According to Stats Canada, more than 2.7 million people in Canada are self-employed, or business-for-self (BFS). Entrepreneurs serve an important function in our economy. Successful self-employed people are typically very hard workers. After years of working long hours to save up enough for a down payment, BFS borrowers might assume that the mortgage qualification process for them would be identical to the process for anyone else. But nothing could be further from the truth. It’s important to know, in advance, what additional hurdles you might face.
Prior to 2008, BFS applicants could obtain a mortgage simply by proving they had a business with an active business license (and good credit, of course). Their income could be stated arbitrarily, as long as it was realistic for their industry. Since then, mortgage regulations have progressively tightened, especially on “stated income” loans.
Here’s what BFS-er’s need to know!
First of all, if you have a history of provable income, everything is fine. Has your business been active for at least 2 tax years, claiming enough income on your taxes? If your 2-yr Total Income average (line 150 on your tax returns) is sufficient to qualify, it’s business as usual. You qualify just like an employed borrower and generally have access to the same mortgage products, rates and terms.
Many BFS clients we deal with have been encouraged by their accountant to write off as much of their income as legally possible. By claiming legitimate expenses and personal deductions, you can artificially lower your total income, thereby reducing the amount of taxes payable. That’s great at tax time, but if you plan on applying for a mortgage in the near future, you’ll want to rethink this strategy. In order to qualify for best rates, lenders will look at your line 150 – Total Income, not your gross business income. If you earn $100K a year but write your income down to $40K, that $40K figure will be the one lenders accept as qualifiable income.
Some lenders allow “Grossing Up” of your total income. Rules vary, but usually you can add 15% to your 2-yr average income and still have it considered qualifiable income for best rates. For example, if your 2-yr average Line 150 income is $65,000, a lender who allows “grossing up” will use an income of $74,750 for qualification. In some cases, this bump may be enough to meet debt servicing requirements.
If not, another option is to qualify for a “stated income” mortgage. The stated income must be realistic as determined by the lender, usually based on the type of business, the industry sector and time in business. The 2-year minimum rule is still typically in play and lenders usually won’t allow a borrower to state their income higher than their recent annual gross business income. “Stated Income” interest rates are nominally higher, by about 10-15bps (0.10-0.15%). Monthly mortgage payments will be about $5-8 more for every $100K owing.
While this can help get you qualified, there are additional conditions involved with “stated income” files:
- your credit profile must be squeaky clean. It’s OK if you owe money on your cards or lines of credit, but it’s best if you keep your balances as low as possible. Every $12,000 in consumer debt will decrease your maximum mortgage by about $100,000. It makes a big difference. Plus, if balances are close to the limits, this will really drag your overall credit score down. Most importantly, stay on top of your payments. Missed payments, especially on previous mortgages, will stick out like black eyes when a lender examines your credit worthiness.
- pay your taxes! Anything owing to Canada Revenue Agency comes first. If you owe a lot of back taxes (GST/HST included), a lender will take a pass on your approval until taxes are brought up to date.
- more down payment/equity may be necessary. Usually the required down payment is 20% to avoid mortgage default insurance. With “stated income” files, this minimum jumps to 35%. There are always exceptions, but the exceptions are usually granted by private or B lenders, who charge higher rates and additional lender fees. At a minimum, you will need a 10% down payment.
In preparation of getting approved for a mortgage, as a self-employed borrower, you have a bit more homework to do compared to the typical income earner. Start collecting your documents now. A lender will likely ask to see many of the following:
- T1 Generals & Notices of Assessment (NOAs) for the previous 2 years. The T1 General is the tax booklet submitted at tax time and the NOA is what Canada Revenue Agency sends back to you. If your T1 Generals included a section called ‘Statement of Business Activities’, make sure that’s included.
- proof that you have paid any income taxes owed, as well as any HST or GST owing
- financial statements for your business for the last 2 years prepared by an accountant or other qualified 3rd party
- copy of your business license and/or article of incorporation
These days, the mortgage qualification rulebook is constantly being re-written, especially if you’re self-employed. It’s important to make sure you’ve thought of everything in advance to avoid any last-minute surprises. That’s where having a knowledgeable mortgage broker works to your advantage. If you have any questions or just want some more info, give me a call today – 250-338-3740