Investment Property Financing: What Potential Landlords Need to Know

Investment Property Financing: What Potential Landlords Need to Know

Homeownership is deeply ingrained in Canadian culture. Many Canadians value the idea of owning property as a worthwhile investment. Compared to a volatile stock market, real estate offers stability, and there’s an innate comfort in investing in something you can see and touch.

Over the past few decades, the real estate market, especially in major cities like Toronto, Vancouver, and Montreal, has seen substantial growth in property values. Many investors believe that due to increasing urbanization and rising immigration numbers, prime real estate in major Canadian cities will continue to appreciate. Plus, with rental properties, there’s an opportunity to generate passive income. It’s also an excellent way to diversify wealth. We explore the basics of investment property financing.

What Exactly is an Investment Property?

Investment property is real estate acquired not for personal use but to generate income or appreciation. Think of it as a financial asset that pays dividends through rent or capital gains. It’s not just limited to residential properties like condos or homes; it can also span commercial spaces, farmlands, or even vacant lands awaiting development.

Common Types of Investment Property Financing

Traditional Financing: The Bank Route

If this is your first venture into property investment and you don’t have substantial equity in your primary residence, investment property financing from a traditional bank would be a good option. Your credit history and score play a significant role in not only getting the loan approved but also in determining the interest rate. The bank will also take a hard look at your income, assets, and overall financial health. Naturally, they want to ensure you can juggle your current home loan and the new loan payments. Investment property financing from a bank often offers more competitive interest rates, especially if you have a strong credit history.

Banks typically require a higher down payment for investment properties than owner-occupied homes. While a 5-20 per cent down payment might be typical for a primary residence, they might require as much as a 35 per cent down payment for an investment property.

It’s worth noting that banks usually don’t consider future rental earnings when calculating your debt. Having cash reserves is a sign of financial stability. Some banks might want to see that you have enough reserves to cover several months of mortgage payments, especially if you don’t have a tenant yet or if the rental market is volatile. Six months is a commonly cited figure, but the exact requirement can vary.

Unlocking the Power of Home Equity

If you have significant equity in your primary residence and need to access funds rapidly (maybe due to a time-sensitive investment opportunity), a second mortgage can be quicker to secure than a traditional loan. This can be done through a home equity loan or a home equity line of credit (HELOC). Typically, second mortgages carry higher interest rates than mortgages, which could mean paying more interest over time. You can borrow up to 80 per cent of your home’s value to invest in another property.

When leveraging a second mortgage for investment property financing, always remember you’re placing your primary residence at risk. If, for some reason, you’re unable to meet the payments, you could lose your home.

Home Equity Loan vs. HELOC: What’s the Better Choice?

With a home equity loan, the bank or lender provides a one-time lump sum based on the equity you’ve built up in your home. This loan usually comes with a fixed interest rate and a set repayment period, just like your initial mortgage. It’s best for borrowers with a specific expense, such as buying an investment property or undertaking a significant renovation. The benefit of a home equity loan is its predictability: you get the entire loan amount at once, and with fixed monthly payments, you always know what to expect. It’s a straightforward option with no surprises.

A HELOC is more like a credit card. It provides a revolving line of credit up to a certain amount, and you can borrow against it as you need, repay it, and then borrow again. Active real estate investors, like those who flip houses, can benefit from a HELOC. Instead of taking out multiple home equity loans for every new property, they can use the funds from the HELOC, repay it when the property is sold, and then use the funds again for the next investment. The flexibility to borrow, repay, and borrow again allows them to adapt quickly to opportunities without securing investment property financing each time.

Navigating Investment Property Financing

Navigating investment property financing can be daunting, but you can get professional help. At RE/MAX, our experienced real estate professionals are here to guide you through every step of acquiring your investment. Contact your local RE/MAX agent today!

Originally published on the RE/MAX Canada Blog.