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Income Property Financing for New Investors





Melanie and Robert McLister, mortgage planners and editors of Canadian Mortgage Trends, have taken the time to write about obtaining financing for real estate investors.  This is a must read for Canadians considering getting into the rental market. 


Aspiring real estate investors seem to ask one question more than any other: “How much do I have to put down to buy an income property?

Most are unaware that it’s now possible to buy a small rental property (2 units or less) with $0 down.

It wasn’t always that way. Until last fall, most borrowers wanting 100% financing on an income property had to resort to “alternative” (private or subprime) lenders, or negotiate vendor take-back mortgages (VTBs). The problem is that VTBs are often hard to arrange and 100% alternative financing is expensive–and has all but dried up thanks to the credit crunch.

In October, however, property investors got lucky. CMHC came to the rescue with its insured small rental program. It allows regular people to buy a small rental property with little or no money down, at fully discounted interest rates!

CMHC’s 100% financing program requires that the borrower (among other things) has a:

  1. Credit score over 679
  2. Credit report that is clean overall
  3. Provable income
  4. Tenant lease (or leases) in place

CMHC looks for a “strong history of managing credit.” If you’ve been recently or habitually late with your payments, don’t waste your time applying.

Regarding point #4, under CMHC’s program “market rents” (rent estimates) are usually not acceptable. That means you need to have a tenant lined up when you go to apply for the mortgage.

This is not necessarily a deal breaker. AIG, another insurer who competes with CMHC, has a rental program of its own. AIG will rely on an appraiser’s opinion of fair “market rents” to qualify the deal. That means you don’t necessarily need an existing renter to qualify with AIG. The downside is that AIG only allows a 95% loan-to-value, so you’ll have to put some cash down.

There’s one key point to remember about rent. Under CMHC’s and AIG’s programs, you can only use 80% of the rent you receive to qualify for the mortgage on a non-owner-occupied property. This is called an “80% rental offset.” CMHC and AIG use 80% instead of 100% to account for vacancies and other contingencies.

Eighty percent is still pretty good. It potentially lets you qualify for additional properties without depending solely on your own personal income. If you’re able to cover the rental mortgage, taxes, and heat with 80% of the rent you receive, you can theoretically keep buying rental properties without any increase in your own income. Restrictions do apply, however, and you’ll need to have cash for the closing costs.

That’s not to say that the borrower’s own income isn’t a factor. While there is no minimum income requirement per se, the borrower’s overall monthly debt obligations must be covered by 40-42% of his or her provable monthly income—including 80% of the rent received.

Here’s an example of how total debt service (TDS) is calculated:

Borrower’s Monthly Income
Salary $6,500
Rent Received ($1,000 per month) $ 800 ($1,000 x 80%)
Total Income $7,300
Borrower’s Monthly Debt
Mortgage – Primary Residence $1,100
Mortgage – Rental Property $ 850
Property Tax – Primary Residence $ 175
Property Tax – Rental Property $ 150
Heat – Primary Residence $ 75
Heat – Rental Property $ 75
Credit Card Payments $ 100
Car Loan $ 350
Total Debt $2,875

In the example above, the person’s TDS ratio is:

$2,875 / $7,300 = 39.38%

Therefore this person would meet CMHC’s and AIG’s TDS requirements.

Keep in mind, there are sometimes exceptions made to these ratios if the borrower is strong in other areas. However, exceptions are becoming less and less common these days thanks to subprime-related credit concerns.

So now that you know some of the qualification standards, let’s talk about what you need to prove you qualify. Here is a sampling of the documents you’ll need:

CMHC Requirements AIG Requirements
Borrower’s Income Job letter & pay stub (Salaried)

OR

Notice of Assessment or two years of T1 Generals (Self-employed)

Job letter & pay stub (Salaried)

OR

Notice of Assessment or two years of T1 Generals (Self-employed)

Proof of Existing Renters Signed leases; rent rolls; cancelled rent cheques; etc. Not required. AIG will do an appraisal and use market rents.
Purchase & Sale Agreement Required Required
Appraisal Not usually required Required

Talk to a licensed mortgage planner for the specific documents required in your case.

Keep in mind that you must prove your income if you want high-ratio financing. I know of no “stated income” mortgage for real estate investors who want to buy with no down payment. However, if one has 25% down, stated income financing may be possible.

On a side note, it’s also possible to finance three or four unit buildings—but they’re a bit different. For one thing, a minimum of 10% down payment is required. This down payment can come from borrowed funds or be gifted (under the CMHC program). For the time being, AIG’s programs still require that the down payment and closing costs (1.5% of the purchase price) come from the borrower’s own resources. This can be proven with three months bank statements.

Note, Genworth also has a rental program but its standards are a bit tougher. Genworth doesn’t offer 80% rental offsets on non subject properties for example. In addition, Genworth is capped at 90% loan-to-value–even for 1-2 unit properties.

So how much do the above programs cost? Well, CMHC and AIG are mortgage insurers, and insurers charge insurance premiums. Here are some sample premiums (based on a percentage of the mortgage amount):

100% financing (CMHC): 7.25%
95% financing (AIG & CMHC): 6.50%
Gifted down payment (CMHC): 0.25% additional
40-year amortization: 0.60% additional

These premiums aren’t cheap. If you buy a $300,000 rental property with 100% financing and a 40-year amortization, you’ll pay CMHC $23,550. If you roll it into your mortgage (which most people do), you’ll also pay interest on top of that. So you need to carefully consider how this increases your total monthly payment.

On a positive note, insurance premiums are a cost of business that can usually be written off over five years. See this link and your accountant for more details: http://www.cra-arc.gc.ca/E/pub/tg/t4036/t4036-e.html#P387_37921

Apart from insurance premiums, there’s interest of course. For qualified applicants, interest rates under CMHC’s and AIG’s programs are currently pretty good. As of this writing, 5-year fixed rates are in the mid-5% range and variables are around prime – 0.60%.

Last but not least, there are closing costs to consider: legal fees, appraisal costs, home inspection fees, land transfer fees, etc. Roughly speaking, and notwithstanding the above, closing costs will run 1.5% to 2.5% of the property’s value.

Now for a few things to be wary of:

  • Things are peaches and cream when real estate values are rising. But they’re not going to rise forever. When home prices fall, unwise investors get hurt. If you’re forced to liquidate in these circumstances, and you’re 107% financed, you could end up owing more than you can sell for. The same goes for buying in a depreciated area. You must have a long-term time horizon.
  • You can’t assume the interest rate you have now will last forever. At the end of your term, rates could, and often do, go up. That means your cash flow projections must be able to withstand potentially higher mortgage payments.
  • Be wary of using the 100% program to do fix and flips. Insurance premiums of 7.25% to 7.85%, and lender interest penalties, are a lot of expense to overcome in a short period of time.
  • Don’t settle for questionable tenants. Always get a credit check on each renter and get statements from the vendor on each tenants’ payment history, if applicable. A few months of vacancy, or a non-paying renter, can crush your cash flow projections and put you under water.
  • Make sure to analyze the property with a magnifying glass. Are there ANY improvements or major fixes that might need to be done? Unexpected expenses will also kill your monthly net income. Capital reserves are crucial in this business. I’ve seen borrowers get into serious trouble because they didn’t budget for contingencies.

Today’s small rental programs are excellent tools for prudent investors that do their due diligence and have capital reserves. Low interest rates and long amortizations help with cash flow, while reduced down payments help investors build property portfolios faster than they otherwise could.

But prudence is the key. Build your rental empire slowly and methodically, and make sure each property cash flows well before buying the next one.

If you’d like more information, contact us or any other qualified mortgage planner specializing in rental properties.

Links for more information:

Please note: The above information is for general educational purposes. Information, rates, and costs are subject to change. Always consult a professional licensed mortgage planner before acting on such information. Financing is not guaranteed and is based on many factors, including approved credit.

photo credit: lumaxart





31 Comments, Comment or Ping

  1. Melanie, I have a quick question, what if the investor has 20% down, does this avoid all mortgage insurance fees like it does on a principle residence?

  2. Hi FT,
    Generally yes. Although if someone needs help qualifying, despite a 20% down payment, this can sometimes only be done by using an insured product.
    Cheers,
    -Melanie

  3. Mel, another question, are the mortgage rates for investment properties different than those for a principle residence?

  4. In most cases no! Fixed and variable rates are virtually the same for rentals and primary homes, for qualified applicants. Although some lenders consider them “Alt-A” (alternative “A”) products and might charge a 0.10% premium for example.
    -Melanie

  5. 5. Daniel

    What would be the best way for us to buy a second property and keep the current as a rental?

    1. Buy the new house (principal residence) with little money down.

    2. Refinance the current house (to become rental) to %100 and use the equity as a down payment for the principal residence.

    Daniel

  6. Daniel, you’ll have to consult an accountant. But I believe if you use equity from your rental to put into a principle residence, that portion of the loan will not be tax ded.

  7. To throw another idea and maybe not for the new investor but another strategy one could use would be to use the LOC and put the Smith Manouever strategy to use. You need the right mortgage to do this. Make sure the property cash flows! Perfect for those looking to paydown their personal residence mortgage, increase net worth and reduce taxes. Have a qualified financial advisor or mortgage broker and accountant explain how to set this up.

  8. 8. Acorn

    HI,
    Are there any specific requirements / financial details for commercial income properties?

  9. Hi Everyone!
    Thanks for the great questions! I’ll answer them all tonight in one big batch if that’s okay!?
    Cheers,
    Melanie

  10. 10. Sarlock

    With the run-up in house prices in most major Canadian cities, rental rates do not come even close to being cash flow positive. Buying a $375,000 home in Edmonton or Calgary will get you about $1,500-$1,800 per month in rent. When net against expenses such as property taxes, maintenance, etc, you will be lucky to cover half of the mortgage payment with the rent. This requires you to have a significant amount of income to cover the shortfall.

    I would advise caution to anyone looking to get an investment property at this time, given what has happened across the border and how over-inflated house prices are in many Canadian cities (especially Vancouver). If house prices drop by $100,000, it’ll take you many, many years to recover.

  11. 11. Brent

    One of the best articles I’ve seen for Canadians looking to purchase revenue properties with a low or no down payment.

  12. 12. paul s

    FT:
    Great article. Just confirmes again for me that your blog is becoming one of the best Canadian financial sites on the web. Well done!

  13. Hi Daniel,

    Normally I like to answer questions online if at all possible, but the answer to your question has a few too many facets. If you’d like to get in touch with me directly we can talk it over and discuss some options.

    Hi Acorn,

    Generally residential income properties with 5+ units are considered commercial. If this is what you’re referring to then this guide is a good place to start your research:

    http://www.milliondollarjourney.com/income-property-financing-for-new-investors.htm#comments

    If you’re talking retail or office space then lending decisions are based largely on the income the property generates, debt coverage ratios, market lease rates, loan-to-value, the marketability of the property, the purchaser’s net worth, etc.

    You’ll often need to provide the following: three years of financial statements, tax returns, net worth statements, pro formas, personal guarantees, etc.

    Hi Sarlock,

    That’s sad but true. With respect to major markets like Vancouver, Calgary, and Toronto, opportunities to cash flow are few and far between.

    Investors we chat with seem to be having the most success in 2nd and 3rd tier markets that have economic and/or demographic catalysts and non-stratospheric prices. St. John’s, NF and Vernon, BC are two such examples.

    Hi Brent and Paul,

    Thank you!!

    Cheers,
    -Melanie :-)

  14. Thankfully real estate prices in St. John’s are no where near the prices in the bigger cities, however we are seeing some first time investors shy away here now. Typical prices for 2-apt investment properties have jumped considerably reducing positive cash flow.
    At a price of $210,000 your monthly mortgage and property taxes would be about $1325 (zero down). Rent for the property would be about $1450. Is it worth the risk for zero down and only $125 per month? One or two vacant months would really hurt if they didn’t have cash in reserve for this.
    Great article by the way…made me call my mortgage broker and discuss some options.

  15. Hi Stephen,

    Thanks so much for the very kind feedback. I’ve heard the same thing about St. John’s from others as well. (i.e. it’s getting a bit rich.) Yet some folks we talk to still seem to be finding occassional value there–especially vis a vis Vancouver, Calgary, etc.

    As a side note, the rule of thumb we use is that people should budget for roughly 10%-15% vacancy (or the local vacancy rate if higher) and have about six months of cash reserves to weather any storms.

    Cheers,
    Rob

  16. A brief update…
    CMHC now also considers market rents in lieu of leases. That’s a plus for folks buying vacant rental properties. You’ll need an appraisal or qualified “opinion letter” to establish fair market rents.

    Just make sure there’s no underlying reason the property is vacant. :)

    Cheers,
    Rob

  17. 17. Kyle

    I am looking at purchasing a rental property with a friend, were both young and want to enter the renting market. How would we go about this. We both have a very good income but both own homes and school debts. Would we start a small business or can we both share the income and income tax breaks etc? Any idea’s would help!
    Thanks

  18. Kyle, there are a couple ways you can set this up. You can setup a general partnership where all income/expenses are personally split between you. Or, you can setup a more formal corporation where you both become shareholders. I would suggest that you speak with an accountant to get the nitty gritty details of each option.

  19. 19. Future Money-Bags

    I know old post but I just found it!

    Great info, very clear. I didn’t have any Idea of what is a good credit for a rental property mortgage, good to know that I qualify at such a young age. The hardest part is getting the ball rolling and getting that first property..

  20. It’s a sad state that the facts and regulations have now changed. The generic term is to say, “..the least amount possible.” The amount of downpayment will depend upon your cash flow requirements and your the duration of your strategy.

  21. 21. Shiraz

    While paying the insurance isn’t ideal, if you purchase the right property my personal preference is to pay the premium and use less of my own money. This leaves more capital available for the next opportunity and drastically improves the cash on cash rates of return. The key is always to choose the right property with positive cash flow and potential for appreciation. Also keep in mind that this is not your residence, it’s an investment, so you get the tax benefits and someone else paying those fees in the long run.

  22. 22. Vision Investment Properties

    Some great points. Another, and somewhat more sensible approach to 0% down, however, is finding the right balance that will allow an investor to lower the monthly mortgage payment by paying something down, while also not putting too much down so cash reserves are depleted. By putting nothing down, cash reserves remain up, but there’s also not as much monthly revenue potential. Again, it’s a delicate balance that an investor must strike by identifying exactly what they want to make in profit each month and then work backward to determine the right down payment that will allow that amount.

  23. 23. DavidD

    Yes – it is very difficult to cash flowing property in Greater Vancouver and even in next tier down 1,000,0000 population cities such as Edmonton. That said, you need to go down to smaller cities to start finding opportunities. I have had good luck in smaller, prosperous centres such as Winnipeg or Regina. In Regina, you can still get a house in a decent area in the low $300,000 range that will rent for $1800 + utilities per month without a suite. At current interest rates with tax and insurance, this should cash flow with 20% down and 25 year amortization. The vacancy rate is 0.6% and so it is not difficult at all to find first rate tenants provided you are not in skid row.

  24. 24. landlordsRus

    If I want mortgage an existing rental property to purchase another property , what are the issues if I only have rental income and no employment income?

  25. @landlordRus – you would need to check with a mortgage broker to see qualification rules. I was told one time that half of the rental income can count as income towards qualification for the mortgage, but again, you should give a broker a quick call.

  26. 26. Claret

    What I will do to get a second property? Can I put my present house under rental? How do I qualify for 0 down on second property?

  27. 27. Rob Pasch

    Hi I was checking on the CMHC website and was only able to find 80% secondary house purchase mortgage financing.
    Did I not search for the right product?
    Have the rules changed?
    Thank you

  28. 28. The Meatman

    How old is this post? I’m told by my mortgage broker that this program hasn’t existed for some time.

  29. 29. Simon

    Any advice on avoiding the HST claw back if you are buying a brand new condo with the intention of renting it out upon taking possession? I am aware you can apply for a landlord rebate but I’d rather avoid the extra hoops.

  30. 30. Cynthia

    Great post! Thanks a lot! I share your idea that things are peaches and cream when real estate values are rising. But they’re not going to rise forever and when home prices fall, unwise investors get hurt. There are some moments when the prices are really very high, maybe it’s due to inflation. But then property prices are falling and you can invest your money on your rental property. It’s always better to study the real estate market prices and read about the predictions.

  31. 31. SST

    re: “…when home prices fall, unwise investors get hurt.”

    Not always so.

    Take 2009 for instance. The government of British Columbia instituted the Economic and Stabilization Statutes Amendment Act (Bill 45), which held real estate assessments at 2007 levels.

    Why would they do that, you ask. It was for the exact reason stated — to “protect” unwise investors from getting hurt. In the government’s own words: “to give property owners more certainty in response to the downturn in the real estate market.” Certainty of what???

    Does it matter what the “predictions” are or what the market direction is when the gov’t can merely ignore the free market in favour of their own valuations?
    (And why only real estate? Why was there no Stock Market floor invoked?)

    With the gov’t at your back, you should buy no matter the price level.

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