September 25, 2013

Mortgages for the Self Employed

Self-employed borrowers have increasingly become a topic of hot debate in the world of mortgage lending.  When the Bank of Canada tightened mortgage regulations last summer the changes made it more difficult for self-employed borrowers who are not declaring their full income, or those that are writing off a good portion of it to get approved for a mortgage.

For salaried employees, typically a pay stub and letter of employment stating one’s annual salary is sufficient verification of income. For self-employed borrowers a different type of verification is required. Lenders generally will look at a two year total earned income average shown on the Notice of Assessments.  For self-employed borrowers this can become difficult as this is the dollar amount they declare after they write off their expenses and this amount is typically lower than what they actually earn.

Lenders will likely also look at business financials from the past two years to see evidence that the business can afford to pay the borrower a reasonable income.  In addition a Business License, or Articles of Incorporation will be required as well as confirmation that income taxes are paid up to date.

As with any type of mortgage approval the lender is trying to assess the borrower’s ability to re-pay debt, and in the case of a self-employed borrower this means getting to know the individual and their business.  Reasonability also comes into play.  The lender may ask, ‘is this a reasonable income for someone in this industry?’

If the income that you report on your tax returns is lower than you need it to be to get approved, some lenders offer ‘stated income’ programs.  Such programs allow your income to be boosted in a reasonable way based on your industry, business financials, tax returns, and the location of your business. Another way that lenders are able to boost self-employed income is by using “Add Backs.”  Some lenders allow you to add back some of your business expenses (to your income), such as capital costs, car expenses, and home office expenses.  Not all lenders offer these programs and the guidelines associated with them are very lender-specific.  Having a mortgage broker assist with this process is essential.

As with any borrower, income, credit, and down payment are the three main factors lenders look at when approving someone for a mortgage.  A 5 % to 10% minimum down payment is typically required for a self-employed borrower.  If putting down a higher down payment is a possibility, it can be beneficial to the borrower as it will strengthen their overall profile. For borrowers who are not declaring a suitable income to cover the costs of their mortgage, the fees charged by the government-run Canadian Housing and Mortgage Corporation (CMHC) can equal close to double that of those who do declare sufficient funds.  If you do need to pursue a ‘stated-income’ program, the minimum required down payment is 10%.  If you want to avoid paying the CMHC insurance premiums, you will need to come up with a 35% down payment as outlined by the Bank of Canada’s new mortgage rules released last summer.

If you do not want to put 35% down but your income showing on your tax returns is not sufficient, you can also add a guarantor (family member), whose income will also be used to help boost your total debt servicing ratio.

A good credit score is also essential for self-employed borrowers as it helps the lender see that the borrower is good at repaying debt.  If you think that your credit could be improved, please reach out to me to ask how.  I will focus on how to improve your credit in a future post.

If you are self-employed and have questions as to how to boost your own borrower creditability, please reach out at kelly@safebridgefinancial.com

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