Buying investment property in Canada. A comprehensive guide

Financing Rules for Buying an Investment Property in Canada

Investing in real estate can be a lucrative way to build wealth, and Canada remains one of the top destinations for property investors due to its stable economy, high demand for rental properties, and attractive rental yields in several regions. However, financing the purchase of an investment property in Canada comes with specific rules and requirements that differ from buying a primary residence. Here’s a comprehensive guide to the financing rules for buying an investment property in Canada.

1. Down Payment Requirements

When purchasing an investment property in Canada, one of the most notable differences from buying a primary residence is the required down payment.

• For properties with 1 to 4 units: The minimum down payment for an investment property typically starts at 20% of the property's purchase price. This is higher than the 5% minimum down payment for primary residences priced under $500,000.

• For properties with 5 or more units: The down payment usually starts at 25% of the property's value. The increased down payment is due to the increased risk associated with larger rental properties.

Tip: A larger down payment can help you secure more favorable mortgage rates and reduce the amount of interest you pay over the life of the loan. If you're a first-time homebuyer or investing in a property that qualifies for government programs, it’s worth exploring options that might offer lower down payments for investment properties.

2. Loan-to-Value (LTV) Ratio

The Loan-to-Value (LTV) ratio is the percentage of the property's value that is financed through a mortgage. The LTV for investment properties is typically more conservative than for primary residences.

• Maximum LTV for investment properties: Lenders generally prefer an LTV of no more than 80% for investment properties, which means that you will need to provide at least 20% of the property's value as a down payment.

• Private Lenders or Alternative Financing: If you are unable to secure financing from traditional lenders (such as banks or credit unions), private lenders or mortgage investment corporations (MICs) may offer more flexible terms but often at higher interest rates and fees.

3. Mortgage Rates for Investment Properties

Mortgage rates for investment properties are typically higher than those for primary residences. The difference in rates compensates lenders for the higher perceived risk associated with rental properties, which can be influenced by factors such as:

• The risk of vacancies or tenant non-payment.

• The potential for property damage or maintenance issues.

• The fluctuations in the real estate market.

• Fixed-Rate Mortgages: A fixed-rate mortgage offers predictable payments over the term of the loan. Fixed rates for investment properties tend to be 0.5% to 1% higher than the rates offered for owner-occupied homes.

• Variable-Rate Mortgages: A variable-rate mortgage (also known as a floating rate mortgage) may offer lower rates than fixed-rate mortgages, but it comes with the risk of the rate rising during the term, making it harder to predict monthly payments.

4. Qualification Criteria

To qualify for a mortgage on an investment property in Canada, you must meet certain financial requirements, and lenders will scrutinize your personal financial situation as well as the investment property's potential to generate income.

• Personal Financial Stability: Lenders will examine your credit score, income, debt-to-income ratio, and overall financial history to assess your ability to repay the loan. A credit score of 650 or higher is generally required to secure financing for an investment property, though some lenders may require a higher score, especially for larger loans or if you're applying for a mortgage on a property with more than four units.

• Rental Income: If the property you plan to purchase generates rental income, lenders will often allow you to factor in a portion of that rental income when determining your ability to repay the mortgage. Typically, lenders will consider 50% to 80% of the expected rental income when calculating your total monthly income, depending on the property type and location.

• Stress Test: As part of the mortgage application process, all borrowers must pass a stress test. This means that the borrower must be able to demonstrate the ability to afford the mortgage payments even if interest rates rise significantly. The stress test is usually based on the Bank of Canada’s benchmark rate or the lender’s offered rate plus 2%.

5. Additional Costs and Considerations

Beyond the down payment and mortgage rate, purchasing an investment property involves several other financial factors and costs.

• Property Taxes: Investment properties are subject to property taxes, which can be higher than those for primary residences, especially in municipalities with high rental demand.

• Insurance: You’ll need to purchase property insurance, including liability coverage. In some cases, you may need additional coverage for rental properties, especially if it’s a multi-unit property.

• Closing Costs: Similar to a primary home purchase, closing costs for investment properties include legal fees, title insurance, appraisal fees, and inspection fees. These can add up to 1.5% to 4% of the property's purchase price.

• Capital Gains Tax: While rental income is taxed as part of your regular income, selling an investment property is subject to capital gains tax. If you sell the property for a profit, you will be taxed on 50% of the capital gain, which is the difference between the selling price and the purchase price, minus any applicable expenses (e.g., renovation costs, real estate commissions).

6. Types of Financing Available

In Canada, there are several types of financing options available for investment properties, depending on your circumstances and the type of property you’re purchasing.

• Conventional Mortgage: This is the most common type of financing used for investment properties. It typically requires a down payment of at least 20% and offers both fixed and variable interest rate options.

• High-Ratio Mortgage: If you’re putting down less than 20%, you’ll need to get mortgage default insurance (offered by the Canada Mortgage and Housing Corporation, or CMHC, among other private insurers). However, this is not common for investment properties, as the minimum down payment requirement is typically 20%.

• Home Equity Line of Credit (HELOC): If you already own a home with significant equity, you may be able to leverage that equity to finance the purchase of an investment property through a Home Equity Line of Credit (HELOC). This can provide a flexible and lower-interest way to finance the purchase.

• Private Lenders: For those who may not qualify for traditional mortgages due to financial reasons or unique property types, private lenders may offer alternative financing options, albeit at higher interest rates.

7. Government Programs and Incentives

While Canada doesn’t have specific programs for first-time real estate investors, there are a few programs that could be beneficial, especially for those who are considering multi-unit properties:

• First-Time Home Buyer Incentive (FTHBI): Although primarily aimed at first-time homebuyers, this program can sometimes be used by investors for properties with up to four units, provided they meet the eligibility criteria.

• GST/HST Rebate: If you are purchasing a newly constructed rental property, you may be eligible for a GST/HST rebate on a portion of the sales tax, which can reduce the upfront cost of the property.

Conclusion

Buying an investment property in Canada involves a thorough understanding of the financing landscape, including down payment requirements, mortgage rates, qualification criteria, and additional costs. It's essential to work closely with a mortgage broker or lender who is experienced with investment property financing to ensure you understand your options and make informed decisions. Additionally, carefully evaluating the potential return on investment (ROI) of your rental property, factoring in all associated costs, will help you maximize the financial benefits of your real estate investment.