Everything You Need to Know About Rental Property Mortgages

Looking to purchase a rental property? Then you’ve come to the right place.

We know how much time, effort, and research goes into finding a rental property that will be a strong investment for years to come. So, in this blog, we’ll provide a one-stop shop with all the information you need so that you can head into the buying process for your rental property with confidence.

Here we’ll cover:

• Mortgage terms you should know
• The differences between residential and commercial lending
• What lenders look at for qualification
• Rental property vs. standard mortgage interest rates
• Lender limitations on the number of rental properties you can own
• The available options if the bank denies you a mortgage loan
• How a mortgage broker can help

Let’s get started!

Mortgage terms to know

Before diving into everything you should know when starting your search for a rental property mortgage, we’ll first go over all the mortgage terms you will likely come across.

Net Operating Income

This is the profit that comes from the rental property after costs like:

• Property taxes
• Vacancy allowance
• Insurance
• Maintenance

Subject Property

The property you are purchasing and will require a mortgage for.

Non-subject Property

Other rental properties that you already own and are receiving income from, these properties are not to be included in the current mortgage.

Gross Debt Service Ratio (GDS)

The percentage of your pre-tax income you’ll use to pay for housing costs.

Costs include:

• mortgage payments
• heating costs
• property taxes
• 50% of the condo fees

Total Debt Service Ratio (TDS)

The percentage of your pre-tax income you’ll use to pay for housing costs (shown in the GDS definition above) and any other personal debts (other mortgage payments, car loans, credit cards, lines of credit, etc.)

Debt Service Coverage Ratio (DSCR)

The metric used to determine if a property is profitable by examining its income compared to its debt obligations. Properties with a DSCR of more than one are considered profitable.

Rental Add back

The percentage of rental income a lender will allow a borrower to add to the income portion of the debt qualification ratio. The rental add back ranges from 50-100% and is lender specific.

Rental Offset

The percentage of rental income a lender will allow a borrower to deduct from their liabilities in the debt service ratio. The rental offset typically ranges from 50-80% and is lender specific.

Units

A unit is a dwelling within a building. For example, a duplex would be considered as two units.

Non-owner occupied

Where the property owner does not reside in the building, this is a true “rental” property.

The difference between residential and commercial lending

Before getting into the differences between residential and commercial lending, it’s important that you first understand what residential and commercial properties are and how they differ from one another.

Residential Property: Properties comprised of 1 to 4 units

Commercial Property: Properties comprised of 5 or more units

When it comes to obtaining a mortgage for these two types of properties, the main difference you will experience comes from the down payment and qualification requirements. With commercial properties, there are more stringent eligibility requirements for mortgage approval. In general, commercial property mortgages also have higher interest rates and require larger down payments. 

If you’re planning on purchasing a commercial property or refinancing one you already own, one of the expert brokers from Pineapple’s dedicated commercial side can help!

What is the required down payment?

For rental properties, the amount required for a downpayment will depend on whether or not it is owner-occupied, meaning the rental property is also your primary residence. For owner-occupied rental properties, the minimum downpayment is typically between 5-20%

For non-owner occupied rental properties where all the units are rented out to tenants, the minimum down payment will be larger, typically ranging from 20-35%. The size of the down payment required will depend on several factors, including:

• Whether it qualifies for insurance
• The property’s number of units
• Location

Can the down payment be gifted?

The answer to this question depends on the lender. That said, most lenders will not allow gifted down payments to be used for rental properties. 

What do lenders look for at qualification?

When you apply for a rental property mortgage, lenders will look at a variety of factors regarding your finances and the property itself to determine whether or not you qualify for their mortgage product. Here’s what those factors are:

Credit Score

Lenders will look at your credit score when determining if you qualify for a rental property mortgage. Typically, conventional lenders will require a credit score of 620 or higher. However, alternative lenders have more flexible credit score requirements, with the tradeoff being higher interest rates.

Income

Your total income is another factor lenders look at when determining if you qualify for a mortgage for your rental property.

Lenders will also look at the income the property currently makes or is projected to make. And if you already own other rental properties, lenders will often factor the income that comes from them into your debt servicing ratios. The way they do this will vary from lender to lender, but generally, it is done in one of the three following ways:

1. The lender will allocate a certain percentage of your rental income to your household income.
2. When determining your debt servicing ratios, the lender will deduct a portion of the rental income from your debts.
3. The lender will calculate your debt coverage ratio by looking at the operating income and expenses.

Net worth

Another factor that some lenders, but not all, consider when determining if you qualify is your net worth. They look at net worth to see how much you have available in liquid assets after making your down payment. Typically they look for this amount to fall within a range of $25,000 – $100,000.

Debt Servicing

Like with typical mortgages, lenders will use Total Debt Service (TDS) to determine if your income will be able to service your debts efficiently. If you already own a property, lenders will often use the Debt Service Coverage Ratio (DSCR) to identify if the new purchase will be profitable by comparing the income the property will generate to its debt obligations.

The Number of Rental Properties You Own

Lenders will consider all of your rental income and debts from the other properties you own into the debt qualification of the subject property. Some lenders have restrictions on the total number of properties you currently own when providing financing.

Own other rental properties already? If you do, you’ll have to be wary that some lenders have restrictions on the total number of properties you can own when providing financing. It’s also important to note that if you own other rental properties, the income and debts associated with them will be considered when determining if you qualify for financing.

The Marketability

Lenders don’t just consider your finances during the qualification process; they also look at the location and condition of the rental property. The better they are, the higher the property’s marketability, which means more potential profit.

Will the interest rate be higher?

The simple answer is yes. Lenders see rental property loans as higher risk than mortgage loans for single-family homes. Because of this, rental property mortgages often see higher interest rates.

Is there a limit to how many rentals I can own?

Yes, there is, but that limit will vary from lender to lender. For example, some lenders allow you to own up to 5 properties in total (4 rental properties + your owner occupied property), while others might use a total dwelling policy. This policy limits the number of units you can own ––the units can be split amongst however many or few properties you choose.

If you already own a rental property in addition to your own home and are on the market for another, then it’s in your best interest to contact a mortgage broker. At Pineapple our agents will work to place you with a lender who is properly aligned with your future investment needs.

Are there other options available if the bank has already declined my application?

Yes! Plenty of rental property mortgage options are available outside of the prime lenders like the banks. Your best bet to find the best option among them is to work with a broker! They will assess your needs and shop the mortgage market to find the best fit for you.

How a mortgage broker can help

Finding the right mortgage for a standard single-family home can be difficult as it is. For a rental property, the rules around mortgages are even more complex. This is why it’s essential to work with a mortgage expert who can walk you through the process and match you with the lender best suited to your situation. At Pineapple, our dedicated team of brokers are committed to doing just that.

Give us a call today to get started!