Investing in a second property was once something only the wealthy might consider. However, with the right planning and financing, owning a second property in Canada can be within reach for many people today. There are several reasons Canadians might consider investing in a second home whether it is as a vacation property, a rental property or even a property to make retirement more pleasant. Whether you are interested in investing in a Toronto condo as a rental property, or a peaceful chalet or cottage for your own use, second properties do require careful consideration. Here’s what you should know.
FUNDING FOR A SECOND PROPERTY IN CANADA
The first thing to consider when investing in a second property is affordability. You might be surprised at how easy it can be to find funding, with three excellent options available:
1. Refinancing Your First Home
If you have built up equity in your first home, this could provide you with the means to invest in your second property. Equity begins to build in your home as soon as you purchase it. Between your down payment and the mortgage payments you make, the money you have paid down on the value of your home and the increased value of your home provide you with equity. The longer you have owned your home, the better your equity. The term “refinancing” might sound a little scary, but it is something to consider. You can speak to your mortgage company to discuss your options and find out how you can tap into your equity through refinancing. They can let you know how much equity you have built up in your home, and how you can access that money to use towards the purchase of your second property. It can also provide an opportunity to renegotiate your current mortgage terms, which in some cases might include lower interest rates. Just be certain to have all potential penalties explained, so you don’t face unexpected fees for breaking your current mortgage agreement.
2. Second Mortgages
Second mortgages are more commonly referred to as home equity loans today. It is another way you can access the equity you have built on your home to put towards the purchase of your second property. You secure your loan against the home you own with as much as 85 percent of the appraised current value of your home available, less the balance of your mortgage. You can investigate how much you would have to pay between your two mortgages to decide if this is an affordable option for you.
The HELOC provides an excellent option for those with a minimum of 20 percent equity in their property. You also must have a good credit rating to qualify. The reason this is more desirable than a second mortgage is that with your second mortgage you are paying interest on the entire amount of the lump sum the bank gives you, whereas with a HELOC you are only paying interest on the money you use. It is a line of credit providing up to 65 percent of the current appraised value of your home.
MORTGAGE APPROVAL FOR A SECOND PROPERTY
You will go through the same process for mortgage approval when purchasing a second property as you did for your home. That means you’ll have to prove you are employed, have a good credit history and are currently able to manage your first mortgage. It can be more challenging for those who are self-employed or depend on commission for their income. As well, chances are you weren’t faced with the added challenge of passing the stress test when you purchased your first home.
The stress test was introduced by the government to help ensure people purchasing homes could afford their mortgage not only at current rates but also in the event rates rise. Therefore, lenders add two percent to current prices, or you must qualify for the Bank of Canada’s five-year benchmark rate, whichever is higher. When introduced, the stress test reduced the mortgages home purchasers qualified for by about 20%.
In general, if you want to pass the test, you should have a gross debt service ratio (the percentage of your pre-tax income needed to cover your costs) at less than 32% and your total debt service ratio (all of your debts compared to your income) at less than 42%.
DOWN PAYMENT FOR A SECOND PROPERTY
There is no difference in what is required for your second property down payment and your first, unless you plan to use it as a rental property. Ideally, you should have 20% to make the mortgage manageable, but you can have the same range as follows for a second home:
$500,000 or less: 5% of the purchase price
$500,000 to $999,999: 5% of the first $500,000 of the purchase price and 10% for the portion of the purchase price above $500,000
$1 million and over: 20% of the purchase price
For “non-owner occupied” property, you will require at least a 20% down payment.
TAXES AND SECOND PROPERTIES IN CANADA
When it comes to taxes, you do not pay capital gains when you sell your principal residence, but you do for your second property (or all additional properties). Your principal residence is the home you live in for the majority of the year, according to the Canadian government.
When you sell “capital property” you pay taxes on 50% of the money you make from the sale of your second property. For example, if you earn $100,000 on the sale, you will pay taxes on $50,000. The percentage of taxes you pay on those gains is then based on your tax bracket.
These are the basics involved in purchasing a second property in Canada. It can prove to be a lucrative investment, even if you intend to use the property for your own enjoyment. For more information about buying a second property in Canada, our experts at OnlyWith.ca can help. Reach out to our team today for any of your real estate needs. To find a rental, check out our brand-new tool that grants you immediate access to all available Toronto’s rental listings.