Beginner’s Guide to Investment Property Mortgages

Buying an investment property — real estate meant to generate income — involves a slightly different mortgage process, with its own eligibility criteria and risks to consider.

Investment property mortgages help you invest in real estate through residential rental units and commercial properties.

Buying an investment property might sound pretty appealing. Get a second house or apartment, then rent it out to some friendly tenants who can cover the costs and provide you with a reliable monthly income. Easy, right?

Well, not so fast. In Canada, investment property mortgages are different from the type of mortgage you applied for when you bought your own home. The rules are stricter and the down payment requirements are higher. Before you jump into this type of investing, here’s what you need to know about investment property mortgages.

(Being a landlord is also a bit more complicated than it might seem — but that’s a subject for another article.)

What is an investment property?

An investment property is a piece of real estate purchased to use as an investment and generate income, rather than as a primary or even secondary residence (like a vacation home).

You might plan to earn income through renting the property, reselling it once it has appreciated in value, or both. Individual investors, a group of investors and corporations can all own investment properties.

Types of investment properties

Investment properties are typically divided into residential and commercial categories.

Residential properties

A residential investment property is one that people would want to live in — a dwelling that you could rent out to a tenant or fix up and resell, for example.

Common types of residential properties suitable for investment include:

Single-family homes.
Apartments.
Condominiums.
Townhomes.
Cottages.
Cabins.

Buildings with up to six units — sometimes known as multi-family properties — are also generally considered residential, though it’s important to check your local zoning to be sure, as some municipalities have lower thresholds. In addition, some banks may have their own rules about how many units a building can have and still qualify for a mortgage as a residential property.

Commercial properties

A commercial property is a building used for business purposes, such as a retail store or an office building. However, a residential building with more than five or six units can also be considered commercial. Again, check your local zoning rules to be sure.

Commercial properties tend to have more income-generating potential, but may require more maintenance and higher costs. Commercial mortgage criteria is also tougher to meet.

Mixed-use properties

You could also have a property that is mixed-use and falls under both of these categories. For example, a building with a retail store on the street level and an apartment on the second floor would be considered a mixed-use investment property.

Since residential investment properties generally have simpler qualifying criteria and are best for new real estate investors, we’ll focus on them in this article.

How investment property mortgages work

Getting a mortgage for an investment property different from a mortgage used to buy a primary or even secondary residence.

First, you’ll need to decide if you will live on the property in any capacity. If not, you will need to apply for a rental property mortgage, also called an investment property mortgage. In this case, you will need a minimum down payment of 20% of the purchase price.

But say you’re planning to buy a property with multiple units, such as a duplex, a house with multiple suites, or a home with a carriage house. If you plan to live in one unit while renting out the others, you can use an owner-occupied mortgage, which may enable you to make a lower down payment by paying for mortgage default insurance.

For a property with three or four units, such as a house with a basement suite and a carriage house, or a four-plex building, the down payment must be at least 10%.
For a property with two units, like a duplex or a house with a basement suite, the minimum required down payment is 5% if the property costs less than $500,000. If it costs more than $500,000 and less than $999,999, you’ll need to put down 5% of the first $500,000 plus 10% of the remainder.

If the property costs $1 million or more, you’ll need to put down 20% whether you’ll live there or not, as you won’t be eligible for mortgage loan insurance.

Qualifying for an investment property mortgage

The application process for a rental property mortgage is more strict and thorough than what you might have for a standard mortgage on a home you occupy.

On top of the hefty down payment minimum, you will need to have a good credit score — which may be higher than that required for a standard mortgage.

You’ll also need to prove to the lender that the building will be able to bring in sufficient rental income. You can demonstrate this with either a current lease for existing tenants or current market rental rates for similar properties.

You must also demonstrate that you will have enough non-rental income to cover the mortgage in case of a break between tenants.

Finally, not every lender offers rental mortgages. In Canada, they’re most common with big banks and lenders.

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What to consider before applying for an investment property mortgage

Owning an investment property can be incredibly advantageous, but it’s not without risk. So, before you jump on board, here are a few pros and cons to be aware of.

Pros

Regular monthly income. Renting out an investment property can provide you predictable monthly payments.
Tax deductions. A number of investment property expenses can be deducted from your rental income, including mortgage interest, property taxes, insurance, maintenance and upgrades, property management and potentially utility bills (if included in rental costs).
Deductible losses. As well as being able to claim expenses, you may be able to claim a tax deduction for any financial losses. This means if your investment property expenses exceed your rental income, you might be able to deduct that loss from your other income.

Cons

New responsibilities. Taking on an investment property, especially if you plan on renting it out, can be a great source of extra income. But you also need to put in a lot of work for that money. Dealing with tenants isn’t always an easy task.
It’s expensive. Buying an investment property is a lot harder and more expensive than just putting your money into other investments, like index funds or stocks. Yes, the money paid by your tenants should ideally cover your monthly mortgage payments, but you still need to come up with that 20% down payment upfront, as well as cover closing costs, home insurance and other immediate expenses. Plus, depending on the property, you might have to pay for upgrades and repairs.
It might not be easy to sell later. A rental property isn’t liquid. If and when you decide to sell, you need to be aware that it might take a while, and you may not be able to time the market. Plus, you’ll need to factor in selling costs like legal fees and potentially hiring a real estate agent.