All property owners want to secure the best interest rate on their mortgage. Most of the factors that impact the mortgage rate for your primary residence also affect the rate you’ll receive for your investment property. However, lenders are a bit warier about lending for investment properties. Those anxieties are represented in your interest rate.
Table of Contents - Which Factors Affect the Interest Rate on Your Mortgage for Rental Property?
When it comes to securing financing for your investment property, two primary factors will impact your interest rate:
- The number of units in your property
- Whether you’ll live in one of the units
While every financing situation is different, your lender will consider these and other common factors when calculating your mortgage interest rate.
How many units does your investment property have?
One of the first things you’ll look for in your investment property is how many units it has. This will impact more than just your mortgage interest rate. The number of units also dictates how many tenants you’ll have and how involved you’ll be as a property manager (or whether you’ll need to hire one). The bigger the property, the more you’ll have to deal with – but also the greater chance of returns.
Most properties with one to four units will be zoned as residential. When you’re dealing with lenders for an investment property, your experience won’t be much different than it is for a primary residence. Expect your interest rate to be slightly higher because it’s an investment property. Your down payment will also vary depending on the number of units and whether you’ll use on as your primary residence (more on that below).
If the property has five or more units, the property is likely zoned as commercial. Meeting the lending criteria for a commercial property is harder. Interest rates are also much higher.
Will you live in your investment property?
If you’ll be living in one of the units, the property will be considered owner-occupied. Whether the property is owner-occupied determines how much of a down payment is required. Regardless of how many units your property has, you’ll need to make at least a 20 percent down payment if the property is not owner-occupied.
If the property is owner-occupied and has two to four units, you only need to put 5 percent down for purchase. If the property has five or more units and you’ll occupy one, you’ll need to put down 10 percent.
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Additionally, if the property costs more than $500,000, you’ll need 5 percent down for the first $500,000 and an additional 10 percent of any amount over $500,000. If your owner-occupied investment property is $600,000, you’ll need at least $25,000 plus an additional $10,000 for a total down payment of $35,000.
Are your finances in good shape?
Your finances will be under more scrutiny for an investment property than they would be when buying a primary residence. They’ll use the same data, but their standard will be higher. You’ll need stronger finances and a better credit score to qualify and receive a good interest rate.
Your credit score is the best indication to lenders that you are a trustworthy borrower. The better your credit score, the lower your interest rate. If your credit score isn’t great, it may not be the time to buy an investment property just yet. Or, you can plan to occupy a unit and have the rent from your tenants to cover your housing costs while you improve your credit score.
Lenders won’t just look at your credit score; they’ll also use your finances to calculate your rate. Your debt-to-income ratio compares your monthly debt obligations (e.g. existing mortgage, car payment and minimum credit card payment) to your pre-tax monthly income. This lets lenders know how well you’re managing your debt and whether you can afford your mortgage each month.
As part of your debt-to-income ratio, lenders look at your gross debt service (GDS) and your total debt service (TDS). GDS compares your monthly household income to your housing costs. This number should be at or below 35 percent. TDS measures your total monthly household income to your housing costs plus any other debts. This ratio should be at or below 42 percent.
Lenders also want to know how much cash you currently have on hand. They want to see that you can comfortably cover your mortgage for a couple of months (ideally six) even if you had no other income. Having a surplus of cash will make lenders more comfortable and help to lower your rate.
The loan-to-value ratio on the investment property compares the amount of the loan to the amount of the house. The more money you can put down, the lower the loan amount and the higher the ratio. Lenders want to decrease their risk by lending you less, and they’ll reward you with a better interest rate.
Will you make a good landlord?
Lenders will look at more than just your finances to determine whether you’ll be a trustworthy borrower. They want assurance that you’ll make a good landlord. If you’re an experienced landlord, it could help your rate. You may be able to get around this by hiring a professional property manager.
If you own several investment properties that are already mortgaged, lenders may limit how much you can borrow. You’ll need to demonstrate that your cash reserves can cover the month's units are unoccupied between tenants, including at your other properties.
What other factors might impact my rate?
Mortgage rates are constantly changing. Some factors that influence your rate are beyond your control. The state of the economy and the housing market will always play an important role. The Bank of Canada’s current interest rate signals to lenders what their mortgage rates should be. If the lender is currently processing a lot of applications, they may pass a premium onto you for their services. Locking at a great rate is the best way to boost your profitability.
Understanding which factors play a role in how lenders calculate your mortgage rate will help you prepare for getting your best deal. While some factors are beyond your control, others can help you plan strategically for your investment.
How Are Interest Rates Determined and What Affects Interest Rates
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