Understanding mortgages in Canada can be overwhelming. An investment property mortgage has unique features that make them different from conventional mortgages. For example, they may be easier to qualify for, offer you better cash flow, and can even have a 5%-10% down payment.
If you're thinking of buying an investment property, this article will simply explain rental property mortgage characteristics, interest rates, income tax claims, and qualification criteria. Continue reading to become an expert in 5-10 minutes.
Initially, your mortgage characteristics will depend on the purchase price and amount of units your investment property has. To qualify for a down payment of less than 20%, your property must meet the following criteria:
For first-time real estate investors, we recommend meeting all criteria. You can still receive a residential investment property mortgage if you don't meet these criteria. However, you will need 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 exceeds five units, it will classify as a commercial property. You'll need a commercial mortgage with higher interest rates and a stricter qualification process in this scenario. A commercial mortgage also has net-worth requirements where your net-worth must exceed 25% of the loan value.
Owner occupied means you will live in one unit for a year. As a result, the investment property will be considered your primary residence, and you will be eligible for a lower down payment and better interest rates. Your minimum down payment can range between 5%-10%, meaning an LTV of 90%-95%. However, as already mentioned, the property can’t have more than four units and a purchase price above $1,000,000. Depending on your lender, you may be able to move out and rent your previous unit after one year.
|Rental Property Mortgages||Standard Homeowner Mortgage|
|Minimum Down Payment||5%-10% if meeting CMHC criteria, otherwise 20%||5%-10% if meeting CMHC criteria, otherwise 20%|
|Maximum Amortization||25 years with CMHC, otherwise 35 years||25 years|
|Mortgage Default Insurance||Required for down payments less than 20%||Required for down payments less than 20%|
|Mortgage Rates||Lowest with CMHC, otherwise higher than conventional mortgage rates||Lowest with CMHC, otherwise higher|
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 all three criteria, you're eligible for 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.
Depending on the type of property you purchase, you can qualify for a maximum amortization of 25 or 35 years for residential property. 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.
As mentioned previously, 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.
Otherwise, if your down payment exceeds 20%, you will not need mortgage default insurance. Although CMHC insurance may provide you with lower mortgage rates, there are additional minor fees.
Your rental property ROI is a measure of your return on investment. There are a few ways to calculate it, but Cash-on-Cash Return on Investment (CoC ROI) is the best method. It is calculated as follows:
= Net Operating Income / Purchasing Costs
You may also include property appreciation to get the true ROI. However, the easiest way to determine this is using a rental property ROI calculator.
Living in a unit of your investment property and having mortgage default insurance will provide you with the best rate. However, if you don't live in a unit and have a down payment of over 20%, your mortgage rate will be higher. In general, you can expect your mortgage rate to be as much as 0.6% higher for a secondary rental property. The rates below are for CMHC variable rate rental properties that are owner-occupied.
You can deduct mortgage interest payments to lower your taxable income in Canada. However, you can only do this with investment properties and not primary residences. 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.
If your property generates cash flow - meaning profits, you should keep your mortgage. However, paying off the mortgage could be a good idea if your property is losing money. In general, mortgage debt enhances your return on investment because you only need a small down payment to receive the total property appreciation and rental income. There are also the tax benefits of mortgage debt, such as deductions.
If your property generates profits, your money would be better spent as a down payment for another rental property. Instead of one fully paid off property, you could have two that appreciate in value and still provide you with rental income.
Each year, you will receive a T5013 slip from your mortgage lender showing the amount of interest paid. You must fill out Line 8710 with the appropriate amount to claim the mortgage interest payments. Additionally, you may claim the costs directly associated with receiving the mortgage, such as:
With the deduction, you will lower the total amount of tax you need to pay. Some other popular rental expenses you can deduct in Canada include:
As a landlord, two crucial factors ensure tenants continue to pay while removing bad ones as quickly as possible. Even if your tenant doesn't pay, you're still expected to pay for mortgage payments, property taxes, and more. This means one missed tenant payment can send you into more debt to make up for your obligations.
To prevent this from happening, one tool is rental income insurance. This coverage provides you with guaranteed rental income if your tenant decides not to pay. You should also get familiar with the eviction process in your province. The easiest way to remove a tenant is to buy them out of their lease agreement at the cost of one to two months' rent. This approach is known as "cash for keys" and can save you thousands of dollars worth of legal fees, damages, and missed rent.
It can be easier to qualify for a rental property mortgage in Canada. This is because you can use some of the rental income you are receiving in the future to meet requirements. You will always need the standard required documents to purchase a property in Canada. However, specific to investment properties, you will also need:
Your mortgage lender will then use this information to calculate your debt coverage ratios. They will also make sure you meet the minimum credit score requirements. Your lender will use one of three different methods to calculate your debt coverage ratio.
Each lender uses a different method which is why they may decline your mortgage while another approves you. For the best chance of approval, understand which ratio is most favourable to you and find lenders that use this calculation method. A mortgage broker could even handle this for you. The three most popular methods are:
|Rental Inclusion||Debt Coverage|
|General Usage||Residential Investment Properties||Commercial Investment Properties|
|High vs. Low||Lower is better||Higher is better|
|Ratio Improvement Levers|
This is the most common method for purchasing residential investment properties (four or fewer units). It shows the percentage of your income that pays off debt and property expenses. Half of your forecasted rental income will be added to your gross income to qualify in this method. As a result, a lower ratio is better.
= (Mortgage Payments + Property Tax + Heating Costs + Other Non-Real Estate Debt Payments)/ (Gross Income + 50% Forecasted Rental Income)
Lenders prefer your rental inclusion ratio to be below 32% to qualify for a mortgage.
Also known as the Debt Service Coverage Ratio (DSCR), this metric is commonly used for commercial real estate mortgages. The DSCR shows how many times your rental profits can pay off your mortgage payments. If your investment property has five or more units, your lender will likely use this ratio to assess you. A higher ratio is better because it shows you can make debt payments.
= (Net Operating Income) / Mortgage Payments
Net operating income is your rental profits after maintenance, vacancy allowance, property taxes, home insurance, and other relevant costs. You can use a rental property calculator to determine your NOI quickly.
Mortgage lenders require your DSCR to be at least 1.10. However, higher ratios will help you get better mortgage rates.
This is another method used when assessing residential investment properties. Although less frequently used, it may help you if you can't qualify for a mortgage using the rental inclusion method. The theory behind the rental offset method is that your rental income will offset 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.
= [(Mortgage Payments + Property Tax + Heating Costs + Other Non-Real Estate Debt Payments) - (Rental Income * Rental Offset Percentage)]/ Gross Income
The rental offset percentage ranges between 50% – 70%. For example, a 50% offset percentage means half your rental income pays property expenses.
To qualify for a mortgage using this method, lenders prefer a rental offset ratio below 32%.
Although your lender can decline your mortgage application, you can take steps to improve your chances of approval. Investment property mortgages can be similar to conventional mortgage loans. However, if your property doesn't meet CMHC mortgage default insurance regulations, the process gets more complex. Although you can still receive a mortgage without meeting the criteria, you’ll have a higher down payment and interest rate.