Most move-up buyers decide to sell their home and put the equity they’ve built up towards their new purchase. But others – those who can afford to – choose to retain their current residence as an investment property when they purchase a new home.
There are advantages to owning an investment property. For example, even though the mortgage interest on your primary residence isn’t tax deductible, you may be able to deduct interest on an investment loan. (Talk to your accountant about whether this applies to your situation and whether your finances can sustain multiple properties.)
If you choose to go this route, here’s what you need to know:
Down payment: In order to get the highest possible equity out of your current home, you might consider a cash-out refinance, where you take out equity from your existing property and use it as a down payment on your new home. In some cases, you might be able to stretch the amortization out to 30 or 35 years, lowering your monthly carry costs but resulting in more interest paid over the life of the loan.
If you are unable to refinance because you don’t have enough equity in your current home, and you are putting less than 20 per cent down on your new home, you are required to get mortgage insurance from Genworth or Canada Guaranty because CMHC will not allow two insured mortgages.
If the potential rental property was recently purchased as a high-ratio mortgage (meaning you put down less than 20 per cent), another lender and insurer may not feel comfortable lending on a second high-ratio mortgage, so it’s ideal to have at least 20 per cent equity in the first property.
Income qualifications: Whether you refinance your old residence or not, you will still need to demonstrate enough income to carry both mortgages. Rental income can help, but it’s likely you won’t have a tenant until after you’ve closed on your new home. Some lenders only accept rent as income if that income is declared on your tax return and will ask for your T1 Generals to show the breakdown. However, some lenders are more lenient and will allow lease agreements or even a schedule A (estimated rent from an appraiser) if the place is rented without a lease or if the property is currently owner-occupied but will be rented once the clients move into their new home. It is important to note that contrary to popular misconceptions, no lender will use one hundred per cent of your rent as income.
Beyond qualifying for a mortgage, you and your mortgage broker should run the numbers to make sure that you can realistically afford two mortgages. Hopefully your income has increased since you purchased the original property, but you want to give yourself a buffer in case the unexpected happens. Make sure your costs are covered – research market rental rates, account for all of your expenses and factor in vacancies, repairs and maintenance. If the equity and your monthly cash flow are too low, carrying two mortgages could be risky.