Rental Properties & Vacation Properties Explained Your How To Guide:
If you’re in the market for a second property, it’s important to distinguish the difference between an investment property and a second home. While both are often considered the same, there are distinct factors that result in both types of homes being treated differently when applying for a mortgage.
Let’s take a look below at some of those differences
A. Rental Property
An investment property, also known as a rental property, is considered one at which is purchased with the intention of renting out. There are two main types of investment properties:
1. A typical rental property is one where you as the landlord do not live on the property.
2. An owner-occupied rental property is one that involves you as the landlord, living in one part at the home. A common example may be where you rent out the basement portion of your home. Another example would include a duplex where you live on one side and rent out the other side.
Because an investment property holds an intended use to gain financially, the minimum down payment required is 20% of the purchase price. Additionally, when acquiring a mortgage on a rental property, you will need a minimum credit score of 620. You will also be subject to standard qualifying guidelines proving you can financially carry both mortgages.
Alternatively, “House Hacking” is a popular strategy many use that allows one to turn their primary residence into that desired rental property, while then shopping for that owner-occupied home. While that next purchase would be one’s primary residence, the benefit of house hacking is that it only requires a 5% down payment as opposed to the 20% down payment in order to secure a rental property.
With that, there are many ways you can save to secure the required funds for a down payment on an investment property. The most common method would be through your own personal savings or a gifted down lump sum from a family member. A secondary option, and a very popular option at that, would be to pull from your existing equity you’ve built up in your current home. It’s important to note that lenders will allow you to pull out up to 80% of your home’s current value. In turn, as this investment property will provide a means of rental income, you will be able to add up to 80% of that income towards the qualification of your mortgage.
While rental income can be used to debt service your mortgage application, remember that some lenders have a minimum liquid net worth requirement outside of the property itself. Also, rental properties will be subject to a capital gains tax on any profits incurred after selling. You will also need to have your down payment ready (from your savings or home equity), as most lenders will require a 90-day history of where the source of your down payment came from. As stated above, the majority of lenders accept up to 50% of the rental income in addition to your main income, while on stronger applications, some lenders will accept up to 80% or more while subtracting your expenses.
B. Vacation Property
A vacation home is more like a second home that is purchased for you and your family to enjoy. Unlike a rental property, a second home is purchased without the intent of gaining rental income. The minimum down payment required for a second home is as little as 5%, and most lenders allow you to use up to 80% of your home’s current equity to fund the down payment. This is done through mortgage refinancing. You can also unlock your home equity through a Line Of Credit or even a Home Equity Line Of Credit (HELOC). These lending instruments allow you to borrow funds as needed and enable you to avoid lender penalties when you break your mortgage.
The rest of the mortgage process is as per usual. All you need to ensure is that your down payment is ready when required. Like your first mortgage, the minimum down payment is 5%. One thing to note is if your vacation home is not winterized or will not have year-round access, then a 10% down payment will be required. You will also need a minimum credit score of 620 if you are putting down anything less than 20%, and you will be subject to qualifying guidelines proving you can carry both mortgages.
How to secure a mortgage for your next Rental Property or Vacation Home?
The best way to obtain a mortgage suitable for your requirement is to have a detailed conversation with your trusted mortgage broker. We at Boychuk Mortgage Group strive to provide details from start to finish with all clients looking to make that next move on a second home or rental property. If you don’t qualify for a mortgage with a big bank, we are able to connect our clients with alternative lending options like smaller banks and financial institutions, to in which, offer competitive market rates and mortgage solutions.
Some common examples of when alternative lending is required
1. Individuals who are self-employed or have a non-traditional source of income.
2. Individuals who already own investment properties.
3. Individuals who have higher debt servicing ratios (most people looking for a second property will have higher debt servicing ratios).
4. Individuals who are looking to purchase a second home.
Expenses other than the down payment
Similar to your first mortgage, securing a mortgage on a rental property and vacation home requires one to cover expenses beyond the down payment itself. Some additional costs to consider are:
A. Closing costs: These are additional costs associated with the closing of your new purchase. Some of these closing costs include home inspections, appraisals, land transfer fees, and title insurance.
B. Repair expenses: Prior to the property being fully contained, there may be necessary repairs required before being able to rent or use the premises.
C. Hookup fees: To obtain phone service and utilities, you will need to cover the cost of “turn-on” fees at the local departments.
D. Insurance coverage: To protect yourself against any property damage, home insurance is recommended, and in most cases, required on the majority of purchases.
E. Professional fees: Professional fees such as lawyer fees, realtor fees, accountants, and other professional services are common fees on every transaction
According to the Canadian Mortgage and Housing Corporation, the average closing costs will range between 1.5% and 4% of the property purchase price. In most cases, lenders will also require the borrower to show that 1.5% - 4% in liquid capital, to in which, provides the lender proof that the borrower will make it to closing.
When should you invest in a second property?
Buying a second property is a big responsibility, especially if you’re still paying your first mortgage. As a result, you want to make sure that you’re prepared for it and not just investing because a family member said to, or because you thought it was a good idea. To determine if you’re ready to take on a new financial commitment, answer these three questions truthfully:
1. Do you have the funds to afford a second mortgage?
Before you take on more debt, assess your financial situation and your personal resources to acquire the funding you need. If you notice that you can comfortably manage the money for a down payment, closing costs, and other purchase expenses, you should have no problem moving forward.
2. Can you cope with your existing monthly payments and a new one?
This is also related to your financial situation but, on a monthly basis. Depending on the income you receive every month, double check to see if you can afford your monthly expenses in terms of debt payments, bills, personal expenses, etc. If you can cover these expenses sufficiently, as well as your new mortgage payments, consider buying a second home or investment property.
3. Are you ready to be a landlord?
Being a landlord means you not only get to charge rent, but you also need to cover expenses like property repairs and on-going maintenance to ensure your rental property is habitable. Alternatively, you will need to invest your time and effort into understanding your duties as a landlord, while also preparing contracts suitable for your tenants and for yourself.
If you’d like to learn more about the responsibilities and requirements when purchasing a rental property or second home, or if you were looking for some more information on qualifying for that next big transaction, reach out to us today at Boychuk Mortgage Group and we’d be happy to help.