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Financing Rental Property - Toronto Star Feb 12, 2006
Financing a Rental Property
Feb. 12, 2006. 09:02 AM ELLEN ROSEMAN
A popular rallying cry for real estate investors is, "No money down." When you buy property in a hot market without risking any of your own cash, you stand to make huge gains because of leverage. Can you get no-money-down financing if you're dipping your toes into the rental property market for the first time?
Maybe, but it will likely cost you more than if you find the money for a down payment. You have to ask yourself a few questions: Do I want to buy a property I can live in myself and rent out to others? Do I want to deal with major lenders? Or will I accept financing from alternative or private lenders? Do I want to get a mortgage insured by the Canada Mortgage and Housing Corp. (CMHC)? Or do I want a second mortgage?
If you decide to go the owner-occupied route, you'll find your financing options are greater. CMHC mortgage insurance protects lenders against default. This lowers the risk and lets them offer more competitive rates. You can get a CMHC-insured mortgage for 95 per cent of the purchase price if you buy a duplex and live in one unit, says Paula Gasparro, manager of business development.
You can get a CMHC-insured mortgage for 90 per cent of the price if you buy a triplex or fourplex, where you also reside. If you don't live in the rental property, however, CMHC will insure your loan for only 85 per cent of the value. (These are all maximum amounts, depending on the property and your financial circumstances.) Don Campbell is an experienced investor who started a for-profit education and networking group. His advice: Be honest.
"If you don't plan to move into a property, do not sign an affadavit or declaration saying that you are," he says in his book, Real Estate Investing in Canada (Wiley, $34.99). "In fact, you should run away as fast as possible from any banker or broker who asks you to sign such a document, if they have the full knowledge that you are not going to move in."
Lying on a mortgage application is not the way to create long-term wealth, he says. Moreover, you're likely to get caught. CMHC and major financial instutitions have stepped up their investigation of homeowner loans. They're knocking on neighbours' doors, asking about the property you purchased. "They have one purpose in mind: to find out if you have fraudulently obtained a loan. If you have, they will go after you with all of their legal might."
In Edmonton, 55 people were arrested in 2004 for participating in such a scheme, he points out. They lost their properties and were also sued for punitive damages. You have to get an insured first mortgage if your down payment is less than 25 per cent. You can add the insurance cost to the principal and spread it over the life of the loan. As well, if you choose not to live in your rental property, you have to show that your debt costs can be sustained.
CMHC requires tenants' rents to cover 110 per cent of your debt. And you must have a minimum net worth of $100,000, or 25 per cent of the property value. You can bypass mortgage insurance by taking out a second mortgage. This can bridge the gap between what the bank lends and what the property costs.
A second mortgage carries a heftier interest rate than a first mortgage. But it's your best option if you want to buy a rental property with no money down. Mortgage brokers are experienced at finding second mortgages. They can tap a variety of lenders, ranging from alternative financial institutions to private individuals.
Elisseos Iriotakis, a mortgage broker and certified financial planner, works in a Mortgage Centre outlet in Toronto's Bloor West Village. About 40 per cent of his clients are buying a second property. He advises using a line of credit secured against your home to borrow what you need — and more — to purchase a rental property.
You get a big tax break if you borrow to invest in real estate. The entire mortgage interest you pay can be deducted from your taxable income. Mortgage interest is not tax-deductible for a principal residence. But you can write off part of the interest if you rent out part of your house.
Here's an example of his borrow-to-the-hilt strategy. Suppose you have $200,000 worth of equity in your own home (after deducting the mortgage). You plan to use a line of credit to buy a rental property. Rather than borrowing $200,000 against your home, Iriotakis says you should ask the bank for a $300,000 line of credit.
This gives you a tax deduction for interest on an extra $100,000 of mortgage debt owed already — interest that is not normally deductible. You take out a second mortgage to cover the rental property's price that is not covered by your $300,000 line of credit. Then, the interest paid on this loan is also tax-deductible.
There are other tax advantages when you invest in rental property, Iriotakis explains. You can pay your spouse or children to take care of the property and collect rents. Then, you can deduct the salary expenses from your rental income.
As well, any losses you incur in the first few years of rental property ownership can be written off against your other personal income — not just your rental income.
His advice to new investors: "Have everything well-documented, especially if you're taking out equity from one property to invest in another. The Canada Revenue Agency needs a paper trail."
Next week, we look at tricks for finding and keeping good tenants.
Posted February 12, 2006 by Ellen Roseman |
