If you’re in the market for a house (and have used our tools to compare mortgage rates), you might have considered buying a house with a secondary unit with income potential (like a basement apartment) to help pay your mortgage. The Canadian Mortgage and Housing Corporation (CMHC) is making it easier to afford such a property with new rules that could let you count up to 100% of rental income when qualifying for a mortgage—up from 50% previously. The new rules take effect September 28.
When you apply for a mortgage, one of the factors that affects your maximum affordability is your debt service ratios. Your gross debt service ratio (GDS) is the monthly cost of carrying your home—the mortgage, property tax, and heat—divided by your monthly pre-tax income. Your total debt service ratio (TDS) factors in the cost of your home plus the monthly carrying cost of all your other debts like credit cards and car payments, divided by your pre-tax income. Lenders typically limit your GDS to 32% and your TDS to 40%.
Under the old rules, if you bought a house with a secondary unit, you could count 50% of any rental income when calculating your debt service ratios; a suite rented for $1,000 per month would credit you $500 of additional income when qualifying for a mortgage. Under the new rules, up to 100% of rental income can be applied, potentially giving you credit for the full $1,000.
There are some conditions to this change. It only applies to owner-occupied two-unit houses, meaning you have to live in the house yourself to take advantage. You’ll need a good credit score and will have to show you can pay for the carrying cost of the rental unit including taxes and heat. The rental unit will also need to have sustained income for two years, and you’ll only get credit for the average rent over that time.
How much will this increase your ability to afford a house? Let’s look at an example of a first-time buyer earning $80,000 per year, with a $50,000 down payment. Here is the maximum affordability, assuming a 25-year amortization with a 5-year fixed rate of 2.43%.
In this example, the buyer would ordinarily be able to afford a maximum purchase price of $488,000. Buying a house with a second unit rented for $1,000 a month, the same buyer can now afford a maximum of $576,000—a difference of $88,000.
It’s important to keep in mind that this rule change only impacts your maximum affordability based on your debt service ratio; you could still be limited by other factors like the size of your down payment. And even though you’re approved for a certain purchase price, that doesn’t necessarily mean it’s wise to spend the entire amount.
Another thing to watch in this scenario is that your cash flow doesn’t actually change. You can still only afford so much on your own; you’re dependant on the additional income from your tenant to afford the extra mortgage.
Taking advantage of this allowance also means becoming a landlord and taking on all the associated responsibilities. Being on call 24/7, having to pay for repairs, and managing a tenant might be more onerous than it’s worth. There are also tax implications when you rent part of your property. Rental income is taxable and you could incur a capital gain (or loss) on the rented portion of the property when it’s time to sell.
Perhaps most importantly, buyers who take full advantage of the additional income credit will be vulnerable to any disruption to rental income. If a tenant moves out or stops paying rent, you’re still expected to make your mortgage payment on time.
An investment property is just that: an investment. You need to carefully weigh the risks and rewards that come along with renting out part of your property. When you do the math, you may find that just because you can borrow more to afford a two-unit house doesn’t mean you should.
Flickr: Jason Baker