Contributed by guest columnist and Vancouver Mortgage Broker Iain MacFadyen
I thought I’d dedicate a blog post to this topic as I have many inquiries from clients looking into doing this, as well as there being differences between lender policy.
Why Not Rent Out Your Apartment For Long Term Gain?
I am contacted regularly by second time (move up) buyers who want me to find a way for them to keep their first property whilst qualifying them for a purchase of a new home. The big issue with this scenario is that now they are increasing their mortgage exposure and the liability that goes with it. They are at the same time adding potential rental income to their profile, but unsure of how this will be viewed by a potential lender?
Rental Property Cashflow vs Rental Income Addback
The make or break policy which most lenders don’t make readily available to the public is their treatment of the rental income and rental property liabilities. There are two different approaches that are most commonly used:
Rental Income Addback: The lender will add a percentage of the current home (future rental’s) potential rental income to the client’s gross income.
Cashflow Analysis: The lender will deduct the future rental property expenses from a percentage of that property’s potential rental income.
Without boring you with the calculations, in 99% of cases you want a cashflow analysis and not an addback scenario. The issue with the addback is you are still left with a LARGE liability in the form of a mortgage payment, strata payment and property tax payment. This is akin to having a massive credit card debt or car loan that creates a monthly liability that will probably disqualify you from the next purchase.
On the other hand a cashflow analysis allows the vast majority of that liability to be offset by the potential rental income. Even in the case that the rent doesn’t cover all the mortgage and property costs, it will cover the majority and the right lender will allow that shortfall to be added to liabilities to see if you still qualify.
Which Lenders Use Which Policy?
As I mentioned earlier there is great variability between lenders for these policies but I will still summarize as follows: Chartered Banks will generally use add back for this income and may even require a lease agreement (problematic when you haven’t vacated yet and only have a best guess for the rent). They do have a cashflow analysis, but usually they require two or more rental properties to do so and require a very healthy cashflow surplus (Difficult to do in most Urban areas).
“Monoline Lenders” which are lenders that only source new mortgage clients through the broker channel have some of the best cashflow calculations available and are my personal favorites for these transactions. They will take between 85 and 90% of the potential rent (confirmed by an appraiser) and subtract the property expenses. This allows many clients to avoid selling their current home.
Preparing For The Purchase
My favorite clients are those who plan ahead and run all plans by me for my input. I often find clients are curious about purchasing but not sure what their next move it. They typically have focussed on paying down their current mortgage and are consequently House Rich but Cash Poor. For these clients I usually recommend refinancing their current home, which will accomplish two things:
1: Provide Net Proceeds (Money) which can be used towards their down payment.
2: Increase their amortization and reducing their monthly mortgage payment.
The benefit of the refinance proceeds for down payment is quite obvious, but equally important is for the clients to reset the amortization on the rental property to 30 years. This allows the lowest payment and gives the cashflow analysis the lowest expenses that we can engineer, setting them up for a purchase.
If you would like to learn more, please send me an email at [email protected]