If you are a first-time commercial mortgage borrower, there are some important phrases and abbreviations you’ll want to be familiar with when it comes to rental income properties. They are:
Multi-unit residential (MUR) propertyRead more
This refers to the type of property being mortgaged. It is important to note that different lenders will define this term under different criteria. Some will assume that a building must have 5 or more units to get a commercial mortgage. Others will say that it must have 7 or more units, and so on.
Smaller buildings, such as duplexes (where a basement suite is rented out, for instance), would not fall under this category. Those are considered residential homes, and require residential mortgages. They are much easier to get.
Personal qualifying ratiosRead more
This term refers to the contrast between what a lender will see as your personal input into the property (i.e. down payment, credit score, net worth, etc.), versus what they will need to lend you, and under what terms (i.e. repayment schedules, interest rates, likelihood of profitability, etc.).
However, each lender will have different rules and policies to determine your eligibility for a loan. So the definition of this term in its practical application would not be universal. A mortgage broker will need to guide you through this.
Net operating income (NOI)Read more
This is a calculation to determine how much it costs to run a rental building, versus how much it can bring in from rental payments. The rental revenue before all expenses is considered gross income on the property (not your personal gross income). The leftover is net operating income (NOI).
After you calculate your NOI, you would subtract your income tax, and personal expenses for your own needs. These are not part of the NOI.
Debt service coverage (DSC)Read more
This is a calculation to determine how well a building can essentially pay for itself. As a start, lenders take the NOI and divide it by the required annual mortgage payments. Then, they consider other potential costs such as vacancies, future maintenance on the building, insurance premium increases, and so on. As a whole, this becomes the debt service coverage (DSC). Another way of saying this is “debt service ratio.”
In multi-unit residential (MUR) mortgage applications, it is very important to have at DSC of at least 1.3. In simple terms, that means the property can generate 130% of what it costs to operate. Most lenders will not approve MUR mortgages if their DSC falls lower than this.
Real estate securityRead more
This term refers to the idea that a rental building will very likely bring in profit. Thus, the owner will certainly be able to make their mortgage payments on time, even after operational costs are factored in. It is a risk factor that is considered in the loan application review. The “security” for the lender should be high, if not reasonable, for the market you are buying the MUR in.
CMHC Insurance or mortgage default insuranceRead more
These terms are used throughout the mortgage financing industry. They refer to insurance that property buyers either must purchase, or optionally purchase on their mortgage (not their property – that is separate insurance!).
Whether or not a buyer is required to purchase default insurance depends on the down payment percentage they can put on a property (the rules are different for different purchase scenarios). Insurance protects lenders in case an owner can’t pay their mortgage bills on time. As a result, lower interest rates can be offered.
CMHC is an abbreviation of “Canada Mortgage and Housing Corporation.” It is only one place to get mortgage default insurance, and the most common. So, often, people talk about “CHHC insurance.” However, the other two places to get this type of insurance are:
- Genworth Canada
- Canada Guaranty
When buying a multi-unit residential property, mortgage default insurance is required if the downpayment is less than 15% of the appraised value of the building. Note that the purchase price will be more. We’ll explain more on this below.
Prepayment privilegesRead more
This refers to the ability to repay your mortgage loan before it is due. It may sound strange, but lenders can charge a penalty fee if you repay your mortgage early. This is because when they lend you money, they plan to earn interest off of it. When you pay it off early, that interest would no longer apply. So, to compensate, they charge a penalty fee.
A good mortgage deal will waive this fee, to a degree. If it is waived, it is called a “privilege.” Competitive residential mortgages allow you to repay 15% – 20% extra on your mortgage each year. This saves you money in the long run.
Now, the reason this term is important in the context of multi-unit residential mortgages is that prepayment privileges may not apply. Or, they may have different rules associated with them. A mortgage broker should be negotiating this aspect of your financing deal for you.
This is a professional evaluation on the value of the property, as it stands ‘right now.’ In other words, it will factor in the building’s current rental income, current land value, current building value, current or recent sales, and so on.
What it will not factor in are the projected increases in income from the property, or the future value of the property.
This is important when purchasing a multi-unit residential building, because the purchase price will factor in the future value, whereas the appraisal will not. The potential to earn more money on the property in the long run will raise its selling price. But the mortgage will only apply to the current appraised value.
Building condition assessment (BCA)Read more
As the name implies, this term refers to a report that is generated by a specialist, who will assess the property to determine its condition.
The specialist will assess structural elements, mechanical components, regulatory requirements and other factors that make the building liveable, legal and safe. It will also look at the quality of finishes such as drywall, paint, flooring and so on.
If the building needs too many repairs, or is ready to be torn down, it is highly unlikely a lender will consider an MUR mortgage on it. A new strategy would be needed, such as a construction mortgage.
Environmental risk assessment (ESA)Read more
Like the building condition assessment (BCA) noted above, a lender will require a specialized report on the safety of the building to both people and the environment.
As expected, this report will check for asbestos, lead, mould and other health-related factors.
There’s still a lot more you should know before purchasing a multi-unit residential property!
Buying a multi-unit residential property is essentially buying a business. Like any new business start up, there can be a lot to learn. And, the rules change frequently. A mortgage broker will be well-versed in the latest offerings and limitations the market can offer, if you’re seeking to finance a property of this kind.
Multi-unit residential properties can be great investments. While we wouldn’t say they involve zero work on your part, they can be a form of passive, recurring income. So, even though they can be a big undertaking for a first-time commercial mortgage borrower, don’t let the details drive you away. We have a team dedicated to guiding clients through this exact process.
We encourage you to contact us for more information. We’ll patiently answer your questions, and advise on next steps, at no cost to you.
We also answer some FAQs on mortgaging a multi-unit residential property in B.C. on this page.