The ins and outs of buying a rental property

If you’re thinking about diversifying your investment portfolio with an investment property, you might want to rethink your approach. It used to be that real estate investors could purchase an investment property with very little down and a super low interest rate.

But that was then. Today, rental financing is far more complex. In order to secure a mortgage for a small non-owner-occupied one, two, three, or four unit rental property you are now required to put down one-fifth of the purchase price in order to secure a reasonable mortgage rate.

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The recent credit crisis and the current state of the Canadian housing market have caused regulators and lenders to toe a harder line in regards to high-risk rental property investors. As a result, it’s now far trickier for investors to qualify for a rental property mortgage.

The following tips will help you to navigate the newly reformed waters of real estate investing…

Are you down with your down payment?

Federal legislation came into effect on April 19, 2010 that put an end to insured rental mortgages with less than a 20 percent down payment. So, if you’re planning to buy a rental home that you won’t live in, you’re going to need to have a minimum of 20 percent of the purchase price in upfront cash, regardless of what lender or mortgage broker you plan to work with. That’s roughly $72,000 on the average $360,000 residential property.

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Thinking about investing in a higher-risk city, like Vancouver or Toronto? Then keep saving – lenders are more likely to require 25 percent down on a rental property mortgage in these areas.

Be selective about your lender

If this is your first investment property, don’t try and find a lender on your own. Instead, work with a mortgage broker who has experience in the investment property arena.

This is because a borrower’s ability to qualify for an investment property rental often depends on how much rental income the lender recognizes. Known as the “total debt ratio”, this number is generally the sum of your total monthly expenses divided by total monthly income from all sources, including rentals. Of course, each lender calculates total debt ratio slightly different – this is when a mortgage broker can be extremely helpful. Their job is to help you find lenders to fit your needs and circumstances. If your qualifications aren’t perfect, you’ll need to find a lender that is open to negotiating underwriting exceptions, a difficult task if you’re not familiar with the market.

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Don’t get greedy

It’s worth noting that most lenders prohibit you from owning and/or financing multiple rental properties. While it’s not explicitly forbidden, it certainly increases your risk, making you a less than ideal customer for lenders. This often results in investors with big rental portfolios being forced to renew mortgages with their existing lender at unfavorable rates and terms.

The moral of the story? If you’re planning to build your own rental empire, be careful. Work with a mortgage broker who has experience working with clients with 10 or more investment properties. He or she will know which lenders to talk to, and which ones may just waste your time.

Rates aren’t the only thing to look for

If you happen to stumble across an exceptionally low rate during your rental property mortgage search, don’t assume that it’s the best option. Now that new legislation is in place, lenders with the best rates often have the tightest rules and restrictions. The most flexible mortgages usually cost more, especially in the world of investment properties. Expect to pay more if you need a lender and mortgage that satisfies one or more of the following criteria:

  • Offers flexible rental income rules
  • Allows for a line of credit with your rental mortgage
  • Lets you put a rental property in a company name for liability protection
  • Doesn’t impose a minimum net worth requirement
  • Will lend large mortgages
  • Allows you to add a second mortgage
  • Allows lengthy amortization periods to maximize cash flow

Prepare for paperwork

In the past, investors used to be able to use an appraiser’s estimate of a property to secure a mortgage. Today, more and more lenders require rental property investors to have a signed lease or other proof of rental income prior to inking a deal.

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It also doesn’t hurt to have your financial house in order before sitting down with your broker. This is because more and more lenders are requesting to review two years’ worth of tax returns prior to offering a rate. Tax returns will show your net gain or loss on a property, which can often make it easier to qualify your application.

In short, investing in real estate is still a very viable option for Canadians, provided they know which lenders to approach. Rental financing is truly a specialized field – working with a broker who has experience in the area could save you time, money and sanity.

GoldenGirlFinance.com is a free personal finance and education site for women.

Nothing contained herein is intended to provide personalized financial, legal or tax advice. Before implementing any financial strategy, you should obtain information and advice from your financial, legal and/or tax advisers who are fully aware of your individual circumstances.

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