Buying a rental property? How the financing game has changed

Just four short years ago, you could buy an investment property with nothing down and get the best interest rates in the market.

That was then. Today, rental financing is night-and-day different. To mortgage a small (a one-to-four unit, non-owner occupied) rental property now, you need to plop down one-fifth of the purchase price. And even then, you don't always get the lowest rate.

With a tipsy housing market and the credit crisis still fresh in memory, regulators and lenders are putting higher-risk borrowers under a microscope. That includes real estate investors.

As a result, it's now trickier to qualify for a rental property mortgage – especially compared to the days before April 19, 2010. (That's when federal legislation put an end to insured rental mortgages with less than 20 per cent down.)

So if you are considering a small rental property and need a mortgage soon, here are some things to remember.

You'll need an ample down payment
If you buy a rental home that you won't live in, almost every lender in Canada will want at least 20 per cent down. That's $72,000 on the average $360,000 residential property.

And if you're purchasing a condo or buying in a "higher-risk" city (like Vancouver), many lenders will want an additional 5 per cent.

Picking the right lender matters more than ever
If you want to be approved, your "total debt ratio" must fall within lender limits. At the risk of oversimplifying, your "total debt ratio" is generally your total monthly expenses divided by total monthly income from all sources, including rentals.

That sounds simple, but it's not. A borrower's ability to qualify often depends on how much of her rental income the lender recognizes.

You'd think that if a tenant pays you $1,000 a month, you could add that $1,000 to your income when qualifying for a mortgage. But in many cases, lenders will credit you with only 50 per cent of the rental income you receive, making it harder for you to qualify.

In all, there are four ways that lenders calculate your debt ratios, which are beyond the scope of this column. Suffice it to say, any competent mortgage adviser can point out lenders with borrower-friendly methods.

And there's one last thing to keep in mind about debt ratios. Different lenders have different limits. Some lenders let you have a 42 per cent total debt ratio. Most others permit just 40 per cent. That extra 2 per cent can make a big difference , especially for folks with mortgages on multiple properties.

The moral here is that the lender you pick can have a major impact on your approval chances. If your qualifications aren't perfect, you'll need a lender that is open to some common sense underwriting exceptions, and those are getting harder to find.

Multiple rental properties = headaches
Many lenders prohibit you from owning and/or financing an unlimited number of rental properties.

Even if they don't explicitly forbid it, the inability to count all your rental income in debt ratio calculations can make approvals challenging, and sometimes impossible. In fact, it often forces people with big rental portfolios to renew mortgages with their existing lender at unfavourable rates and terms.

So if you plan to finance a small rental empire, find a broker that has several clients with 10 or more rental properties. They'll need that experience to help you know which lenders to use, and in what order.

The key to remember is that lenders with the best rates often have the tightest rules. If you want the best terms, you'll want to use the more restrictive lenders early in your empire building and save the flexible ones for last. That ensures you don't run out of competitive lenders when your portfolio gets big.

More paperwork
A few years ago, it was easier to use an appraiser's estimate of a property's rental income in lieu of a signed lease. Today, more and more lenders want to see a signed written lease or other proof of rental income.

It also helps to have two years' tax returns available. That's because using tax returns to show your net gain or loss on a property can make it easier to qualify, as opposed to using other standard debt service calculations.

The rate is often secondary
Rental mortgages are higher risk so many lenders now charge rate premiums.

Fortunately, you can still find lenders that extend their best rates on investment financing. The question is, do they offer the other features you need?

In keeping with supply and demand, the most flexible mortgages usually cost more. That's especially true for investment property financing. Be prepared to pay a little extra if you need a lender that satisfies more than a few of these criteria:

• has highly flexible rental income rules
• allows you to carry a greater debt ratio
• lets you put a property in a company name for liability protection
• lets you finance more than four or five properties
• doesn’t impose a minimum net worth requirement
• allows 30– to 35-year amortizations to maximize your cash flow
• lets you prove rental income with “market rent” appraisals
• allows a gifted or borrowed down payment
• allows you to add a second mortgage
• will lend on large mortgages (e.g., $750,000+)
• has a low minimum credit score (e.g. 600 versus 650)
• allows rental income from suites that don’t conform with current municipal bylaws
• provides cash back (sometimes handy for improvements and closing costs)
• allows you to add a vendor take-back mortgage (this is where part of your purchase is financed by the property seller)
• offers a line of credit with your rental mortgage
• pays for your switching fees (this is far less common with rental mortgages than it is for regular mortgages)

Choose your broker carefully
If you want the best rental rate and most flexibility, an experienced no-fee broker is the way to go.

Rental financing is truly a specialization and probably only one in 10 mortgage professionals are actually proficient at it.

Rick Robertson, founder of the lender comparison firm Mortgage Mentor, says one way to screen brokers is to ask how many properties they've financed in the last year. If the number is less than 10 or 15, find a more experienced broker.

And Mr. Robertson adds, "Deal with a broker that uses a lot of lenders. Each lender has its own niche and no two lenders in Canada have the same rental policy."

Robert McLister is the editor of CanadianMortgageTrends.com and a mortgage planner at VERICO intelliMortgage, a mortgage brokerage. You can also follow him on twitter at @CdnMortgageNews.