Many landlords believe that they shouldn't report the income they generate from their rental properties in hopes of keeping more of the cash to themselves (and not the taxman). I am going to share a few reasons why it is necessary to disclose rental income to Canada Revenue Agency (CRA). Not only is claiming rental income necessary to satisfy tax law, but it can actually affect your qualifying ability when purchasing additional properties, and can benefit you in more ways than you might expect.
1. Deductible Expenses and Taxable Income
Most landlords spend a large amount of money on expenses directly related to earning the rental income. Deductible expenses can reduce the taxable income and can have a significant impact on a tax return, but only if the landlord discloses their rental income to CRA. (I'm not an accountant, but here are some examples: advertising, insurance, interest on borrowed funds for the purchase, professional or management expenses, utilities, repairs, and maintenance).
2. Qualifying for Additional Mortgages
In some scenarios, not claiming rental income on your income tax returns can impact the approval amount when purchasing additional properties. To reiterate, in some scenarios not claiming rental income has no impact on qualifying for another purchase, but in a lot of scenarios it does. While there are many different lenders with their own unique lending guidelines and restrictions, I will speak to what I have seen, especially on insured purchases when a client with an existing rental property does not claim their rental income and is looking to buy an additional property.
When qualifying for a mortgage, your debt service ratios need to be within a specific threshold (that varies on based on the lender, transaction, insurer, credit score, etc.). Basically, you can only have a limited amount of monthly expenses compared to your monthly income. For example, the cost of all mortgage payments, property taxes, and condo fees (on all properties owned) have to be less than 35% (if insured through CMHC) of what the client grosses each month, or under 39% if insured through either of the other two insurers. Some clients with high incomes can qualify to hold all of their properties without factoring in any rent, and in those scenarios not claiming the rental income MIGHT NOT be a factor. However, if a client can't debt service holding their rental property (including property taxes and condo fees) and the new owner occupied purchase, then they need to show the rental income coming in to offset or reduce those costs. In order to use the rent most lenders will ask for a signed lease agreement and 3 months of bank statements showing rent deposits. In some cases the deposit history and lease agreement are sufficient, and other times the lender or insurer will want to see the previous year's tax return (sometimes two years) showing the rental income.
Claiming the rental income increases the lending options, and will give your client the most flexibility. Each lender has different policies, rates, and timelines, so having the most options available is ideal. Don't hesitate to reach out with any questions.
The most common question I get asked from clients is, "what's the best rate". While rate does matter, choosing a mortgage product based solely on rate can be a costly mistake. All lenders calculate break penalties differently, and it is no wonder that big banks try to lure us in with 5 year fixed rates. More than 2/3 of home owner's break their term early (average is 3.5 years) when they move and don't port, get divorced, refinance, or revert back back to renting. Fixed rates with mono-line lenders (dedicated mortgage lenders) are the safest fixed option, as they calculate the break penalty based on your actual interest rate, whereas big banks calculate the penalty using inflated "posted rates that are 2-3% higher than your actual rate. With all of the uncertainty in our current climate, now more than ever it is important to review lenders with more flexibility, smaller break penalties, and to review the flexibility that goes along with a variable mortgage. Click here to read about a client who lost her job and the bank charged her more than $30,000 to break her mortgage.
After reviewing the questions below we can discuss the best rates available to the client. I hope you find this interesting!
1. Fixed or Variable?
2. If fixed, 1 Yr,, 2 Yr., 3 Yr., 4 Yr., 5 Yr., 7 Yr., or 10Yr.?
3. If variable, which lender? Each lender has different features and policies.
4. Do they want a line of credit now, or option in the future?
5. 20% down or less, can they reach 20% down?
6. Portability between provinces?
7. Do they need the flexibility to put down large lump sums?
8. Who wants to be on title?
9. Will title be held in the name of a holding company?
10. Origin of the down payment (e.g., gift, investments, out of country, line of credit, etc.)
11. Are all applicants' income taxes filed and up-to-date?
12. Is there a commission, bonus or overtime component to the income?
13. Have they had a consumer proposal or bankruptcy filing?
14. If part-time, are hours guaranteed, do we have 2 years tax history?
15. Are there any debts that might not show up on one credit report but might on another?
16. Does the client own other real estate?
17. Was their previous mortgage insured (less than 20% down), how long have they owned it, is it a rental now, which insurer is it with?
18. Does it make sense to port the default insurance over to the new purchase if they are selling the other one? (there are top-up premiums on the new money)
19. Is the client aware of the legal fees and closing costs?
20. If a new build, does the builder need progress draws, if so, where is the property?
21. If a new build were there incentives included in the contract?
22. Was the property ever a grow-op or drug lab?
23. Are extensive upgrades planned?
24. Is this a fix and flip, rental, or long term hold?
25. Have any of the applicants been divorced, or ar in the process of separating? Do any of the applicants pay spousal or child support? Are they current with their payments?
26. Has the deal been sent in somewhere else? What did that lender say? What did the insurer say? Which insurer saw the deal?
27. Does the client have late payments showing on their credit bureau in the last year? How many? Why were they late? Which lender?
28. If the clients own rentals, are any of the condos? What are the condo fees? How much rent is coming in? Do they have deposit history and does the rent show on their tax returns?
29. Have any of the applicants had their employment affected by COVID-19?
30. Are any of the applicants on work visas or student visa? Have they been in Canada longer than 5 years?
31. Do they have established credit since coming to Canada?
32. How long do you see yourself living in at this home?
33. Are any of the clients self-employed? Do they have two full tax years of self-employed income?
34. Do the clients own their own business? Do they T4 themselves?
35. Is the property an acreage? What town or area are they interested in?
36. Is this a refinance (equity take-out), switch/transfer, owner-occupied purchase, or rental purchase? How much equity do they have in the home?
As you can see, there are a lot of factors affecting a mortgage approval. Time and time again clients come to me after getting "pre-approved" elsewhere, and then having their deal declined when the deal goes live. If these questions aren't covered prior to a live deal, and if the documents aren't reviewed prior to a live deal, a mortgage pre-approval cannot be granted. Once I've covered these bases with the client they can rest easy know their approval is in stone. I hope this snapshot gives you a bit of insight into what goes on behind the scenes on a mortgage approval.
The majority of this list comes from a book called "Be the Better Broker V1" by Dustan Woodhouse (2015) who is the President of one of Canada's national mortgage brokerages.
To be honest, I wasn't sure how the spring/summer would look when it came to my business. The spring started with a high volume of clients switching lenders to take advantage of low interest rates, and then the purchases started to pile up in June once some of the restrictions were changed in Manitoba. The summer and fall were both quite stressful due to the insane volume, but also due to several factors that made mortgage lending more difficult.
Challenges in the industry:
1. Branches closed, or open with limited hours and limited staffing levels
2. Lawyers, appraisers, underwriters working remotely
3. Everything is slower with all of the above working remotely (lenders, lawyers, appraisers, insurers)
4. Limited listings has resulted in bidding wars and short financing deadlines, which increased the stress levels based on points #2 and #3
Positive changes in the industry:
1. virtual meetings that save clients drive time and often creates a more comfortable experience from the clients home
2. virtual signings for mortgage documents which has made it easier for clients with busy schedules and children
3. I am now using a secure portal for document collection where clients can drag and drop their documents which makes the experience more streamlined
With all that being said, things are different, but I am still able to provide the same tier of client support, just virtually.
Every several weeks I hear from a new client that had been pre-approved at their bank/credit union, but when they had an accepted offer, they were declined or told they needed to increase their down payment. This is usually because the pre-approval was based on discussions and not on documents (I may need to copyright that).
If a lender doesn’t underwrite the application up front, they wouldn’t know if the client is on probation, how they filed their taxes, or if they have outstanding collections. There are many types of documents that we review when underwriting a file: paystubs, letters of employment, T4’s, T1’s, NOA’s, 90 day history of down payment funds, and their credit application. We look at pay stubs, and make sure the year to date earnings are on track to hit what the job letter says. We review probationary periods, call the job letter to see what HR will say, and address any past collections or late payments.
How taxes are filed for commissioned employees, employees who work overtime, and the self-employed can have a significant impact on the pre-approval amount, so I ask the questions up front and review their tax documents before issuing a pre-approval. For example, a client may tell you that they make a $100,000 per year, but aren't aware that all of the write-offs and business expenses that reduce their taxable income to $55,000, means that their qualifying income for their mortgage application is now $55,000. The amount of house that you can buy with an income of $55,000 is drastically less than an income of $100,000 (e.g., 5% down and minimal debts lets say $240,000 compared to $420,000).
By reviewing everything up front ( make sure that we have taken out any of the guessing, and can confidently tell my client that they are pre-approved. I get all documents up front. I pull credit up front, I ask the “tough questions” up front. If they are paying spousal support/child support payments, I get those documents up front. I review the tax documents up front and coach clients on how to handle their current debts in order to maximize their purchasing potential. It may be more work up front, but there will be no surprises, and the clients will have a concrete pre-approval. This will reduces the stress during the financing window because we will have the majority of the documents all ready to go.
Clients that are on work permits or student permits and have been in Canada longer than 5 years have very limited lender options. Genworth and Canada Guaranty will not insure the mortgage when an applicant has been in the country longer than 5 years and has not yet obtained their permanent residency status. If the applicants are putting down less than 20% that leaves us with CMHC, and we all know their qualifying guidelines (e.g., debt service ratios) are more stringent than the other two insurers. Even though CMHC is okay with this scenario, the majority of lending institutions will still not lend to clients who have been in Canada longer than 5 years that do not have their PR. Also note that most lenders will want the applicants to have at least 6 months remaining on their work permits following the possession date. I do have several lenders that will look at the file even if the clients have been here longer than 5 years, but they need to be strong on paper. If you have clients on work/student permits, I will gladly review their documents with them and let you both know their options.
The real estate market is on fire right now, and with limited inventory and competing offers, clients and realtors are trying to make their offers more appealing to the sellers, I get a lot of questions about the financing condition, and if they really to include one in their offer. Here is why I tell my clients to include a financing condition.
However, when it comes to the property, the approved value and the history of that home are out of my hands. In some cases, homes have been former grow ops, or have had significant structural issues that may not be visible to the eye, or that have not been disclosed on the listing (the sellers might not even be aware of the issues). This is why I always recommend a financing condition and home inspection. I can confidently pre-approve you, but not the property.
Please reach out with any questions, and know that I will always do whats best for you.
Do your clients ever complain about having to go through CMHC/Genworth/Canada Guaranty when they don’t have more than 20% down? Did you know that insured mortgages (when a client puts down less than 20% and has to pay mortgage default insurance) can actually get interest rates lower than those clients that put more than 20% down? With an insured mortgage the lender knows that they can get their money back if the client defaults, and therefore some lenders will actually reward the clients by offering them a lower interest rate. When clients put down more than 20%, lenders will often pay the mortgage default insurance premiums themselves, and then increase the interest rate to recoup that cost.
So you can always tell your client going through CMHC isn’t all that bad, and that they could actually get a lower rate!
Purchase Plus Improvements
I’m sure you and your clients often come across homes that are almost perfect, but need a little work. The Purchase Plus Improvements program is great if the clients have room in their debt service ratios (how we calculate the amount they are approved for) because they can add up to $40,000 to their mortgage for renovations. Prior to closing the clients have to have quotes from contractors or quotes on materials if they are going to do the work themselves. If the lender and insurer approves it, the funds get added to the mortgage, and sit in trust with the lawyer until the work is completed. Once the renos are completed (most insurers/lenders want them done within 3 months), the insurer often sends in somebody to confirm the work was done before instructing the lawyer to release the funds. So…. This means that your client needs to either pay for the materials or work up front with the contractor, or they can work with a contractor that is familiar with the program and will accept payment upon completion. I have a list of contractors that are familiar with the program and take payment after the funds have been released.
Check out the Genworth page for a quick video on the program, and let me know if you have any questions!
With the uncertainty that seems to hang over almost every aspect of our lives right now, it is understandable that many Canadians are not sure if now is a good time to buy or sell. When it comes to the current state of the real estate market, I defer to the real estate professionals. However, here is some information on what you need to know about qualifying for a mortgage during the pandemic.
Permanent full-time applicants & self-employed applicants
If you are still working and have permanent full-time employment, then qualifying for a mortgage is business as usual. For self-employed applicants, typically lenders and insurers ask for 2 full tax years to establish an average annual income. In recent weeks, depending on the industry, some self-employed applicants have also had to produce recent invoices and proof of bank deposits to show that they are still operating their business.
Applicants receiving government assistance
At this point, CMHC and the other insurers are not using government assisted income as qualifying income for mortgages. If an applicant has been laid off and is receiving EI, we can't use that income, nor the income the applicant will be receiving when they are back at work. This can drastically affect the mortgage approval amount and can hinder an applicants ability to switch lenders to take advantage of a lower interest rate, as they need to have qualifying income in order to switch lenders. In some cases we may be able to use EI as qualifying income for seasonal employees that are typically laid off this time of year and have a return date set in stone,
Please reach out if you have any questions or need help navigating these challenging times.
During this pandemic, many clients and friends have been asking me what is going on with mortgage rates, and they always assume that interest rates are continuing to drop based on the markets. However, with all of the economic uncertainty, and the fact that over 1 million Canadians have filed for Employment Insurance, lenders and investors are worried about increased insolvency. With large increases to risk premiums, lenders are having to spend more to borrow the funds to mortgage clients which is why we have seen most low promotional rates expire. Right now fixed rates are comparable to the mortgage rates we had in February before this hit North America (between 2.69%-3.24% depending on the type of mortgage needed).
In regards to variable rates, the Bank of Canada dropped the overnight lending rate 3 times since the onset of the COVID-19 pandemic, and the majority of lenders have dropped their Prime rates in the days following those rate drops: