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Mortgage lenders generally like it when borrowers use their property to earn extra income. But some home-rental circumstances make lenders nervous—and you can avoid finding yourself without financing by understanding what they are, and why they’re problematic.
A homeowner’s decision to rent out a portion of their property is often predicated on finances. What better way to earn some extra cash than offering up that extra room or basement suite for short-term stays? Even after you pay for the guest supplies and for the extra insurance coverage that’s required, you’re still in the black. But some part-time landlords are worried: What if renting out a portion of your home prevents you from getting or renewing a mortgage? While there are some home-rental circumstances that make lenders nervous, you can avoid finding yourself without financing by understanding what they are, and why they’re problematic. Here’s what you need to know.
People looking to rent out space in the property they use as their primary residence can rest easy. “If you’re living in your home and you decide to rent out a room or suite, you won’t have a problem getting a new mortgage or securing an optimal rate at renewal time,” explains Ron Butler, an independent mortgage broker at Toronto-based Butler Mortgage. “But if you’re buying a property [specifically] to earn money through short-term rentals, then forget about getting a mortgage.”
According to Butler, no institutional residential lender will give a mortgage loan on a real estate investment property that’s used solely as a short-term rental unit.
“Lenders like the security of a person living in a home because it’s the best possible security,” explains Butler. “Lenders are confident that if someone is living in the home full-time, then there is a really good chance that they’ll want to keep a roof over their head, and that means they’ll make their mortgage payments. It’s why ‘owner-occupied’ is often part of the mortgage contract.”
In fact, mortgage lenders aren’t fazed at all if you rent out a portion of your home to make extra money—and they don’t care if you make this money through a leased tenant, via short-term rentals or by boarding a foreign-exchange student.
“As long as you keep living there, the bank has no interest in what you do,” says Butler. (However, insurance companies do care if you use your home to earn extra cash, so you’ll need to keep them informed. For details, read here.)
Let’s say you move out of your principal residence, but continue to use it for short-term rentals while you continue to pay down the mortgage. Technically, you need to notify your lender—and, currently, no bank or residential mortgage lender in Canada will offer a mortgage on a property used solely for short-term rentals. So you would need to apply for a commercial mortgage, which is significantly more expensive (more on that below).
However, there’s no active enforcement of this…yet.
“Airbnb and the short-term rental phenomenon is fairly new [in Canada],” says Butler. He estimates that the short-term rental market only began to radically expand in the last 18 to 24 months. There hasn’t been enough time for lenders to implement any meaningful policies regarding the use of a property for short-term rentals—but that doesn’t mean policy changes aren’t coming.
“Unless a property is sold, all mortgages renew,” explains Butler. In other words, for now, the mortgage on your Airbnb property is likely safe as long as you continue to own it. However, Butler says, “some lenders may choose to start implementing a review of properties upon renewal. A simple search can show whether or not a property has been rented out on a short-term basis, [and] as soon as a lender finds that your property is being used as a short-term rental, they can choose not to renew your mortgage.”
At this point, the owner has two choices:
Let’s assume that, as the property owner in this situation, you choose to be honest. On this path, you’ll quickly learn that lenders won’t approve a residential mortgage for a property that is being used for commercial reasons—and using your former home as a rental investment constitutes a commercial venture.
But hang on a second, you say. My uncle Freddie, owns a triplex that’s always rented out—why does he have a “regular” mortgage?
Turns out lenders look at longer-term leases differently from Airbnb-style rentals.
“Lenders don’t feel comfortable with assessing the cash flow on a short-term rental,” explains Butler. “But a lease for a specified period of time is pretty straight-forward and easy to understand. Plus there’s no hot season or dry spell [with the risk of no rental income to fund mortgage repayments] to contend with.”
Being forced to shop around for a mortgage through a commercial lender can add a whole new dimension of difficulty to the financing process.
For instance, a residential mortgage typically closes relatively quickly—usually within a week or two. Approval on a commercial mortgage application, however, takes much longer—anywhere from 60 to 365 days.
Plus, commercial mortgage rates are much higher than residential mortgage rates. At present, a 5-year fixed residential rate hovers around 3%. A commercial 5-year fixed mortgage sits closer to 6.5% (although, you may be able to find 5.95% if you shop hard). For most budget-conscious homeowners that 300-basis-point jump will really add up and could quickly erode any money earned from using your property as a short-term rental.
Playing devil’s advocate for a moment, let’s look at what would happen if you opted to lie about the use of your short-term rental property.
Initially, this seems like relatively simple fib, with little consequence, but don’t be fooled.
“If you knowingly provide false documents to back-up your claims a lender can flag your account,” says Butler, “and send it to the shared fraud database.”
Once you’re in this database, which is known as Citadel, you are “severely restricted in your ability to get a mortgage,” says Butler. “Eventually, if you have enough equity in the property you’ll get a mortgage, but it will have to be through private lending with very, very high rates.”
We’re talking a mortgage rate of 10% or greater, depending on the situation.
The best way to protect yourself is to be honest and upfront, and to live in the property you choose to rent out casually as short-term, temporary accommodation.
While you’ll probably have to pay extra for insurance, as well as consider the implications it will have on your annual taxes, from a financing standpoint you’re in a good spot.
The real difficulty lies in the properties that are not owner-occupied and used as short-term rental income generators.
“There are even developers advertising how easy it is to Airbnb their condo units,” says Butler, “some of which are built without a stove!”
The reality, however, is that lenders aren’t prepared to take on this financial risk and, as property investors, you need to realize how dangerous it can be to leave yourself exposed.
One way around this dilemma is to purchase a real estate investment property that has at least two units; that way, you can rent out one unit to a tenant with a lease and keep the other as an Airbnb or short-term rental suite. At the very least, lenders will consider the loan application as a residential mortgage and this enables the you to avoid the high cost of commercial mortgages or the exorbitant private lending rates.
Work with a mortgage broker or agent who is familiar with loan applications that include short-term rental income declarations. Also, become familiar with how lenders classify commercial properties (some lenders consider four or more rental units to be a commercial property, while some classify a property with five or more units as commercial). Remember, lenders like it when borrowers earn extra income (they’ll even take a portion of that income and use it to reduce your debt ratios)—but only if that income is generated in a stable, reliable manner.
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The same situation for the same reasons exists in the US. Lenders will become less nervous with experience of success on the part of landlords of short-term rentals, but more importantly they’re going to see that short-term rentals allowed by home owner associations and government has a profound effect on the value of the property. One thing missing in the article is the relatively greater appreciation of the property value of short-term compared to long-term rentals. Bankers, especially when there is plenty of business in the owner occupied market, tend to be pretty ham fisted when some new scenario comes along. Financing long-term rentals will continue because of banker familiarity with the business plan. Something will eventually catch their eye and bankers will realize they are missing something in the equation, and it is missing in this article. A specific, but common condition needs to exist in statute, the grandfathering of rules in place at the time of purchase which usually happens because politicians don’t like to be depleting property values enacting new rules, but will happily do so if all it does is suppress the future. Then, you have to wait but not for very long. Government and associations are actively and in rapid pace restricting short-term rentals. If you’ve got one, you’re sitting on dwindling supply. What the lenders are currently missing is valuation increase in excess of inflation of the asset value securing the loan. You need to have a vehicle to transfer ownership without triggering the loss of grandfathering. It is pretty simple in Florida, but I confess I have no idea about Canada.