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Guide to Financing a Rental Property

Our hearty congratulations if you are considering purchasing your first (or next) investment property! You are not alone. According to the Globe and Mail, one in three Toronto condos are investor owned. We have produced this Guide to Financing a Rental Property to answer some of the most commonly asked questions and helpful tips.

What is an Investment or a Rental Property? 

  • An Investment Property is a real estate asset that is purchased for earning rental income. 

Can I live in a part of my Rental Property? 

  • Yes. If your property has more than one self-contained unit (think of a basement unit that has its own kitchen and bath room), and you plan to live in one and rent out the rest, the property is considered “owner occupied” as opposed to “rental property”. In this case, the part that’s rented out is a “rental suite”. Standard qualification Rules for owner occupied properties apply to rental suites. 
  • The upside of renting a part of the property is that you can add your rental income from the rental suite to your employment income to help you qualify for a bigger mortgage. Lenders usually consider only apply 50% to 80% of discount to the rent earned from a rental suite in order to account from vacancies and added expenses. 
Wonder if you can afford multiple investment properties? Keep reading to find out!

Do number of units in my Rental Property matter? 

Yes. Most mortgage lenders only lend to properties that have less than 4 units. 

If your property has 5 or more units, it will likely be a commercial property rather than residential. Commerical properties follow a different set of rules than residential properties. Commercial mortgage rates are often higher than residential as well. 

How many Rental Properties can I finance in total? 

  • Major financial institutions finance between 5 and 20 rental properties per owners. The more properties you have, lenders impose stricter qualification ratios making it tougher toqualify for more mortgages.

How can I qualify for an investment property mortgage?

  • Down Payment: a rental property requires at least 20% of down payment. 
  • Debt Service Ratio: debt service ratio measures your ability to meet your monthly expense and debt obligations based on the income you earn. To qualify for an investment property, lenders not only look at your personal income and expenses, but also take into account the income and expenses from the investment property. 

Here is the high-level formula lenders use to calculate Total Debt Service (TDS) ratio: 

For Principle Residence (*PITH Stands for Principle, Interest, Property Taxes, and Heating)

TDS = (PITH* + Other Monthly Debt Payments)/Income

For Investment Property, the formula changes into the following: 

TDS = (PITH of Principle Residence + PITH of Rental Property + Expenses of Rental Property + Other Monthly Debt Payments)/(Employment Income + Rental Income)

What documents do I need to provide?

To qualify for an investment property mortgage, you will need to provide the following documents: 

  • Proof of employment income (T4, NoA, etc.)
  • Proof of rental income (lease, bank statements, Schedule T776 etc.)  
  • A new investment property requires a market rent assesssment
  • Proof that you have at least 20% down payment (some Lenders do not allow gifted down payment for rental properties)
Determining how rental income can be used for your mortgage is not as simple as it seems. Keep reading to find out why.

How is rental income determined? 

  • Purchasing a new rental property: if the property you are purchasing is new to the market, some lenders may need a “market rent” assessment to estimate the amount of rental income you may be able to generate with the property. This assessment is usually performed by a 3rd party appraiser or property valuation models based on recent comparable data of similar rental units hear your investment property. Lenders usually discount “market rent” by 20%-50% when qualifying you for the mortgage to stay conservative. The discount also provides Lenders comfort against potential vacancy when tenants turn over. For example, if an appraiser estimates that your Investment property will rent for $2,000 per month and your mortgage Lender discounts it by 20%, only $1,600 rental income will be considered to calculate your TDS. 
  • Refinancing an existing rental property: Your rental property is now worth 20% more.  As an investor, you may want to refinance it so you can get on to your next (investment property) venture. In such cases, Lenders  evaluate your actual rental income based on the actual income earned minus the expenses reported by you on your tax return.   So, it is important to be realistic with your expenses when you file your tax return. A rental loss (per Schedule T776 of your tax return) may impact how much you can qualify when you refinance. 

Can I buy an investment property with friends and family? 

Yes. Because investment properties can be lucrative, you may choose to team up with friends and family to co-invest and share the benefits. If you are contemplating this option, here are a few things to think about: 

  • Create a co-ownership agreement. Owning a property together in some ways is like neing married. Everything looks great in the beginning, but you may have disagreements from time to time. There is also the possibility of a break-up (sorry for being syndical but life happens). So, it’s important to set the ground rules such as what happens if one party wants to sell, who handles the maintenance, etc. 
  • Each of you is responsible for 100% the mortgage regardless of how much of the investment property you own.  No, I’m not kidding. If your co-owner fails to make the mortgage payment, the Lender can foreclose on the entire property and go after your wages if the Lender is unable to recover the entire mortgage amount from the sale (in certain provinces). 

Can I purchase an Investment Property under a name of a corporation? 

  • A Personal Holding Company can be an effective structure to purchase and hold investment properties. A Personal Holding Company is an extension of a person and can not be running an active business. Immediate family members must hold all shares of the holding company. This structure provides you a certain level of protection against potential liabilities and some flexibility for tax planning. Therefore, it can be especially beneficial for people who have more than one investment propertyies. Many lenders require additional documentation when qualifying mortgages for a personal holding company. If you have specific questions about financing a rental property through a Personal Holding Company, one of our Advisors would be happy to answer your questions. 

What are some of the key product features for investment properties?

  • Amortization: an Investment Property mortgage can have amortization up to 30 years. 

Mortgage Default Insurance: since you need to provide more than 20% of down payment, Lenders do not require you to purchase default insurance. 

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