Are you looking for financing for a rental property investment? This is for people who are looking to purchase a rental property or already own one. Mortgage rates are at historic lows. Well, you’ve come to the right place.
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Obtaining mortgage financing is a lot like obtaining financing for your primary residence. But it’s different in several key ways. We’ll look at some of the ways lenders let you factor in rental income when buying a rental property.
What are the different methods lenders are able to use to factor in rental income?
There are three main methods that mortgage lenders use to factor in rental income. Under each method, lenders are able to choose the percentage of rental income used.
Lenders will use a variety of methods and percentages depending on several factors. That includes whether it’s a purchase, transfer or refinance. Or if it’s a primary residence or rental property. If it’s a non-owner-occupied property the down payment on the buy is 20 per cent. Another factor: is it the subject or a non-subject property. Plus, what is the number of units your building has? That will determine whether the building is zoned residential or commercial. And interest rates with commercial mortgages are higher.
Method One: Rental Addback
Under the first method, rental income is added to your personal income that’s then used for debt servicing. Lenders usually use 50 percent of rental income. But they can use as much as 100 percent. This will determine your debt ratio in the eyes of the lender. That’s how they calculate your ability to make the mortgage payments and cover other debts. Out of the three methods for mortgaging a rental property that we’re looking at here, this is the least helpful in qualifying for additional mortgage money.
Formula:
- PITH / [borrowers income + (rental add-back percentage x rental income)]
- P = Principal
- I = Interest
- T = Property Taxes
- H = Heat
Method Two: Rental Offset
Unlike the first method where rental income is added to the borrower’s income, under method two, rental offset, the rental income is directly used to offset the “PITH” part of the formula. So an offset applies the monthly rental income against the monthly housing costs. The surplus income is then added to your personal income. If there’s a deficit, it’s added to your liabilities, which is then included in the Total Debt Servicing formula. So you have to cover it with your other income. This method does a lot more for you, to qualify for mortgage financing for a rental property.
Most lenders let you use between 50 and 80 percent of rental income. Some lenders are more generous than others and let you use as much as 90 to 100 percent of rental income under this formula.
Formula:
- PITH / [borrowers income + (rental add-back percentage x rental income)]
Method Three: Debt Coverage Ratio
The third and final method looks at the ratio of cash needed to service the expenses of the property. Mortgage lenders usually want a debt coverage ratio of 1.1 percent or greater in order to qualify. So the higher this ratio is, the easier it is to get a loan for a rental property.
Formula:
- Net Operating Income / Debt Service
Rental Worksheets
In addition to the above mentioned formulas, some lenders will also use rental worksheets. Rental worksheets are as they sound – worksheets that include your rental properties. Each lender’s rental worksheet is different. But usually it includes basic information for your rental properties, such as rental income, property taxes, home insurance, and repairs and maintenance.
The rental worksheet is used to calculate the minimum debt coverage ratio. You must meet that in order to qualify for mortgage financing.
The Bottom Line
It’s best not to get overly concerned about the various methods. All you need is a basic understanding. A mortgage broker can help you navigate the policies of various lenders and find a lender with a rental policy that works best for you. Look into it, though. There are historic opportunities in the market, right now.
Sean Cooper is the bestselling author of the book, Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom for Canadians. He bought his first house when he was only 27 in Toronto and paid off his mortgage in just 3 years by age 30. An in-demand Personal Finance Journalist, Money Coach and Speaker, his articles and blogs have been featured in publications such as the Toronto Star, Globe and Mail, Financial Post and MoneySense. Connect with Sean on LinkedIn, Twitter, Facebook and Instagram.
