Thinking About Buying A Rental Property? Here's What You Need To Know About Loans

Thinking of buying a rental property? Congratulations on discovering the best way for smart investors to secure and grow their money. Rental properties represent an avenue to invest in a long-term asset, allowing you to generate monthly income. It has many advantages over stocks, gold, commodities, and cryptocurrencies. It is tangible and resilient against a lot of the shocks that stocks and mutual funds are vulnerable to. At the same time, however, investing in real estate is not a walk in the park.
There are potential pitfalls that first-time property investors need to be aware of if they are to make the most of their investments. And one of the most challenging areas for would-be real estate investors is financing. Getting a mortgage for a primary residence is very different from a mortgage for a rental property. Today we will dive into helping you understand the key things you need to know when applying for an investment property loan.
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Do you qualify?
What do traditional lenders look at before they decide to approve or to decline a loan application? They look at a combination of the person's financial capacity and their money management abilities. The factors they may consider include:

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• Credit score: ​The general standard credit score to get approved for a mortgage is 640. But when applying for a rental property mortgage, it is usually higher.
• History of late payments: In addition to good credit score and despite it, some lenders check for a history of debt repayment problems.
• Gross Debt Service Ratio (GDS): This is the percentage of the applicant's after-tax monthly income required to cover the costs associated with owning the property. The ratio should not exceed 32%.
• Total Debt Service Ratio (TDS): This measures the percentage of the individual's monthly income needed to cover all their monthly debt obligations. The desirable ratio is 40% or less.
• Stress test: The person must keep up with mortgage payments even if interest rates increase in the future.
• Other things: Other factors are the individual's income, employment records, general expenses, current debts, how much they want to borrow and the amortization period

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​Financing Options
Along with conventional mortgage loans, investors have other options for financing the purchase of their second property:
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• Hard Money Loans: These loans are issued by private lenders. They are often used by investors who employ a short-term investment strategy, as the interest rate is slightly higher, but the applicant's credit score is not a huge factor in determining approval.
• Private Money Lenders: These are loans made by people in the investor's personal network. It is an excellent option for people who do not qualify for a traditional mortgage.
• Home Equity Loans: Borrowers can use the equity on an existing home to finance their investment property. With a home equity loan, you may be able to borrow up to 75% of your home's value. Your credit score is not a big factor in this case.

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Types of Investment Properties
In addition to the qualification criteria listed above, the type of investment property an investor is planning to purchase is essential as it determines what their financing will look like. There are two types of investment properties:
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• Residential buildings: Buildings that have 1-4 living units are deemed as residential. The qualification criteria for these investment properties are slightly different from mortgage criteria for a primary residence. Furthermore, if the owner plans to live in one of the units, the property is classified as owner-occupier, which further softens the mortgage terms. If the owner will not live in the property, it is non-owner-occupier, and the loan terms are different.
• Commercial buildings: Any building with 5 living units or more is zoned as a commercial property. Commercial properties require a commercial mortgage, and the qualification criteria for these property types are often tougher.

Down payment
Since 2010, the down payment required for investing in a rental property in Canada is 20%. For owner-occupied properties with 3-4 living units, the accepted down payment may be as low as 10%. If the home has only two units, the down-payment for owner-occupied homes goes down to 5%. But if a property is non-owner-occupied, regardless of whether it has 2 or 4 units, the down-payment is 20%. Additionally, non-owner-occupied homes have a maximum loan-to-value (LTV) ratio of 80%, versus 90%-95% for owner-occupied properties.

Amortization periods
Investors who make a down payment of less than 20% can expect an amortization period of 25 years. But if they down put 25% of the property value or more, they qualify for an amortization period of 30-35 years. This is regardless of whether the property is owner-occupied or not. More extended amortization periods mean lower monthly payments, but more interest is paid over the loan's lifetime. But a more extended amortization period is a plus for rental property owners because interest payments are tax-deductible, and it lowers the monthly carrying costs on the property.

Finally, one of the best things you can do for yourself, as a first-time rental property investor, is to find a mortgage broker who has experience with investment properties. An experienced broker will help you navigate the inroads of investment property financing and ensure you get the best rates available in the market. To learn more about how to leverage your home equity to buy a rental property, have a friendly call with Jim today at 604.620.2697.