With cap rates compressing in major cities, knowing exactly how lenders assess rental income can be the difference between an approved and declined application.
What is Investment Property Financing?
Investment property financing in Canada refers to the process of obtaining a mortgage to purchase a property with the intention of generating rental income. This type of financing is different from a primary residence mortgage, as it requires lenders to assess the property's rental potential and the borrower's ability to service the debt.Down Payment Requirements
When it comes to down payment requirements, investment property financing in Canada is similar to primary residence financing. Borrowers typically need to put down at least 20% of the purchase price to avoid paying mortgage insurance. However, if the down payment is less than 20%, the borrower can use the CMHC's "gross debt service" (GDS) and "total debt service" (TDS) ratio rules to qualify for a mortgage. Here are the GDS and TDS ratio rules:| Ratio | Description |
|---|---|
| GDS | The percentage of the borrower's gross income that goes towards paying the mortgage, property taxes, and insurance. The maximum GDS ratio is 32%. |
| TDS | The percentage of the borrower's gross income that goes towards paying all debt, including the mortgage, car loans, credit cards, and other debts. The maximum TDS ratio is 40%. |
Rental Income Qualification
Lenders use the debt service coverage ratio (DSCR) to assess a property's rental potential. The DSCR is calculated by dividing the net operating income (NOI) by the annual mortgage payment. A DSCR of 1.2 or higher is generally considered acceptable. Here's an example of how the DSCR is calculated: * NOI: $120,000 per year * Annual mortgage payment: $80,000 per year * DSCR: $120,000 ÷ $80,000 = 1.5Current Rates and Terms
The current mortgage rates for investment property financing in Canada are higher than those for primary residence financing. The best rates for investment property mortgages are typically offered by private lenders, such as First National or CMLS. Here are some current rates and terms:| Lender | Rate | Term |
|---|---|---|
| First National | 4.29% | 5-year fixed |
| CMLS | 4.19% | 5-year fixed |
Cash Flow Analysis
When it comes to cash flow analysis, lenders want to see that the property will generate enough rental income to cover the mortgage payments, property taxes, and insurance. Borrowers can use cash flow analysis to determine whether the property is likely to generate a positive cash flow. Here's an example of a cash flow analysis: * Rental income: $120,000 per year * Mortgage payment: $80,000 per year * Property taxes: $20,000 per year * Insurance: $5,000 per year * Net operating income: $15,000 per yearWhen performing a cash flow analysis, borrowers should consider all expenses, including maintenance, repairs, and vacancies.
Common Mistakes to Avoid
When it comes to investment property financing, borrowers should avoid making common mistakes, such as: * Not considering all expenses, including maintenance, repairs, and vacancies * Not calculating the DSCR correctly * Not providing sufficient documentation, including financial statements and tax returnsBottom Line
Investment property financing in Canada requires a thorough understanding of the lender's requirements and the borrower's financial situation. Borrowers should carefully review the lender's terms and conditions, including the interest rate, term, and amortization period. Additionally, borrowers should perform a cash flow analysis to determine whether the property will generate a positive cash flow. By understanding the lender's requirements and the borrower's financial situation, borrowers can increase their chances of approval and make informed decisions when it comes to investment property financing in Canada.Reviewed for accuracy
Manbir Natt BCFSA Lic. #MB612411
Licensed mortgage broker · MBA, Rotman School of Management, University of Toronto
AI-generated content. This article was produced with AI assistance and reviewed for general accuracy. It is for informational purposes only and does not constitute financial, mortgage, or legal advice. Always consult a licensed mortgage professional before making any financial decisions.
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