A Beginner's Guide to Investment Properties

Buying an investment property sounds pretty appealing. Get a second house or apartment, then rent it out to some friendly tenants who can cover the costs and provide you with a reliable monthly income. Easy, right?

Well, not so fast. In Canada, investment property mortgages are different from the type of mortgage you applied for when you bought your own home. The rules are stricter and the down payment requirements are higher. Before you jump into this type of investing, here’s what you need to know about investment property mortgages.

What is an investment property?

An investment property is a real estate property purchased to use as an investment and generate income rather than a primary residence or your own vacation home. You might plan to earn income through renting the property, eventually reselling it, or both. Individual investors, a group of investors and corporations can all own investment properties.

Types of investment properties

Investment properties are typically divided into residential and commercial categories.

Residential investment properties

A residential investment property is one that people would want to live in — a home that you could either rent out to a tenant or fix up and resell. Common types of residential properties suitable for investment include single-family homes, apartments, condominiums, cottages, cabins and townhomes. Buildings with one to four units are also generally considered residential, though it’s important to check your local zoning to be sure.

Commercial properties

A commercial property is a building used for business purposes, such as a retail store or an office building. However, in Canada, any building with five or more units is usually considered commercial, even if those units are residential. Again, check your local zoning to be sure. Commercial properties tend to have bigger returns but require more maintenance and higher costs. Commercial mortgage criteria is also tougher to meet.

Mixed-use properties

You could also have a property that is mixed-use and falls under both of these categories. For example, a building with a retail store on the street level and an apartment on the second floor would be considered a mixed-use investment property.

Since residential investment properties generally have simpler qualifying criteria and are best for beginners, so we’ll focus on them in this article.

How investment property mortgages work

Getting a mortgage for an investment property is not the same as getting a mortgage for your primary or even secondary residence, such as a vacation home.

First of all, you need to decide if you will live on the property. If you’re renting out the entire property and have your own separate home, you will need to apply for a rental property mortgage. But say you’re planning to buy a duplex and live in one unit while renting out the other. In this case, you will need an owner-occupied mortgage. This decision affects your minimum down payment.

For an owner-occupied building, like the duplex described above, the minimum required down payment is 5%. If one or both sides have basement suites, giving the property three or four units, the down payment must be at least 10%.

However, if you’re not planning to live on the property and are just renting it out, you will need a minimum down payment of 20%. Then, as the property price increases, so do the minimum down payment requirements.

How to qualify for an investment property mortgage

The application process for a rental property mortgage is a little stricter and more thorough than what you would have for a standard mortgage on your own home.

On top of the hefty down payment minimum, if you’re not planning to live on-site, you will need to have a good credit score and prove to the lender that the building will be able to bring in sufficient rental income. You can demonstrate this with either a current lease for existing tenants or current market rental rates for similar properties. You also need to demonstrate that you will have enough non-rental income to cover the mortgage in case of a break between tenants.

Not every lender offers rental mortgages. In Canada, they’re most common with big banks and lenders. You will probably have a tough time finding a small lender that offers this service and, even if you do, they’ll typically add a small premium to the rate.

» MORE: How to choose a mortgage lender

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What to consider before applying for an investment property mortgage

Owning an investment property can be incredibly advantageous, but it’s not without risk. So, before you jump on board, here are a few pros and cons to be aware of.

Pros

Regular monthly income. Renting out an investment property can provide you predictable monthly payments.
Tax deductions. A number of expenses that come with an investment property can offer you a tax break, including mortgage interest, property taxes, insurance, maintenance and upgrades, property management and potentially utility bills (if included in rental costs).
Deductible losses. As well as being able to claim expenses, you may also be able to deduct your losses. This means if your investment property expenses exceed your rental income, you might be able to deduct that loss from your other income.

Cons

New responsibilities. Taking on an investment property, especially if you plan on renting it out, can be a great source of extra income. But you also need to put in a lot of work for that money. Dealing with tenants isn’t always an easy task.
It’s expensive. Buying an investment property is a lot harder and more expensive than just putting your money into other investments, like index funds or stocks. Yes, the money paid by your tenants will cover your monthly mortgage payments, but you still need to come up with that 20% down payment upfront. Plus, depending on the property, you might have to put in some extra money for upgrades and repairs.
It might not be easy to sell later. A rental property isn’t liquid. If and when you decide to sell, you need to be aware that it might take a while. Plus, you’ll need to factor in the selling costs like legal fees and hiring a real estate agent.

DIVE EVEN DEEPER

Mortgage Pre-Approval: What It Is, How to Get It

A mortgage pre-approval is when a lender evaluates your finances to give you an estimate of how large a mortgage you might qualify for. Pre-approval can be considered a pledge, but not a guarantee