Requirements for Getting a Loan for a Rental Property.

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Getting a Loan for Rental Property: The Requirements

For Canadians, or people living in Canada, who are looking to buy a rental property, there is a lot of money to be made in the current housing market. At the moment, the Canadian rental real estate market is roaring due to strong demand, high property prices, and increasing rents.

But buying investment properties in Canada is not just about rental income. Despite skyrocketing rents, many landlords are struggling to make their properties profitable. That’s because high property values often mean high mortgage payments and rents may not always cover that.

This is why, probably, the most important part of the house buying equation for newbie property investors is the location of the home they will buy. A lower-priced home that earns enough rental income to cover the mortgage payments is a good deal even if it is not in one of the major cities.

But before you can buy that property, there is one important hurdle you have to cross. You need to qualify for the mortgage on the property, that is, if you plan on financing the investment through a loan. This article deals with how you can get past that initial obstacle.

What you need to qualify for a rental property loan

Credit score

  • Requirements for Getting a Loan for a Rental Property.

The first thing a lender does is access your creditworthiness by looking at your credit report and credit score. There should be no delinquencies in the report. Credit scores range from 300 - 900. The best score to qualify for a rental property loan is above 713. Though it is possible to get a loan if your credit is between 660 and 712, the loan terms will usually be tougher.

Here is a breakdown of how lenders categorize credit scores when evaluating mortgage applications:

  • Excellent: 741+
  • Good: 713 – 740
  • Fair to average: 660 – 712
  • Below average: 575 - 659
  • Poor: 300 – 574

Proof of income

You must have income that is sufficient to accommodate monthly payments on a mortgage. If you are a salaried worker, the following documents will be required:

  • A recent letter of employment (less than 30 days old)
  • Pay stubs
  • Copies of your most recent Notice of Assessment (NOA) from the CRA

For people who are self-employed or whose income comes mainly from commissions, they must provide:

  • Proof of business (business registration or website URL)
  • Financial statements for the business
  • Proof of income for 2-3 years (in the form of NOAs)

Proof of down payment

  • Requirements for Getting a Loan for a Rental Property.

Lenders want to see that you have enough savings to make a down payment on the property. The down payment is the portion of the purchase price of the rental property that is paid by you. This money is paid upfront and the amount is determined by lenders.

Money used to make the down payment cannot be borrowed; it must be saved, legitimately earned, or gifted to you. How much lenders require from you as the down payment will depend on two things: the number of rental units in the building and if you will live in the building or not.

Number of rental units
Investment properties are either classified as commercial or residential. Residential properties are those buildings with 1-4 rental units in them. Buildings with 5+ rental units are commercial. Commercial properties attract higher interest rates, more fees and charges, and the loan terms are generally harder.

Owner-occupied or not
The second factor that determines how much you put down on a property is whether you will live in the building or not. Investors who live in one of the units in the rental are given more lenient terms, compared to investors who don’t. Here is a breakdown of how this affects the down payment on a property.

  • For owner-occupied homes with 1-2 units, the down payment is 5%
  • For non owner-occupied homes with 1-2 units, the down payment is 20%
  • For owner-occupied homes with 3-4 units, the down payment is 10%
  • For non owner-occupied homes with 3-4 units, the down payment is 20%

Note that investors who put down less than 20% on a property will be required to buy mortgage insurance.

Level of indebtedness

  • Requirements for Getting a Loan for a Rental Property.

Lenders also look at how much debt you have since that could impair your ability to make the monthly payments. They will want to know what percentage of your monthly income goes to paying off loans and how resilient your finances are in case of unexpected events. Ideally, a maximum of 40% of your income should go to loan repayments. If that percentage is 35% or less, you are in an even better position.

Proof of additional funds

You will also be required to show proof that you have enough savings to cover the closing costs of the loan and other costs. Mortgage closings costs are usually 2% to 5% of the purchase price of the home. The least you can expect to pay in closing costs is 1.5%. In addition to closing costs, there will be appraisal fees, legal fees, and other costs.

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