Investment properties in Canada
Buying an investment property is a popular option for Canadians looking at different ways to invest their money. However, unlike the mortgage you took out on your principal residence, financing an investment property is a little more complex. The number of units in the building and whether or not you'll be occupying one of the units are the two major components that control what your financing will look like. Let’s take a look at how investment property mortgages work in Canada.
Investment property mortgages
When you start shopping around for an investment property, the first thing you need to consider is the number of units your building will have. Most buildings with 1-4 units are zoned residential, so the qualification criteria and financing options from lenders are only slightly more difficult than that of a mortgage similar to what you have on your principal residence. However, buildings with 5 or more units are zoned commercial, so a lender would require that you take out a commercial mortgage on it. With a commercial mortgage, the qualification criteria is even tougher to meet and interest rates are often much higher.
If it's a multi-unit property, the second thing to consider is if you, the owner, will be living in one of the units or not. If you will be occupying one of the units, the property would be considered owner-occupied. If all of the units will be rented out, your property would be considered non-owner occupied. The major difference between the two is how much of a down payment you need to make.
Since April 19th, 2010, Canadians have been required to make at least a 20% down payment on non-owner occupied investment properties. Use the following chart to see the minimum down payment both owner and non-owner occupied investment properties require.
|Units||Owner-Occupied?||Down Payment||Max Loan-to-Value|
As you can see, non-owner occupied investment properties require at least a 20% down payment. However, if you plan on living in one of the units, you can put down as little as 5-10%, depending on the total number of units in your property.
As of February 15th, 2016, if the purchase price is over $500,000, the minimum down payment for owner-occupied properties is equal to 5% of the first $500,000 plus 10% of any amount over $500,000.
Maximum amortization period
If you put down anything less than 20% on an investment property, your maximum amortization period will be 25 years. However, if you put down 20% or more, you may qualify for a 30 or 35-year amortization period. This is one aspect of an investment property mortgage where it does not matter if the property will be owner-occupied or not.
Mortgage default insurance
Investment properties with 1-4 units are eligible for very competitive mortgage rates, as mortgage default insurance exists to minimize the risk to lenders. When reviewing the charts, note that it's rare to find yourself in a situation where you would need to purchase mortgage default insurance after you make a down payment of 20% or more, but it's not impossible. Depending on your financial situation, your lender may require it, in order for you to access their best mortgage rates and terms.
Mortgage default insurance rates for owner-occupied investment properties (1+ unit)
If at least one unit in your investment property will be owner-occupied, your mortgage default insurance premium rates will be as follows:
Mortgage default insurance rates for non-owner occupied investment properties
If your investment property will not be at least partially owner-occupied, your mortgage default insurance premium rates will be as follows:
Calculate Your Investment Property Mortgage Payment
Investment property mortgage rates
So long as you meet the qualification criteria and can make at least the minimum down payment on your investment property, you should qualify for the same mortgage rates and terms as you see on our site – these include fixed, variable and adjustable rate mortgages.
It’s important to note, however, that some smaller lenders don’t offer investment property mortgages at all - that is, unless you are going to occupy one of the units. If you can find a smaller lender to work with, be prepared for them to add a small premium to the mortgage rate, such as +0.30 per cent.
Below are today's best mortgage rates for Owner-Occupied investment properties (1-4 units) with down payments under 20% and maximum amortization period of 25 years
|Provider||5 Year fixed||10 Year fixed||3 Year fixed||5 Year variable|
Best market rate
To qualify for an investment property mortgage, you will need to provide your lender with:
- the Agreement of Purchase and Sale
- proof of a sizeable down payment
- proof of steady income, usually in the form of a job letter and pay stubs or Notice of Assessment for two years of T1 Generals (self-employed)
- proof of existing renters, if there are any
- zoning documentation to prove you are purchasing a residential property and not a commercial property
Your lender will also need to run a credit check and calculate your debt coverage ratio.
In order to qualify for an investment property mortgage, a lender must evaluate your ability to meet your monthly debt obligations and expenses. There are essentially three different methods - or debt ratio calculations - lenders employ for investment property mortgages.
The first two methods are extensions on the basic Gross Debt Service Ratio (GDS) and Total Debt Service (TDS) Ratio calculations used for a principal owner-occupied residence. These measure the maximum debt you are allowed to carry as a percentage of your income. GDS is the percentage of your gross income needed to cover housing expenses. TDS is the percentage of your gross income needed to cover housing expenses plus other debts.
The basic formulas for GDS and TDS are as follows:
|PITH||= Principal + Interest + Property Taxes + Heating|
|GDS||= PITH / Gross Income|
|TDS||= (PITH + Other Monthly Debt Repayments) / Gross Income|
Here are the two extensions of the basic GDS/TDS calculation used for investment property mortgages, taking into account your potential rental income:
1. Rental offset
Lenders usually offer rental offsets of around 50 – 70%. For example, a 50% rental offset means that 50% of your total rental income for the year will be used to offset expenses such as your mortgage payment, property taxes and utility costs. Lenders don’t offer 100% rental offset due to vacancies and other potential issues, such as unpaid rent. TDS with rental offset is calculated as follows:
|TDS||= (PITH* + Other Debts - (Rental Offset % x Rental Income)) / Gross Income|
*Note: PITH generally takes into account housing costs from all of the borrower's properties.
2. Rental inclusion
With this method, 50% of your annual rental income is added onto your actual income to qualify you.
|TDS||= (PITH + Other Debts) / (Gross Income + Half of Annual Rental Income)|
The final qualification method is based on a cash flow assessment, as income generated from the property is generally the primary source of repayment on the loan:
3. Debt Service Coverage Ratio (DSCR)
The DSCR is calculated as the Net Operating Income (NOI) from the property divided by the annual mortgage payments (principal and interest), where NOI is total income of the property less operating expenses. The DSCR ratio should ideally be over 1, meaning that the property is generating enough income to fulfill its debt obligations. The higher this ratio is, the easier it is to obtain a loan.
|Net Operating Income (NOI)||= Rental Income – (% Allowance for Vacancy and Collections x Rental Income) – Operating Expenses|
|DSCR||= NOI / (Annual Principal + Interest)|
When looking at the NOI, lenders will make sure the stated income and expense data are accurate, supported and reasonable. For instance, if the allowance for vacancies and collections is atypically low, a lender may substitute in higher “market” vacancy and collection rates.
Typical operating expenses subtracted from rental income include taxes, insurance, repairs and maintenance, utilities and property management fees.
Bank vs. mortgage broker
Similar to when you took out the mortgage on your principal residence, you can choose to have either a bank2 or a mortgage broker help you get pre-approved and then approved for investment property financing. With investment property mortgages, it could be even more important to consider working with a mortgage broker because of their experience with other investors and familiarity with the special financing conditions required by individual lenders.
The other benefits of working with a mortgage broker are obvious: they only need to pull your credit report once, they shop around for you and they look for a product and rate that will match your financial situation. The best part is that you don't have to pay them for their services - instead, the lender you end up getting financing from pays the mortgage broker a fee.
References and Notes
- If you put down 20% or more, you may qualify for up to a 30-year amortization period. However, this will add 0.25% to your premium.
- It’s also important to note that a number of financial institutions don’t offer investment property mortgage products.