Getting approval for a rental property mortgage is not as simple as getting the same thing for a primary residence. There are numerous hurdles to cross and plenty of opportunities to get disqualified along the way. It is this way because lenders view your primary home as a necessity. Therefore, they offer concessions that make it easier for people to buy the home they will live in.
However, a second home is viewed as a luxury and lenders are not obligated to make any allowances. If a person can afford a rental home, it is assumed that they should be able to meet the lenders’ requirements. Consequently, the conditions for rental property mortgages are tougher than those for a primary home. Here is what you should know about the process.
The first things you should think about after you have pinpointed the exact location of the property are:
- The number of units in the building
Investment properties are categorized by the number of units they contain. Buildings with 1-4 units are residential properties, while anything above 4 units is a commercial property. Lending requirements for commercial properties are more stringent than those for residential properties. You may need to provide zoning documents for the home to prove that you are not buying a commercial building in the name of a residential property.
- Will you live in the building?
Buildings where the owner occupies one of the units are treated differently from non-owner occupied buildings. That is because there is a lower risk of default and damage when the owner lives on the premises. As a result, owner-occupied homes have easier terms than non-owner occupied homes.
Mortgage qualification criteria
The following items are what lenders will require in order to approve your loan application.
- Proof of income
You must provide evidence of a steady job with a sufficient salary. You will be expected to provide proof through a letter of employment that is not older than 30 days, pay stubs going back a few months, and Notice of Assessment from the CRA.
If you are self-employed, lenders will want to see proof of business registration, proof of income going back two years, and tax returns. If your income stream is unreliable, it could keep you from getting approved.
- Proof of a sizeable down payment
You should have enough money in your bank account to cover the down payment on the property. This must be money that has been in your account for, at least, three months. And it must not be borrowed.
Depending on whether the rental is a multi-unit and if you will live in it, the down payment can range from 5%-20% of the purchase price of the home. In addition, you should have enough cash to cover six months of mortgage payments (on your primary and secondary mortgages) and to pay the closing costs on the loan.
- Credit checks and debt ratios
The minimum credit score allowed for a rental property is 680. But even with this score, you will only succeed in getting a loan with the most difficult terms. A credit score of around 720 is recommended if you want the most favorable mortgage terms. Furthermore, lenders will conduct tests to determine your level of financial resilience.
The principal thing they check is your debt ratio. This is the ratio of how much you earn compared to how much you owe. The idea is to see what percentage of your income goes into paying off debts. Ideally, this should not be more than 45%.
All lenders require you to pay some money toward the purchase of your property. Investors who are borrowing to buy a non-owner home must make a down payment of, at least, 20%. But, if they are buying an owner-occupied home with 1-2 units, the down payment on the home is 5%. But if the building has 3-4 units and the owner is going to live in it, the down payment will be 10%.
There is another condition as of February 2016 and that is if the price of an owner-occupied home is over $500,000, borrowers will be allowed 5% on the first $500,000. On any amounts over the initial $500,000, they have to make a down payment of 10%.
Maximum amortization period
This is one area where it does not matter if a home is owner-occupied or non-owner-occupied. What determines the loan amortization period is how much the investor paid on the property. Down payments of less than 20% attract an amortization period of 25 years. If the down payment is over 20%, the amortization period is 30-35 years.
Mortgage default insurance
Borrowers who make a down payment of less than 20% may be required to purchase mortgage default insurance. The only time this becomes a requirement after you pay 20% down is when there are questions about your financial situation. Mortgage default insurance rates are influenced by both the down payment on the home and the amortization period of the loan.
There you have it, what you need to know about getting a loan to purchase a rental property.
Source : https://www.leenanproperties.com/