Buying real estate is one of the most popular additions to an investor’s portfolio. Investors are attracted to real estate for its long-term stability, high return on investment, and potential rental income. In recent years, the number of homes being bought for the purpose of investment, often for rentals, has exploded. According to recent statistics, one in four homes in Ontario and one in five homes in Canada are bought as investments rather than for a primary residence.
If you already own the home you live in and are looking to acquire a second property as an income property, you may have found that investment property mortgages you are offered do not exactly resemble the one you got for your first home. This is no mistake. Often, mortgage rates for investment properties will come in higher than owner-occupied properties.
Banks treat mortgages on rental properties a little differently than on owner-occupied homes and there are a few reasons behind this that you should know. In this article, we will cover why rates vary with investment properties, how much higher they are, what your mortgage options are for an investment property, and how to find financing for investment properties.
Why are rates different for investment property?
Mortgage interest rates are decided largely by how risky the bank perceives your loan to be. They will charge more interest on any loan that they see as riskier in order to shelter themselves from issues.
One reason banks see owner-occupied residences as less risky is that for someone who is purchasing a home to live in, the bank figures they likely have much more at stake and will do more to ensure their mortgage remains in good standing. A person who is buying a property solely for investing does not truly need the home to live. In the event of financial hardship, the investment property will be the first asset to go rather than their primary home. Investment properties do not usually have mortgage default insurance which means if an investor is to default, the bank won’t be protected.
or this reason, banks and lenders see rental property as a riskier asset for them to invest in with a loan. To offset the risk, the bank will usually charge a higher interest rate. In fact, many mortgage lenders will not offer financing for an investment property at all.
How much higher are investment property mortgage rates?
Your mortgage rates will likely be higher for an investment property than for the same property bought as an owner’s residence. In fact, if you are buying a property with rental units but you also plan to live in it, you will still not face the same restrictions as a pure investment purchase. Your interest rates for an investment property may be as much as 0.6% higher than a standard mortgage.
However, this gets a little more complicated in terms of the actual increase in funds needed. For one, investment properties usually have a larger down payment, which can mean better rates in general. Even with a higher rate, an increased down payment may offset the costs. In addition, investors tend to be smart with their money and probably have healthy credit scores which can also help them receive relatively better rates.
Investment mortgages are also usually not forced to purchase mortgage insurance unless your particular lender requires it. For low down payment mortgages, this insurance often costs thousands of dollars upfront or more as interest accrues over time.
Finally, investors may be able to collect sizable rents from an investment property or use their expanded cash flow to pay down their mortgage much quicker, mitigating the effects of higher interest rates.
What kind of mortgages are available for investment properties?
Though there are a few differences between a conventional mortgage and investment property mortgages, your options for mortgages will be very similar. Due to the facts mentioned above such as high down payments and good credit, you will likely have many options available in terms of how you want your mortgage to be.
Investment mortgages are able to be both fixed or variable rate. The amortization period you choose will decide on how much you want your monthly mortgage payments to be. This is helpful if you plan on having tenants who pay rent, as you can coordinate your rent income with your monthly payments. Investment mortgages can use any of the standard amortization periods all the way up to 35 years. The process of monthly payments, mortgage term length, and interest compounding will be the same as a traditional mortgage as well.
How rental income factors into your mortgage and debt coverage ratio
Lenders will often require you to have a certain debt coverage ratio before you get an investment property mortgage. This ratio is found by dividing your net operating income by your debt service amount. However, lenders may also factor a rental offset into this ratio.
Essentially, they assume you will collect a certain amount of rent once you purchase the property. Lenders will offset a percentage of your rental income against your loan payment, and any leftover income can be included in your debt ratio.
Financing a rental property
One of the biggest things you need to know if you want to finance an investment property is that your down payment has a higher minimum than the normal 5% minimum down payment on homes. Mortgages for investment property are required to pay a minimum of 20% down unless you plan on living on the property.
There are also some other requirements that some lenders will place on your mortgage. For example, some lenders will require a minimum net worth, often $100,00 per property, before they will lend to you.
Because financing for rentals can be more complex than owner-occupied homes, it’s best to contact a mortgage broker to help you find the best deal. The broker will handle all the work of tracking down different lenders and rates and present you with only your best options. You can even find a broker who specializes in investment property and they will bring the most amount of expertise to the table.
If you are hoping to purchase a property for the purpose of flipping rather than renting, you will have the hardest time getting financing. Due to the rapid turnaround on flip houses, most buyers in this field choose to finance the entire cost of the home without a lender.
Mortgage Rates Canada for Rental Property by Corben Grant | Canadian Real Estate Wealth