Things to Know Before Buying a Second Home to Rent
Buying a second home for use as a rental property is one of the best investments you will ever make. A rental property in a good location, if well managed, can yield stable and substantial income, as well as provide the funds for future property acquisitions. A lot of people are realizing this and that is why more Canadians are taking the bold step to become real estate investors.
But the problem with being a newbie property investor is that you need a lot of cash to get started. Since most would-be landlords do not have enough personal savings for outright property purchase, they usually need some type of loan. However, as RCPM Solutions says, the challenge with getting a rental property loan is that lender’s requirements can be very hard to meet.
Unless you have prior knowledge of what to expect and enough time to prepare, chances are high that your application will be rejected. This is the number one reason many prospective property investors are unable to fulfill their dreams. With this article, you can avoid that happening to you and this guide provides all the information you need to meet the lender’s requirements for residential property loans.
The minimum credit score you need to qualify for a rental property mortgage is 680. Although on paper, it is possible to qualify with a credit score of 600 – 680 but the terms for such loans are usually tough.
Lenders will only pay you serious attention if your credit score is at least 680. However, to get the absolute best terms and maybe be in the position to negotiate, aim for a score of 740 and above.
Investment property classifications
Investment properties are classified according to the number of units they contain. Buildings with 1-4 units are classified as residential, while those with 5 or more units are classified as commercial. Loan requirements for commercial buildings are different from the requirements for residential properties; they are much steeper.
All types of rental property mortgage lenders require borrowers to pay some money down. The down payment amount influences the interest rate and whether a mortgage insurance will be required for the loan. The standard down payment for rental properties is 20%. If a borrower puts down less than 20%, they will be asked to buy mortgage insurance.
There are two main factors that determine how much lenders will accept as a down payment; the number of units in a building and its owner-occupied status.
- For buildings with 1-2 units where the owner will live in one of the units, the accepted down payment is 5%
- For a building with 3-4 units where the owner will live in one of the units, the accepted down payment is 10%
- For buildings of 1-4 units where the owner will not live in any of the units, the expected down payment is 20%
Proof of income
Lenders also expect you to show proof that you have sufficient and stable income to make the mortgage payments on your primary home and the rental property. If you have a job, the proof they want is a letter of employment (issued in the last 30 days), pay stubs, and your most recent Notice of Assessment (NOA) from the CRA.
If you are self-employed, expect to provide proof of business registration, proof of income for the past 2-3 years, and the business’ financial statements for the last 2-3 years.
Proof of substantial savings
Lenders want to see that you have enough money set aside to make the down payment on the property and the closing costs of the mortgage. They may also want to see enough money or assets (held in easily convertible instruments) to cover as much as six months of mortgage payments on your home and the rental in the event that something happens to your source of income.
Lenders will perform stress tests on your income to determine the level of your financial resilience. These tests are designed to find out how much of your monthly earnings go to servicing debts.
These debts will include your two mortgages, your car payments, credit card debts, and other debts you may be carrying. Ideally, lenders expect that no more than 45% of your income should go toward paying off debts every month.
The amortization period for an investment property mortgage is 25 – 35 years. If you make a down payment of less than 20%, the amortization period will be 25 years. But if the down payment is more than 20%, the amortization period will be 30 – 35 years.
People who are in the market to buy a second home have an additional option for raising the funds they need to buy their rental property. In addition to directly applying for an investment property loan, they can use the following options:
- They can refinance their home by taking out a new mortgage on it
- Or they can get a second mortgage with their home as collateral.
There you have it, things to know before buying a second home for investment.