Investment Property Mortgages - What You Need to Know
Understanding mortgages in Canada can be overwhelming. An investment property mortgage has features that make it different from a conventional mortgage. For example, you may have to have a 5%-10% down payment to qualify for one of these special loans and they may offer better cash flow than conventional mortgages.
If you’re thinking of buying an investment property, this article will explain the key factors to consider when taking out a mortgage on a rental property, including interest rates and tax breaks.
Your purchase price and the number of units in your investment property will affect your mortgage characteristics. To qualify for a down payment of less than 20%, your property must meet the following criteria:
- Residential zoning
- 1 – 4 legal units
- You must live in one of the units for at least a year
For first-time real estate investors, we recommend meeting all of these criteria. But if you don’t meet them all, you can still receive a residential investment property mortgage. You need to make a minimum 20% down payment. This process is known as “house hacking” because the other 1-3 units will contribute to your monthly mortgage payments and ideally leave you with some rental property income.
If your property is larger than five units, it will be considered a commercial property. In this case, you’ll need a commercial mortgage with higher interest rates and stricter qualification standards. Commercial mortgages also have net-worth requirements which ask that your net worth must exceed twenty-five percent of the loan value.
The Down Payment
If you don’t live in one unit for at least a year, you’ll need a 20% down payment. However, if you live in one unit and meet the three criteria below, you’re eligible for one of two types of mortgage default insurance. The first type requires a minimum 5%-10% down payment. The lower down payment is due to mortgage default insurance, so you’ll need to meet all CMHC mortgage rules.
A benefit of mortgage default insurance is that you’ll likely receive better mortgage rates in Canada. You can pay a minimum 5% down payment on the first $500,000 in value of your property. However, any value between $500,000 – $1,000,000 must have a 10% minimum down payment. For example, a $700,000 property would need a down payment of at least $45,000 (500,000*5% + 200,000*10%).
Your mortgage amortization is the number of years it will take to pay off your mortgage fully. Generally, real estate investors prefer more extended amortization periods because it reduces their monthly mortgage payments.
As a result, a longer amortization will provide you with more profits each month. If you have CMHC mortgage default insurance with a down payment of less than 20%, then you’ll have a maximum amortization of 25 years. If your down payment exceeds 20%, you can extend your amortization to a maximum of 35 years.
You will not need to live in a unit to do this. However, there is an amortization extension fee, and you will likely have higher interest rates than a CMHC insured mortgage. Ideally, your monthly mortgage payments will be smaller, but given the variables, it’s helpful to use a mortgage payment calculator to compare.
Mortgage Default Insurance
You must have mortgage default insurance if you have a high-ratio mortgage or down payment of less than 20%. The insurance protects your mortgage lender if you default on your loan. You must purchase a property with four or fewer units valued below $1 million and live in a unit for a year to receive the insurance.
If you own property that has more than four units valued at over $1 million, or if you have a down payment greater than 20%, then you will not need CMHC insurance. Although CMHC insurance may provide you with lower mortgage rates, there are additional minor fees.
Mortgage Rates for Rental Properties
If you live in the unit and take out mortgage default insurance, you’ll get the best rate. However, if you don’t live in a unit, make a down payment of over 20%, and don’t have mortgage default insurance, your mortgage rate will be higher. Generally speaking, you can expect your mortgage rate to be as much as 0.6% higher for a secondary rental property. Be sure to consult with a mortgage specialist for the current interest rates on rental properties.
Mortgage Payment and the CRA
You can deduct the mortgage interest you pay on investment properties to reduce your taxable income in Canada. However, you cannot deduct the interest on your primary residence. You must factor out your proportionate square foot percentage from the deduction if you live in a unit. For example, if you own a 5,000 sq ft. rental property and inhabit a 1,250 sq ft. unit, then you can only deduct 80% ((5000-1250)/5000) of the mortgage interest costs.
Each year, you will receive a T5013 tax slip from your mortgage lender showing the amount of interest paid. The amount on Line 8710 of your income tax return must be filled out with the appropriate amount to claim the mortgage interest payments. Directly associated with receiving the mortgage are other costs that can be claimed, such as:
- Mortgage brokerage fees
- Legal fees
- Processing fees
- Application fees
By claiming the deduction, you will pay less in taxes. Some other common rental expenses that may be deducted in Canada include:
- Rental property insurance
- Travel expenses
Requirements for Rental Property Insurance
Qualifying for a rental property mortgage in Canada is easier than you may think. You can use some of the rental income you are receiving in the future to meet requirements. To buy a property you will always need standard required documents, but if it’s an investment property, you will also need:
- Proof of tenants
- Lease agreement
Your lender will use this information to calculate your debt-to-income ratio and other financial information, such as your credit score, that lenders use to decide whether you qualify for a mortgage. Each lender uses its own calculation method, so you may be approved by one bank while another bank declines you.
To give yourself the best chance of approval, talk with a mortgage broker or banker to find out which calculation method is most favorable to you and then find banks that use this method.
Method #1: Rental Offset
This is the most favorable method of calculating your income and qualifying for the largest mortgage amount possible (in many cases). The theory behind Rental Offset is that your rental income will help pay some of the costs of your property. As a result, your gross income is less important because you will need to pay fewer expenses with your salary. A lower ratio is better because it shows less of your income goes towards paying for property maintenance costs.
The rental offset percentage ranges between 50% – 80%. For example, a 50% offset percentage means half your rental income pays property expenses.
Method #2: Add to Income Rental Inclusion
This is the most common method for purchasing residential investment properties (four or fewer units). In this case, the amount of monthly rental income generated by the property is added to your annual gross salary.
Let’s say your job pays you an annual salary of $70K and the property you plan on purchasing can be rented out for $2K per month ($24K annually). Your gross salary when applying for the mortgage now becomes $94K per year.
Even if your lender declines your mortgage application, there are steps you can take to improve your chances of approval. Investment property mortgages are similar to conventional mortgage loans. But if your property doesn’t meet CMHC mortgage default insurance regulations, the process gets more complex. You may still receive a mortgage without meeting the criteria, but you’ll have a higher down payment and interest rate.
How can Ahmad, mortgage specialist at AskAhmad.ca and the Total Mortgage Source 360 Team help you?
Ahmad and his team are industry experts on mortgages. They offer excellent customer service and pride themselves on their ability to help you find the right mortgage product for your needs.
We can offer you some of the most competitive interest rates and mortgage products available because we have access to Canada’s leading lenders, including banks, mortgage firms, trust companies and private lenders.
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The Mortgage Centre at Total Mortgage Source 360
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