Rental Income in Mortgage Qualification
Banks are hyper-conservative when considering rental income in mortgage qualification. This is due to possible vacancies and loss of income for possible extended periods. While this is not likely, at least in the BC Lower Mainland, policy is created for lending across Canada and vacancy rates can be much higher in smaller communities.
Banks are also considering things like maintenance/repairs and the fact that tenants are harder on properties than owners – no pride of ownership – so the value can be negatively affected which is a risk to their security.
In most cases banks usually only count 50% of rental income to be added to a borrower’s annual income. Only 39% of total annual income needs to be enough to cover all property obligations so really only 39% of half the rent is used. The idea being that if the property couldn’t be rented for an extended period of time due to vacancy or a major repair the applicant would still be able to cover the property obligations comfortably.
For example, let’s say you own a rental house with these monthly payments:
Mortgage payment – $1,500
Property taxes – $166.67 ($2,000/year)
Heating allowance – $125
Property Obligations: – $1,791.67/month
Say you rent it for $2,000/month – it pays for itself! Sounds good.
Here’s how the banks look at it they will only consider
Half monthly rent – $1,000/month ($12,000/year)
39% of half – $390/month
Extra property cost – $1,401.67/month – included in debt-servicing
If it’s a stand-alone rental property some banks will look at a rental offset which is a more generous way of looking at it. That’s where they consider a portion of the rental income offsetting the rental property obligations first, and then either adding the surplus to income or adding the shortfall as additional monthly debt. Most banks will not include a heating allowance and some even property taxes when calculating an offset.
But banks are still conservative and consider 50% to 80% of income for an offset in most cases. Taking the same example above at 50% offset that’s $1,000 off the mortgage payment so it is a $500/month residual mortgage payment that is to be included in qualification – not as much as the Add to Income method but that’s like having another car loan. And at 80% that’s still another $100/month payment that needs to be factored in.
So while investing in real estate is a solid gamble and can be profitable banks want to know borrowers are strong enough to maintain payments even in the worst-case.
As always, reach out if you have any mortgage questions – I’m here to help!
- Written by Kristin Woolard