Four Steps Real Estate Investors Can Take Right Now to Improve Their Next Mortgage Application
Updated: Mar 19
With the 2021 real estate market already proving fiercely competitive, it's common to have a conversation with a client who just made an offer on a property without a formal financing pre-positioning review. Clients are then surprised when they don't qualify under traditional rules, and their alternatives end up costing much more than they had planned.
It doesn't have to be this way. Real estate investors in particular can benefit from:
surrounding yourself with a strong team
focusing on the long-term goal
It's important to discuss your investor profile and mortgage options with a financing professional before making a purchase. Below are four steps real estate investors can take right now to significantly improve your ability to qualify for better financing options on your next mortgage application.
Experienced investors know the value of being able to access critical data quickly because real estate doesn't wait. Your mortgage binder can be physical or digital, but the idea is to have an organized system where all of your information is stored in one place. Lender requirements typically include:
Income documents for the last 2-3 years including Notices of Assessment, complete T1 Generals, T slips, original employment offers, and copies of current contracts, plus access to recent paystubs and letter of employment.
Business documents including Articles of Incorporation and/or business license, business tax returns and financial statements for the last 2-3 years, access to the last 6-12 months' bank statements to confirm business deposits, and copies of any invoices from client contracts.
Current property tax bills for all properties to confirm the annual amount due and payments made on time.
Annual mortgage statements for all properties that show property address, mortgage balance, and payment amount. If you have multiple mortgages or lines of credit secured on a property, keep them all together.
Lease agreements - if leases have expired, keep a paper trail of the month-to-month agreement or a tenant acknowledgment agreement, along with the last 3 months' bank statements to confirm rental income is being received.
Updated investment statements from your RRSP, TFSA, Non-Registered savings, ESOP, etc. Fallback of $50,000 in liquid assets for each property owned is ideal so that net worth is diversified outside of real estate.
Rental spreadsheet with all property details. As your portfolio grows, having a current snapshot of holdings will allow for a high-level conversation when needed. The VINE Group Rental Worksheet is customizable and free to download.
Real estate partner contact details including mortgage broker, accountant, lawyer, real estate agent, insurance broker, and property manager. Contact me if you need a referral.
Everyone should monitor their credit score to know where they stand and allow time to address any issues that may come up. Order your free report annually from both Equifax and Transunion (mark your calendar so you don't forget).
If the idea of putting this together seems overwhelming, start with the easiest section and commit to adding other items as they become available. For example, file your property tax bill right away when it comes in. Use the VINE Group Rental Worksheet as motivation to track net worth.
Residential mortgage lending always comes down to affordability, which means lenders need to see a certain level of income versus expenses for continued access to funds. If you've decided to be aggressive with your payments, you may have inadvertently put yourself in a position where future financing options are restricted due to higher monthly expenses.
For example, let's say you have $400,000 left on your mortgage. You're making accelerated biweekly payments of $900 every two weeks and will be mortgage-free in 24 years. Your monthly expense from an underwriting perspective is:
$900 x 26 payments per year = $23,400 annually or $1,950/mth
(not $900 x 2 = $1,800/mth, as you might think)
A refinance could stretch the amortization from 24 years to 30 years, reducing payments to $1,680/mth. That's a difference of $270/mth which translates to about a $50,000 higher approval amount.
What if you want to qualify for more and pay down your mortgage faster? The answer is prepayments. Many lenders will let you make additional payments that apply entirely to the principal balance and don't report on the credit bureau. In our example, you would keep the mortgage payment as low as possible ($1,680/mth) and prepay the difference ($270/mth). This is one of my favorite strategies because it also gives you more control over monthly cash-flow.
When underwriting a mortgage application, lenders complete a credit check and review all of your personal credit balances. This includes car leases, student and other loans with fixed payments, unsecured lines of credit, credit cards, etc. Depending on the credit type, lenders use a portion of the balance to include a repayment amount on your application.
For revolving accounts such as credit cards and unsecured lines of credit, most lenders use 3% of the balance for repayment. Even though these accounts typically require an interest-only payment, a much higher monthly expense is considered for lending purposes. For fixed instalments such as a car loan, lenders use the actual ongoing monthly payment.
For example, let's say you have the following accounts. The monthly repayment from an underwriting perspective is:
If you wanted to buy a new property, the total liability of $1,250/mth would reduce your borrowing capacity by $225,000. By consolidating these credit balances into a mortgage, the new payment could be only $335/mth and improve purchasing power by $175,000. Quite a difference!
HELOCs or Home Equity Lines of Credit are excellent tools for investors because they combine interest-only payments with reasonable rates. This makes it easy to finance a new rental property and keep cash-flow in check.
What most investors don't know is that a HELOC with a balance can make it challenging for future lending on a mortgage application. That's because lenders will treat the HELOC balance (and sometimes, the entire limit) as a mortgage and calculate a monthly expense payment, similar to the Bank of Canada's Stress Test for affordability. For example, a $250,000 HELOC balance would typically have interest-only payments of approximately $650/mth. For underwriting, this balance is treated like a mortgage at 4.79% amortized over 25 years, with a payment of $1,424/mth - more than double the actual amount. This is equivalent to $120,000 in reduced lending capacity.
One easy fix is to ask your lender to take the balance portion of the HELOC and convert it to a mortgage. In the above example, $250,000 could be converted to a new 5-year variable term. Assuming a rate of 2% amortized over 30 years, the new payment would be $923/mth.
This is significantly lower than the $1,424/mth stress test payment lenders would otherwise use to qualify you and would increase your borrowing capacity by about $75,000.
Not all lenders can convert a HELOC so it's a good idea to ask about this useful feature when first setting one up.
Mortgage lending hasn't gotten any easier over time, so the secret to success is staying ahead of the curve by being strategic. Investors should complete an annual review with their financing partner to see if re-amortizing, consolidating, or making other changes could improve your next mortgage application.
It may be possible to do this without refinancing, or you may need to refinance multiple mortgages to improve debt to income ratios. Most investors can improve buying power by making one or more of these changes so a formal review can identify if the benefits outweigh any fees/penalties.
You never know when the next real estate investment opportunity will present itself. Is your portfolio ready to make it happen? Book your complimentary 1x1 to find out.
Adapted from VINE Group Market Update - March 2021. Sign up now to get on the list.