We have helped many of our clients purchase a rental property over the years, and, in some cases, some clients were in a fortunate situation to purchase several rental homes that have not only added net worth to their portfolio (as the mortgages have been paid down) but have also added a nice ongoing net increase to their annual income (great for your retirement years!). So . . . how easy is it to get financing on a rental home today?
Surprisingly, not all lenders deal with rental properties the same way. Let’s take a look at an example. Joe Saver has found the perfect rental property that has a legal suite. The upper level rents out for $1,200 per month and the lower level (with a separate entrance) rents out for $800 per month. The combine rental income is $2,000 per month. The purchase price of the rental property is $400,000. Joe has saved 20% ($80,000) and so is seeking a mortgage for $320,000. Assuming a 5 year rate of 3.45% and a 30 year amortization, the monthly (PIT) payment is approx. $1,624 (includes property taxes of $200 per month). Joe’s gross income from his job is $45,000. His own residence has a mortgage of $200,000 with a monthly (PIT) payment of $1,200. He has no other debts, excellent credit and has been with his own bank for the last 20 years where he does all his banking, including his investments and mortgage. He was shocked when the financial services manager at his bank declined his request. Let’s take a look why this happened at his bank.
His bank calculated his monthly income to be $3,750 ($45,000/12) and then considered only 50% of the rental income ($2,000/2) which is $1,000 for a total combined monthly income of $4,750. That’s right…only 50% is ADDED to your income. You then need to support BOTH mortgages. Both combined mortgage payments, including taxes, total $2,824 per month. His bank calculated his debt servicing to be too high at 59% ($2,823/$4,750). The threshold with most lenders can be as high as 44%. Let’s now take a look at how another lender takes a more favourable approach.
Everything as stated above remains the same. The key difference is that our lender will now use 80% of the rental income and will REDUCE the new rental mortgage payment (PIT) by that amount. You then debt service the remaining amount with your existing mortgage. Let’s see how that works. 80% of the rental income is $1,600 ($2,000 x 80%). The rental mortgage payment is $1,624 (PIT). The new lender then only needs to add $24 per month for debt serving. So, if your existing mortgage payment was $1,200 (PIT) and we then add $24 for a total of $1,224, the new debt service ratio is 32.6% ($1,224/$3,750). This is well within this lender’s guidelines and the deal is approved!
In recap, the main difference is that most lenders today now use only 50% of rental income which is added to your own income. You then need to debt service all mortgages from that combined income. As shown above, this is a much more difficult way to get approved. The more favourable way is when a lender will reduce the rental mortgage payment by up to 80% of the rental income. You only then need to debt service this shortfall which is added to your own existing mortgage situation.
Give us a call today for any mortgage financing concerns or requests you may have, especially if you are considering a purchase of a rental property. We look forward hearing from you soon!