Did you know that not all rental income is treated equally?
Every lender has their own way of calculating market rents on a property, some are much better than others and may make the difference between reaching that sale price or having to settle for less. Knowing in advance can increase the range of properties you can confidently make an offer on.
For insured mortgage (less than 20% down) the rules are fairly rigid but if you have at least 20% down there are more flexible options available to you.
There are a few basic ways lenders look at rents:
Added to income
The most common but also the least effective.
This is a calculation where the lender adds between 50% and 100% to the clients annual income (usually 50%), then qualifies the file with full mortgage payment, taxes, heat and (if applicable) strata.
It is helpful, but it generates the least purchasing power.
This is the standard calculation if you are putting down less than 20% and require default insurance.
Typically only available on stand-alone rentals, it is an off-application worksheet that can be used to “wash” away all the additional debts associated with investment properties and the application can then be adjudicated on the property being purchased (or refinanced).
Not widely available, when used it is generally for a suite in a home and highly effective.
This is a calculation where a percentage of the available rents can be used, usually about 75% of rents subtracted from the mortgage payment, taxes, heat and (if applicable) strata. Any surplus/deficit is added to the application. This is the most favorable especially if the lender also allows a rental worksheet in conjunction.
Gross yearly income: 90,000
Interest rate: 3.49%
Amortization: 30 years
Heating cost: 100 monthly
Taxes: 4000 yearly
Available rent from suite: 1000 monthly
Down payment: 20% in each scenario
Assume no other debts
Using no rent
Max purchase price: 550,000
Max mortgage: 440,000
Max payment: 1967
Using 50% of rents added to income
Max purchase price: 594,500
Max mortgage: 475,600
Max payment: 2127
Using 75% rental offset
Max purchase price: 900,000
Max mortgage: 720,000
Max payment: 3219
The difference between 50% added and 75% offset is a purchase price of 350k higher using contract rate.
Some things to keep in mind:
- If the property is being purchased most (but not all) lenders will allow economic rents to be confirmed instead of a lease, where a lease is used it generally needs to be supported by an appraisal.
- Some lenders will require the suite to be “legal”, but most do not.
- Outbuildings and guests suites are an exception, but generally not acceptable.
- Using the higher “upper floor” rents can be considered, depending on the lender.
- Even if the math works the deal has to make sense, a family of four cannot live in a one bedroom basement etc. and rent out the upper floor for example.
Rules are changing at a rapid pace, for the most up to date policies please contact me direct at firstname.lastname@example.org