debts in addition to the mortgage payments (including principal, interest, taxes, utilities, and more). |
| TERM | DEFINITION |
|---|---|
| Variable-Rate Mortgage | With a variable-rate mortgage, the interest rate will fluctuate based on a financial index. Monthly payments could remain the same, but the amount paid toward interest versus principal could change. If rates increase, more money is paid toward interest, but if rates decrease, more money goes toward the principal. |
