The best types of loans for investment properties in Canada

Why buy investment property?

Think about it like this: As long as a country continues to see positive population growth, more people will need a place to live. This brings us to the traditional economic model of supply and demand. Since demand will increase over time, so too will the property value.

However, Canada’s real estate market has been starved of housing supply for decades. This means that current housing prices are inflated due to supply constraints.

The good news is this doesn’t mean that investing in real estate is a bad idea. As supply issues are fixed, prices will just increase less quickly and not stop increasing all together.

Taken together, this means property investment tends to be low risk and high reward, with plenty of options for tax write offs.

But there are also opportunities for investing in fixer-upper properties in lower value neighbourhoods for those who don’t have a million dollars laying around.

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Your options for loans for investment properties

The flip side of a strong housing market is that the buy-in price is correspondingly higher.

Technically, minimum down payments on a property can vary between 5% and 20%, depending on purchase price. However, if you put less than 20% down, the Canadian Mortgage and Housing Corporation charges a premium for mortgage loan insurance.

For most Canadians, 20% down plus a loan is going to be the way to go if you plan on getting into real estate investment.

The four options for loans for most investment properties are:

1. Traditional bank loans
2. Hard money loans
3. Home equity loans
4. Private money loans

Each type of loan covers a different investment scenario.

Chances are you’re already familiar with traditional bank loans, which are based purely on your credit score and credit history plus income, assets and liabilities. A traditional bank loan means you’ll end up paying either a fixed rate or variable interest mortgage. Check out Money.ca’s mortgage calculator for more information.

Since the other loans tend to favour specific investment scenarios, we’ve broken them out into their own categories below.

Hard money loans

Hard money loans are short-term, high-interest loans designed to help you repair and flip a property in short order.

A hard money loan is determined based on the property's estimated value after getting fixed up. If a bank thinks the property will sell after repairs, you can get a loan in a matter of days instead of weeks.

Because of the higher risk, hard money loans can also be easier to qualify for, since the property’s resale value is part of the equation. It’s not just about your credit score.

However, you can expect higher interest rates, a short repayment period, plus higher origination and closing costs.

Private money loans

As the name implies, a private money loan is from one private citizen to another.

The most common way to secure a private loan is to ask your family for help. Some parents will loan their children money to help get them into the housing market. These loans are typically backed by a legal contract rather than an agreement with a bank.

If you pursue a private money loan, make sure you trust your investor.

Home equity loans

Home equity loans allow you to borrow money against existing real estate equity (e.g. your home, a cottage, etc.) to invest in a new property.

As you can guess, this is a riskier investment.

Essentially, you’re betting on the investment property working out using existing assets through a home equity line of credit (HELOC) or a cash-out refinance. HELOCs can allow you to put up to 80% of the value of your home towards your investment property. A cash-out refinance extends the mortgage on your home. It can also mean paying more interest.

Again, this is a risky loan investment. If you fail to repay your loan, you could lose your home through foreclosure.

Pro and cons: What to consider before taking out a loan for an investment property

Now that we’re up to speed on the different types of loans available, let’s take a look at real estate investment prospects.

To be clear, real estate is a gamble even if the long term prospects are good. Whenever you invest in anything, you’re making a bet on a given economic marketplace. As we discussed above, some loans are riskier than others.

Even so, there are plenty of benefits to real estate investing.

Pros

• Extra income from renting the property
• Property value appreciation over time
• More tax deductible expenses (e.g. home insurance, property taxes, repairs, etc.)
• Capital gains tax exemptions (e.g. RRSP and TFSA contributions, ownership transfers, capital losses, etc.)

Cons

• Upfront costs
• Real estate is a physical asset and can take time to both sell and close on a deal
• Being a landlord takes time you might not have
• Market volatility can tank your investment and force you to hold for long periods of time until the market rebounds

It also bears mentioning that if you’re planning to be a landlord, you should brush up on landlord and tenant relations.

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Conclusion

Finally, we want to touch an old investing adage: Always be prepared to lose on your investment.

When it comes to housing, this is an unlikely prospect. Although you may lose money the chances of your investment being reduced to zero is very low.

For more on real estate, check out Money.ca’s coverage of the most affordable places to live in Canada (which can be idle for those interested in following the 2% rule).

FAQs

Is it hard to get a loan for an investment property?

Getting a loan for an investment property generally requires a deeper financial commitment. Expect high interest rates, stricter credit standards outside of hard money loans and larger down payments.

What is the 2% rule for investment property?

The 2% rule is the idea that you should make 2% of the purchase price of a property back in rent each month to recoup your investment.

Simply put, the 2% rule is unrealistic in most high cost of living real estate markets. This is doubly true in the red hot Canadian real estate landscape.

Say you purchase a single detached home in the Greater Toronto Area for $1,000,000, which is about the average. Using the 2% rule you’d want to be covering $20,000 per month. Finding anyone willing to pay this much for a rental is next to impossible.

But what if you want to try to apply the 2% rule to a down payment instead of the purchase price?

At 20% down that means your initial investment is $200,000. At 2% this turns out to be a monthly minimum of $4,000.

This may sound reasonable at first. However, it doesn’t account for your mortgage situation, the land transfer tax, insurance, property tax and any year-over-year changes or market fluctuations.

As such, the 2% rule is best used, if at all, for an initial assessment informed by a full understanding of the target investment property.

Can I put less than 20% down on an investment property?

There are some situations where you can put less than 20% down on an investment property, but they have limited scope for most investors.

The easiest way to pay less than 20% for a down payment is by moving into the new property yourself. By occupying the property and renting out the extra space you can get a lower rate.

Another option is to make the new property your new primary residence and rent out your previous primary residence.

Sources

1. Cision: More than 1 in 4 Canadians plan to purchase an investment property in the next five years: Royal LePage Report

2. RBC: Proof Point: Canadian renters face higher hurdles to accumulating wealth than homeowners

3. TD Stories: What’s going on with Canada's housing supply?

4. Government of Canada: How much you need for a down payment

5. CMHC: Mortgage loan insurance and premiums

6. Government of Canada: Landlord and tenant relations