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.