Downpayment Options
on Rental Properties
By Peter Kinch - Mortgage Specialist
Over the past few years I have consulted with hundreds of Real Estate Investors and have seen a wide variety of mortgage scenarios. When sitting down with these clients to map out a game plan or course of action to attain their real estate goals, the single most common question I get from those investors is how to make a limited amount of equity stretch over a maximum number of investment properties.
As you may know, the standard downpayment requirement for most lenders is 25% and in some cases 35%. But what do you do if you want to buy 4 or 5 properties over the next few years and you have a fixed or limited amount of money available for the downpayment? Surely there must be some way around this? I began to hear this comment so often that I decided to sit down and analyze it myself and compile a list.
So what are your options? Well, there aren’t as many as you might like, but here’s a list of seven that I know of:
#1
Use equity from an existing property to access the 25% down. This will be the easiest and get you the best rate available in the market with no fees. The equity you access can be a secured Line of Credit (LOC) set up against your principle residence or it could be from refinancing an existing revenue property that has built up some equity. Remember too that any interest paid on a LOC that is used for investment purposes is tax deductible.
#2
CMHC insured – high ratio rental mortgage up to a maximum of 85%. You can purchase a rental with a lower downpayment if it’s insured. But a caution here – qualifying criteria is very strict and CMHC fees are higher than that for owner-occupied properties. The application fee for a CMHC insured rental mortgage is between $600 and $900 depending on the number of units you’re financing and the insurance premium is as high as 4.5%. The property must also have a debt coverage ratio of 1.1%, which is unlikely to happen in the Greater Vancouver area.
#3
CIBC has an Option product and FirstLine Mortgages has a similar product that allows you to put 15% down on a rental property but the rate is closer to posted with a small fee (around $300). This can be a good option for a client that is looking at making the downpayment stretch over two properties and there is great cashflow.
#4
XCEED Mortgage now offers a product for investment properties that only requires 10% down. The maximum loan amount is $500,000, the rate is a little higher than posted (currently just over 8%) and there is a small fee. This obviously isn’t for everyone as the cost of borrowing is higher than conventional rates with 25% down, however there are circumstances in which this product could be either a good choice or a last resort. As in every case, you need to analyze your options and consider the ‘opportunity cost’ of putting 10% down in lieu of 25% and then balance that against the additional cost of borrowing. A couple of key points with the XCEED product are that they have no GDS, a more flexible TDS and they have no minimum credit beacon requirement. They utilize a sliding credit scale and offer rates based on A, B, C or C- credit (bankruptcy 1 year discharged with re-established credit). They also have a very aggressive rental offset policy, which effectively uses a 71.25% true offset (many lenders simply add a percentage of the rental income to your verifiable income and this is less beneficial than subtracting a percentage of the rent from the cost of borrowing). XCEED also allows refinances on rentals up to 85%. This again, could be a valuable tool for someone with an existing portfolio looking to access some cash to grab that ‘great deal’. Not a perfect solution, but good to keep in mind.
#5
Wells Fargo : A newcomer in the Canadian mortgage market, Wells Fargo is making inroads into the Canadian sub-prime market much like Xceed with the availability of 100% financing at higher rates. They do have some products for the rental market, but make it very clear that their main focus is on the homeowner. Wells Fargo uses a matrix as a pricing guide that takes a little getting used to. They will finance the purchase of a rental property with only 15% down, but the interest rate will be adjusted upwards similar to Xceed. They are they are strong in is when there is less than perfect credit.
#6
Vendor Take Backs: VTB’s for up to a maximum 15% are allowed by most banks. Please note, in almost every instance, the lender will still want to see at least 10% of your own money into the deal. To my knowledge, there are no Canadian lenders that will allow the full 25% of the downpayment in the form of a VTB. VTB’s are harder to come by these days as it requires a motivated vendor – but keep in mind, you don’t know if you don’t ask! The key with a Vendor Take Back is that you have to determine the motivation of the vendor. Remember, most Vendors don’t even know what a VTB is. If a vendor was planning to take the proceeds of the purchase and invest them in the bank or stock market, then they may be very thankful that you offered them an opportunity to make a better return via a second mortgage on their own house – again – You don’t know if you don’t ask!
#7
Joint Venture partnership. This is the most ignored option, but can be the best. You become the deal maker and then look for an investment partner who has the money to cover the downpayment. A note of caution here, the JV partner will, in most cases, go on title, and as such, you will need to debt service their liabilities as well. This can be a great way though to build a portfolio with a limited amount of available equity. On the upside, for those familiar with my article on the 1.1% rule, you can use property from a JV partner to qualify for having three or more properties, even if this is your first purchase! Call me for more details on this.
There may be more options available, but this is a good list to start with. As I sit down with clients, I like to remind them that as they look over their 5 year plan of action, they will inevitably be faced a few challenging decisions along the way over rate, product etc. The best way to decide which course of action to take is to be clear on your goals. Keeping focus on your goals makes decisions along the way a lot easier to make.
Happy Investing!!!
Peter Kinch
pkinch@peterkinch.com
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