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Inheriting a cottage can be a headache if the proper measures aren’t in place.

StphaneLemire/Getty Images/iStockphoto

Demand for secondary properties has surged during the pandemic. But as most aspiring multiproperty owners soon find out, financing additional properties isn’t as straightforward as getting a mortgage on an owner-occupied residence.

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For a taste of what to consider when planning a secondary property mortgage, here’s a rundown of the basics by property type.

Financing raw land

  • Minimum down payment: 20 to 50 per cent.
  • Interest rate: 1 to 2 per cent-plus above regular owner-occupied rates.
  • Best lender options: Major banks, credit unions and small non-prime lenders.
  • Tip: Plan for a bigger down payment if the lot is unserviced (has no utilities, municipal water and sewer), in a remote or less marketable location, more than five acres, not residentially zoned, won’t be built upon right away, or the borrower is not well qualified. For quicker financing with less hassle, consider private interest-only financing. The rates are less pleasant (6 to 9 per cent-plus and fees) and the required down payment is bigger, but if the holding time frame is short, it’ll save you some grief.

Financing a second home or cottage

We’re talking an insulated property here with potable water, a kitchen and bath, a permanent heat source and year-round access.

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  • Minimum down payment: 5 to 20 per cent.
  • Interest rate: Regular rates or near-to.
  • Best lender options: Banks, credit unions and mortgage finance companies (if the mortgage is default-insured).
  • Tips: The owner or a relative can occupy the property, but it can’t be rented out. If you plan to rent the property, you’ll need “rental financing” instead, which costs a bit more. If you put the minimum 5 per cent down, you’ll pay default insurance, the amortization is limited to 25 years and the maximum property value is limited to $500,000. If you put down less than 20 per cent, you can only buy a second property up to $999,999.99, depending on the location and property type.

Financing a ‘true’ cottage

This refers to a cottage that doesn’t meet the above criteria – for example, one with no year-round road access or insulation.

  • Minimum down payment: 10 to 20 per cent.
  • Interest rate: Regular rates, or up to 1 per cent above, depending on property type/location.
  • Best lender options: Banks and credit unions.
  • Tip: If you put less than 20 per cent down, you’ll pay default insurance, the amortization is limited to 25 years and the property value might be limited (for example, $350,000 maximum).

Financing new construction

This refers to a house you’re having built on a lot you own, not a home purchased from a developer. This sort of financing is typically called construction draw financing.

  • Minimum down payment: 20 per cent (exceptions possible).
  • Interest rate: Regular rates after completion of the property; often 1 per cent-plus above regular rates during the construction phase, if it’s a bank.
  • Best lender options: Major banks and small non-prime lenders.
  • Tip: Some lenders will also finance up to 50, 65 or 80 per cent of the land value, depending on the lender and circumstances. Plan on having extra cash on hand for lien holdbacks and cost overruns. Mainstream lenders prefer the property be built by an established professional contractor versus it being owner-built. Owner-built homes often entail significant rate premiums. The lender allocates funds (draws) as the work is complete. An inspection is required at each stage before the lender releases more money. Small non-prime lenders are far easier when it comes to the overall process, but the rates can be at least five to seven percentage points higher, plus fees, albeit they’re usually interest-only.

Financing a rental property (one to four units)

This is a non-owner-occupied property that you own to generate income.

  • Minimum down payment: 20 per cent.
  • Interest rate: A 0.10 to 0.25 percentage-point premium to regular rates if you’re well qualified.
  • Best lender options: Major banks, credit unions and non-prime lenders.
  • Tip: Keep in mind that most mainstream lenders don’t allow you to use all of the property’s income in your mortgage application, knowing there may be vacancy. That makes it tougher to “debt service” on paper. In those cases, a non-prime lender may be your best bet. You’ll pay a one to two percentage point higher rate, but the lender will be far more lenient on debt-ratio limits.

The key in all these cases is that you must qualify. That means your credit must be good, unless you use a more expensive non-prime lender. You must also prove you can afford the monthly payments of the secondary property. That’s harder to do with mainstream lenders since the government’s new tougher mortgage “stress test.”

If you do take the plunge on a new property, have ample money in the bank for the unexpected, like big repairs, rising interest rates, rental vacancies or an inability to sell as quickly as you thought.

Robert McLister is mortgage editor at RATESDOTCA and founder of RateSpy.com and intelliMortgage. You can follow him on Twitter at @RobMcLister.

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