Buying a rental property? How the financing game has changed

 

Buying a rental property? How the financing game has changed

by Robert McLister

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 paymentIf 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 everIf 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 = headachesMany 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 paperworkA 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 secondaryRental 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 carefullyIf 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

All My Single Ladies!

It’s becoming increasingly apparent that a greater number of women are now taking the reins when it comes to home purchases. There’s a growing trend among single women – and, more precisely, professional single women – who are becoming independent homeowners. While many of them may be putting off marriage, they’re not waiting around for Mr Right before taking the plunge into homeownership. It’s believed that around 20% of homebuyers in North America are single women based on a report released last year by the US National Association of Realtors. Harvard University’s Joint Center for Housing Studies also released a report that said single women are buying in record numbers. There’s no equivalent data for Canada, but an abundance of anecdotal information has led to the creation of shows like HGTV’s Buy Herself, which follows single women making their first real estate purchases. Women are looking for ways to become financially independent, and investing in real estate and building equity for themselves are ways to invest in their future – building financial security. Women are taking advantage of historically low interest rates and recognizing homeownership is often within their grasps. Seeking expert advice One of the amazing things about women looking to invest in real estate is that they’re getting more advice before they make the decision to enter the market. They’re seeking out mortgage experts and real estate agents, and building a plan for the perfect entry into the market. They’re making lists of areas in which they’re interested in purchasing, itemizing amenities they would

need in their ideal neighbourhoods, ensuring they have all the facts around closing costs and fees associated with making the purchase, and securing a mortgage. Buying a home is likely one of the largest purchases you’ll ever make in your lifetime, and can feel overwhelming. That’s why working with a mortgage professional, real estate agent, home inspector and so on is essential. You’ll be working with these professionals closely – possibly for months – so interactions should feel comfortable, and they should be knowledgeable and responsive even to the smallest question. The more prepared you are, the smoother the experience will be so do a little research on your own over the Internet to get a good idea of what types of properties and areas are of interest to you. Make a list of questions to ask the experts – and keep it on hand so you can add to it as more questions arise. Interest rates are the lowest they've been in history and they have nowhere to go but up. Industry professionals believe that as rates begin to rise, they'll continue to rise for some time. And, effective July 9th, four changes to insured mortgages are coming into effect. The two that will have the largest impact on Canadian borrowers include: 1) a reduction in the maximum amortization period to 25 years from 30 years; and 2) a reduction in the maximum amount of equity homeowners can take out of their homes when refinancing to 80% from the current 85%. So if you're looking to make a purchase, or renew/refinance an existing mortgage, and you're seeking a 30-year amortization and/or access to 85% of your equity, this opportunity expires Monday, July 9th! If you'd like to review your options or if you have any questions, please give me a call or send me an email, and I'll be happy to discuss how these changes may affect your mortgag e situation. It's my job to ensure you have the best options and strategies available at all times!

Clarifying Mortgage Penalties

Last month, the federal government published a Mortgage Prepayment Code to ensure borrowers are better informed by lenders (federally regulated institutions) when it comes to situations where mortgage prepayment penalties may be charged – namely, for the purpose of clarifying interest rate differential (IRD). This is a positive step, because IRD calculations and penalties have traditionally been very confusing to borrowers. IRD is a charge many borrowers face when paying off a mortgage prior to its maturity date, or by paying the mortgage principal down beyond the amount of annual allowable prepayment privilege limits. And IRD penalties can prove quite costly depending on the remaining mortgage term. IRD is based on: 1) The amount that is being prepaid; and, 2) An interest rate that equals the difference between the original mortgage interest rate and the interest rate that the lender can charge today when re-lending the funds for the remaining term of your mortgage. Most closed fixed-rate mortgages have a prepayment penalty that is the higher of three months’ worth of interest or IRD. The new code requires that lenders “provide the information in language, and present it in a manner, that is clear, simple and not misleading.” The Code requires lenders to provide, among other things: 1. Annual Prepayment Information. This includes such things as prepayment privileges that the borrower can use to pay off their mortgage faster without having to pay a prepayment charge. Examples include making lump-sum prepayments, increasing the regular payment amount and increasing the frequency of the payment to weekly or bi-weekly. Lenders

must also inform borrowers of the dollar amount of the prepayment that the borrower can make on a yearly basis under the terms of their mortgage without having to pay a prepayment charge. As well, an explanation must be provided on how the lender calculates the prepayment charge for the borrower’s mortgage (for example, a certain number of months’ interest or IRD). 2. Information Provided When Borrower Faces a Prepayment Charge. If a prepayment charge applies and the borrower confirms to the lender that the borrower is prepaying the full or a specified partial amount owing on their mortgage, the lender will provide, among other things, a written statement to the borrower including the applicable prepayment charge and a description of how the lender calculated the prepayment charge (for example, whether the lender used a certain number of months’ interest or IRD). If the lender used IRD to calculate the prepayment charge, the lender will inform the borrower of: the outstanding amount on the mortgage; the annual interest rate on the mortgage; the comparison rate that was used for the calculation; and the term remaining on the mortgage that was used for the calculation. 3. Enhancing Borrower Awareness. To assist borrowers in better understanding the consequences of prepaying a mortgage, lenders will make available to consumers information on the following topics: differences between various types of mortgages; ways in which a borrower can pay off a mortgage faster without having to pay a prepayment charge; ways to avoid prepayment charges (for example, by porting a mortgage); how prepayment charges are calculated, with examples of the prepayment charges that would apply in specific circumstances; and actions by a borrower that may result in the borrower having to pay a prepayment charge. Click here for full details of the code requirements from the federal finance department. As always, if you have questions about mortgage penalties, or other mortgage-related questions, I’m here to help!

Financial Planning

Regardless of your current job security level and your overall financial wellness, taking a proactive approach to your finances by putting mortgage payments aside while you’re doing well can help set any homeowner’s mind at ease for the future. It’s a wise move to set money aside each pay period so you can accumulate six to 12 months’ worth of mortgage payments in a short-term GIC as security for a possible job loss. Planning for the future and things such as illness or potential job loss is one of the most important undertakings homeowners can make to ensure you can pay your mortgage in uncertain times. And, best of all, if you remain healthy and your job remains secure, you can take the money out of your GIC and make a prepayment back on your mortgage on your anniversary date (or whenever your prepayment options permit you to do so), which can end up saving you thousands of dollars in interest payments and trim down the amount of time it will take to pay off your mortgage. But if it’s not plausible to save money each pay period, refinancing to access the equity you’ve

already built up in your home is another valid option for planning ahead in uncertain times. In addition to freeing up money to store future mortgage payments in a GIC, some of the money can also be used to pay off high-interest debt – such as credit cards – and get your New Year off to a fresh financial start. You will find that taking equity out of your home to pay off high-interest debt can put more money in your bank account each month. And since interest rates are at historic lows, switching to a lower rate may save you a lot of money – possibly thousands of dollars per year. There are often penalties associated with paying your mortgage loan out prior to renewal, but these could be offset by the extra money you save through a refinance. With access to more money, you will be better able to manage your debt. Refinancing your mortgage and taking some existing equity out could also enable you to do some home renovations, take a vacation or even invest in your children’s education.

Must have Real Estate Apps for 2012

	Crumbtracks This is a real estate journal for buyers.  Buyers  can take video, photos, make notes, comments and rate every home they view.  It stores and organizes it all for the client and realtor.  Even includes a working mortgage calculator!
	TourNarrator This captures buyer's comments as they view the listing.  It is captured in a PDF and can be emailed to your buyer or the listing Realtor for instant feedback on your showing of their listing.
	Real Alert Safety device for agents that can set off an alarm on your phone, insta-dial 911, locate hospitals on GPS, records suspicious data, instant alerts a friend via email with your location and has a flashlight built in.
	Magic Plan The only app that measures, draws, and publishes interactive floor plans of homes just by taking pictures.  Create floor plans of your listings in minutes!
	Photosynth A very simple app that creates 360 degree virtual tours of your listings from a series of shots taken by your smart phone.
	Milebug Full GPS tracking on your phone and reporting of all your mileage in categorized by work or pleasure.  One of the most sought after audit areas with Revenue Canada and Realtors.
	My Measures & Dimensions Lets you take any photo and quickly draw dimensions on top of objects or spaces in the photo. After photos are marked up with measurements, they can be emailed to anyone, or added to the iPhone's photo library.
	Courtesy of GoMax Solutions www.gomaxsolutions.com

Hybrid Mortgages: Consider a 50/50 mortgage?

Hybrid mortgages – also known as 50/50 mortgage products – include an equal mix of fixed-rate and variable-rate components within your single mortgage. This means you get the best of both worlds – the security of fixed repayments with the flexibility of a variable rate. Although there was a time in recent years when mortgage experts considered a variable rate mortgage as the obvious choice to save mortgage consumers money over the long term, with fixed rates remaining near historic lows, a 50/50 mortgage may be a great alternative for you. In essence, since it’s extremely difficult to accurately predict rates over the long term, a 50/50 mortgage offers interest rate diversification, which can help reduce your level of risk. If you opt for the Dominion Lending Centres 50/50 Balanced Mortgage, half of your mortgage is locked into a five-year fixed rate and half is at a five-year variable rate. You can lock in your variable-rate portion at any time without paying a penalty.

As well, each portion of the 50/50 mortgage operates independently – like two separate mortgages – yet the product is registered as only one collateral charge. The 50/50 mortgage product is well-suited to a variety of borrowers, including those who: Would normally go fully variable but are afraid prime rate is at its bottom Aren’t comfortable being locked into a fully fixed rate Can’t decide between a fixed or variable mortgage Savvy first-time homebuyers Some features of the 50/50 mortgage include: 20% annual lump-sum pre-payment privileges 20% annual payment increase ability Portability (the option to transfer your existing loan amount to a new property without penalty) As always, if you have questions about the 50/50 mortgage product and whether it’s right for you, or other mortgage-related questions, I’m here to help!

Introducing EnRICHed Academy

Dominion Lending Centres is proud to announce the launch of EnRICHed Academy’s “Smart Start for Financial Genius”! This program has been designed to educate young adults (13-23) and their families on the fundamentals that build wealth in an entertaining, funny and entirely interactive way. No program like this currently exists, and the need and demand across North America is at an all-time high. This is our way of giving back to communities across Canada, ensuring our youth embrace financial literacy. Click here to view the EnRICHed Academy trailer on YouTube. Why we created EnRICHed Statistically, 6 out of 10 Canadians live paycheque to paycheque, which means if their income stopped for only one pay period they’d have to rely on a Line of Credit or Credit Card to make ends meet  From 1989 to 2006, total credit card charges rose from $69 Billion to $1.8 Trillion; a 2,600% increase  Today the average household credit card debt is $16,007 The yearly savings rate of an average Canadian has gone from over 12% of income in the early 90s to under 2% today Household debt in Canada has more than doubled over the past 10 years 84% percent of college graduates in North America indicated they needed more education on financial management topics. Parents expect the schools to teach financial literacy and schools expect parents to. The fact is, most parents and teachers are ill equipped to teach students and kids on this subject and, therefore, don’t

The average college graduate is $23,186 in debt What EnRICHed looks likeThe program comes in a box and contains 5 DVDs of entertaining but highly educational video on creating a foundation for building wealth. There is a 100-page workbook that the family will work through that includes activities and exercises as well as other materials that correspond with the topics covered in the program. 15 key topics covered by EnRICHed Understanding money 101 Why some people don’t save money… no matter how much they make How much we actually spend at an early age Saving money vs Making money Why starting to save at an early age is critical The magic behind compound interest and how it works How to buy your first investment property by the age of 23 How to get into the stock market How credit cards work Good debt vs Bad debt How taxes work on a paycheque Why goals are critical to building wealth The difference between a dream and a goal How to write down goals and take action The importance of building your personal brand Feel free to give me a call or send me an email if you’d like to learn more about EnRICHed Academy.