BUYING A RENTAL INCOME PROPERTY
Land is a finite resource.
There is a reason many people invest in real estate: land is a finite resource, and therefore it will over time increase in value. How fast those increases occur and in what areas are some of the variables, but in general land is a solid investment.
It’s undeniably convenient that, in putting a roof over your head you can at the same time be providing for your future. It’s also true, however, that there will always be people looking to rent, and becoming the person that they rent from can be a great way to generate some income for yourself and pay down the mortgages you use to acquire property.
Lenders actually acknowledge this in the way debt servicing ratios are calculated when there’s a rental in the mix. But before we get to that, it’s important to note that there are two distinct situations where you might have rental income: owner occupied plus rental properties and non-owner occupied rental properties.
An owner occupied plus rental property would be a house that you’re purchasing for yourself to live in that also has either a suite, carriage house, or basement that you’re able to rent out to another person. The rules around down payment in this case are same as with a normal purchase in that you can put 5% down. A portion (usually 50%) of the income generated from the rental portion of the property can be added to your regular income, thus helping you to qualify for a more expensive purchase than you would have otherwise. Rental income from a suite can be a great way for a buyer to get into the larger house he or she wants a little sooner than would have been possible without the suite.
A non-owner occupied rental property is simply one that is not lived in by the owner and is instead rented out completely, whether it is a house, condo, or even a house with more than one suite. The rules around down payment are different here, and buyers must put 20% down instead of just 5%. The important thing to keep in mind is that you need to be able to qualify not just for the mortgage on the rental property, but also any existing mortgages you have as a complete picture. The rental income can, of course, help here, in the same way as it would in a house with a suite.
Here’s how: When dealing with a non-owner occupied rental, many lenders are now using what’s called a “rental worksheet” rather than a simple add to income formula, particularly in cases where there are multiple rentals in play. This is a spreadsheet where all of the costs associated with the properties (i.e. maintenance, taxes, heating, mortgage payments, and vacancies) are subtracted from the income generated by the properties. Where there is a profit, that amount is added to your personal income. In cases where there’s a deficit, the shortfall is shown as a monthly cost alongside all other debts. While these can get complicated with multiple properties, they do provide a good big picture perspective for analysis.
As far as determining the actual rent amount to use, in the early stages this can be estimated by your broker for qualifying purposes, and then down the road it is usually confirmed either by a signed lease if the rental is already occupied or a fair market rent letter produced by an appraiser if it’s not.
While becoming a landlord is not for everybody, owning rental property in the form of a suite in your own home or even a fully separate property can be a great way to round out an investment portfolio, generate extra monthly income, or even just pay down your own mortgage more quickly.