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

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FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.
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Gerald
5 years ago

How would I go about financing a new 30 unit retirement residence which I have the concept drawings ,the site and the market demand for it?

SST
7 years ago

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.

Cynthia
7 years ago

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.

Simon
7 years ago

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.

The Meatman
8 years ago

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

Rob Pasch
8 years ago

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

Claret
8 years ago

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?

landlordsRus
8 years ago

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?

DavidD
8 years ago

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.

Vision Investment Properties
9 years ago

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.