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Borrowing to Invest in Rental Property: Do’s and Don’ts

Tags: Investing

Are you thinking of leveraging your existing home’s equity to invest in a second property? There are a number of factors to consider, including borrowing options, the local rental market, and non-financial factors like time, effort, and comfort with risk. Read on for tips on how to do it wisely and do it right!

DO: HAVE YOUR EXISTING PROPERTY RE-APPRAISED

If you own property in Toronto, it’s likely that it has increased in value since your purchase. Perhaps you bought in a high-demand area, or maybe you completed key renovations. In any case, most of your borrowing options rely on a calculation of your existing home’s current market value. It’s important to make sure this appraisal is accurate and up-to-date.

DON’T: DISREGARD THE NON-FINANCIAL FACTORS IN OWNING A RENTAL PROPERTY

Being a landlord requires time, labour, patience, and people skills. For example, you may have to paint, clean, and repair the property between tenants. You may have to deal with tenant complaints, late rent payments, or feuding neighbours. Prolonged vacancies in your property may be a source of financial difficulty and stress.

Ontario’s Residential Tenancies Act outlines the rights and responsibilities of both landlords and tenants. Here’s a handy guide to the Act so you can get an accurate idea of what goes in to managing a rental property. If you’re up for the effort, being a landlord can be rewarding!

DO: KNOW YOUR OPTIONS

You can re-finance your mortgage, borrowing a sizable chunk of your home’s value minus outstanding debt, but this may change the terms and rates of your mortgage agreement. If you’ve made mortgage pre-payments, you can borrow from amounts you pre-paid, although this may also mean a different interest rate than the one on your original loan. You can take out a home equity line of credit (HELOC), which is a separate credit line from your mortgage, but which also relies on the existing value of your home. Finally, you can take out a second mortgage with a different lender, but second mortgages are riskier for lenders so rates are often higher.

Visit the Financial Consumer Agency of Canada for more information on these options.

DON’T: ACCESS HOME EQUITY IF YOU MIGHT SELL YOUR PRIMARY PROPERTY SOON

If there’s a chance you plan to sell your primary property in the near future, you’ll have to pay off all the debts on it first. It’s unadvisable to take out a home equity loan shortly before planning to sell, as you’ll need to pay off the loan or line of credit before selling. If you’re relatively certain that your primary property is an asset you’ll be holding for a long time, you can feel more secure about taking out a home equity loan.

DO: RESEARCH THE RENTAL MARKET

Renting a condo to tenants is a smart alternative to cover your ownership costs, but make sure you’re aware of vacancy rates and rental prices in your area. This will help you understand the risk you’re undertaking and the expected return on your investment.

The Canada Mortgage and Housing Corporation publishes annual rental market reports for regions throughout Canada, and you can download the 2015 Greater Toronto Area (GTA) report here. Important takeaways from this report include:

  • In October 2015, the GTA vacancy rate was 1.6%—significantly lower than the national average. Finding a tenant should be relatively easier here than elsewhere in Canada.
  • Rental demand has shifted to “high-end segments of the market such as newer purpose-built structures and newly completed condominium rentals.”
  • The average rent for a two-bedroom GTA apartment increased by 3.3% in 2015, up from 2.7% in October 2014.

DON’T: PUT ALL YOUR EGGS IN ONE BASKET

Your property investments are part of your larger financial portfolio, and you may not wish to put too much money into one type of asset. A second property means a larger chunk of your portfolio is made up of real estate, and financial advisors recommend diversifying your investments to protect against the risk of specific sectors or asset classes devaluing over time. If you already have a diverse investment portfolio, you may feel more secure investing in a second real estate property.