Mortgage Solutions for Self-Employed Borrowers
Many of my clients are self-employed and they have been self-employed for many years. Some of them are renewing their mortgages for the very first time since purchasing their home and are shocked and sometimes angered when told of the changes made to the mortgage rules pertaining to self-employed people in the past couple of years.
The changes, which were introduced in June 2012, were part of The Financial Stability Board’s (FSB) guidelines ensuring all entities that originate mortgages adhere to the Principles for Sound Residential Mortgage Underwriting Practices (FSB Principles), otherwise known as B-20.
Prior to 2012, self-employed individuals could basically declare their income and as long as they were credit-worthy, they typically would not have any issues finding mortgage financing.
After 2012, if individuals are able to prove their income using their Notice of Assessments for the past two years, mortgage financing should not be a problem. Of course, credit history and score must meet lender and insurer guidelines.
However, if income on Notice of Assessments are lower due to write-offs and deductions (an advantage of being self-employed) then self-employed people have increased challenges, such as larger down payment requirements and higher costs for mortgage default insurance. Also, only two of the three mortgage default insurers will insure mortgages where income is declared. To qualify, eligible borrowers must show they have been in business for a minimum of two years and the declared income must be reasonable based on the industry, length of operation and type of business.
All self-employed borrowers must provide a plethora of documents. Often, lenders will not review an application unless all documents are provided up front. These include, but are not limited to:
- Financial statements (T1 Generals with Statement of Business Activities) for the last two to three years
- Bank statements for the business (for a minimum of the past six months)
- Copy of the business license or Articles of Incorporation, if applicable
- Proof GST account is paid in full
- Proof income taxes are paid up
- Contracts showing expected earnings for the coming year(s)
In regards to mortgage default insurance, below are rates for those with provable income versus declared income.
|Loan to Value*||Provable Income||Declared Income|
|Up to and including 95%||3.15%||Not Available|
|85.01% to 90%||2.40%||5.45%|
|80.01% to 85%||1.25%||3.35%|
|75.01% to 80%||Not Applicable||1.90%|
|65.01% to 75%||Not Applicable||1.15%|
|Up to 65%||Not Applicable||0.90%|
*Loan to value is calculated as a percentage of the loan and is based on the size of the down payment. The higher the percentage of the total house price/value that you borrow, the higher percentage you will pay in insurance premiums.
Taking the above into consideration, I believe it is very important to be strategic when considering the purchase of a home. If possible, reduce the amount of deductions and expenses for the two years prior to purchasing a home, which will result in higher income being reported on the Notice of Assessments. Unfortunately, this will most likely mean an increase in taxes paid to Revenue Canada. However, it could save a borrower thousands of dollars on mortgage costs.
The above information pertains to borrowing from mainstream lenders (also referred to as “A” lenders). However, there are other types of lenders known as alternative lenders (and often referred to as “B” lenders). These lenders will use gross income to substantiate a mortgage application for self-employed borrowers. This may be a solution for some self-employed people to own a home, but please be aware that interest rates are higher. In addition, fees such as lender and broker fees may be applicable, increasing the cost of borrowing for the borrower.
Lastly, none of the above pertains to commissioned employees – that’s a whole different article.