It doesn’t matter if your office is a garage, a downtown shared space or the front seat of your pickup truck, being your own boss is truly a thing of beauty. Of course, being self-employed comes with a lot of perks like flexible working hours, charting your own destiny, and the allure of a cubicle-free paradise.
But, does it seem like the Canadian mortgage products were designed for the typical T4 employee?
Sure, most Canadians find self-employment exhilarating and quite fulfilling. Seeing your own business take root and burgeon from a sketch on paper to vibrant profitability is amazing. That is until you attempt to apply for a mortgage, then the challenges begin. Unfortunately, often times self-employed Canadians have to work harder to secure a mortgage.
There is some good news however. While securing a great mortgage as a self-employed person can be a bit more challenging, it isn't impossible. In fact, it can be quite easy if it’s done right.
What you need to know before trying to secure a mortgage
We are all aware that mortgage lenders aren’t going to have an appetite for every kind of applicant. Unfortunately, mortgage lenders often consider self-employed people as higher risk. Typically, there is a lot more paperwork and a more thorough underwriting process that needs to happen with a self-employed applicant. That’s why many lenders prefer T4 employee applicants.
You may end up paying more for the mortgage
In the eyes of the lenders, you may be viewed as a higher-risk borrower. You need to ask yourself some tough questions. For starters, are you willing to pay a little extra to secure a mortgage?
Although it varies wildly from one bank to another, the interest rate you will pay may be a little higher. But, is it worth it? Absolutely! Here’s why… many of my self-employed clients show very little income on paper. This means we need to secure their mortgage utilizing certain mortgage products such as “stated income” products. This means the interest rate is often a little higher than what it would be if they declared more income, or were a T4’d employee. However, when you calculate the extra interest cost of the higher mortgage rate, and compare that to the alternative, it’s typically quite worth it! What is the alternative you ask? Simply declaring more income on their tax returns, and therefore paying more income tax! Usually, the increased income tax they would pay is much more than the small increase in rate they pay on the mortgage going with a “stated income” mortgage product. With that said, if you declare enough income to qualify for the mortgage, you can often secure the same great rates and terms that a T4’d employee can.
As counterintuitive as that might seem, the actual mortgage application process for the self-employed and others such as T4 employees is quite similar. You’re going to get the regular rate quote, fill out an application, sign some paperwork and provide supporting documentation. The debt to income ratios, down payment, and credit requirements are also similar.
The documentation requirements, however, is a different story. While employed personnel need to provide a few documents (T4s and payment stubs) as a proof of income, self-employed people are required to show a bit more documentation, including financial statements prepared by a certified accountant alongside Notices of Assessment and T1 and/or T2 Generals to name a few. Are you a sole proprietorship or a corporation? The documentation requirements will vary for each.
Lending standards for self-employed are tough
I always try to set reasonable expectations with my self-employed clients. Most lenders require a minimum two-year track record of earnings. That implies two years of tax returns which as I mentioned above, often don’t reflect their true take-home income. There are lenders that will lend to applicants with less than a two-year history of income, but once again, those mortgage products come with a higher mortgage rate and often restricted terms.
Traditionally, self-employed people tend to write off a number of expenses that T4 employees can’t in a bid to lower their net income for tax purposes. For mortgage underwriters, however, this works to your disadvantage. Lenders calculate your debt-to-income ratio - a measure of how much of your income is used to service your debts - using the net income, which is after the expenses have been deducted. Needless to say, if you’re deducting a lot of expenses, and therefore showing a lower net income, your debt service ratios might be unfavourable because they will be higher. That’s where it becomes a little tricky because lenders prefer debt-to-income ratios in the neighbourhood of 35 - 44 per cent, depending on a few additional factors.
Some mortgage lenders get it
Not all mortgage lenders are the same. In most cases, the underwriters will allow specific expenses to be added back to the net income when calculating the debt-to-income ratio. Think of a large non-recurrent write-off, depreciations, and depletions. A hefty one-time licensing fee, for instance, can be used to tilt the debt-to-income ratio to your advantage. The trick is to ensure the mortgage professional you are working with thoroughly understands your business, and your business finances so they can align you with a lender who does as well.
How to spruce up the odds of your mortgage application being approved
It might seem overwhelming at first, but don’t sweat it. Some lenders are actually out to help the self-employed secure mortgages, too. Some lenders actually love working with self-employed applicants and cater to them with great tailored mortgage products. Here are some tips to help you score a great mortgage as a self-employed person.
1. It pays to plan ahead
Speak to a trusted mortgage professional well before you are ready to secure a mortgage. Where do you stand on debt, expenses or business growth? Are you looking to do any major restructuring to your business? How much income do you plan to declare? All of these things end up influencing your chances of getting the best mortgage product available.
Since most expense write-offs tend to negatively impact your debt-to-income ratio, often times you may want to dial them down significantly in the 2 years prior to securing your mortgage. Or, as we discussed above, maybe it’s well worth it to claim less income, pay a bit more on the mortgage rate, but save on the income tax side. Speak to a trusted mortgage professional well in advance and plan accordingly.
2. Keep a good credit score
It is imperative to maintain a sound credit history. This is more important than ever with the introduction of the new mortgage rules late last year. There are many mortgage products that are only available to those with credit scores above a certain benchmark. Some websites give you free access to view your credit score so ensure to monitor yours at least twice a year.
3. Be organized
Keep your financial statements, tax returns, T1 Generals, Notices of Assessment, etc. in good order. Keep them organized and accessible. Most importantly, have your taxes up to date! By having your documents in order and available to the lender, it helps instill confidence, thus helping you secure more favourable rates and terms.
Scoring a great mortgage as a self-employed person shouldn’t be an arduous task. Consider the above tips to help ensure you’re in the best position possible to secure a great mortgage product. Most importantly, plan well ahead and speak to a trusted mortgage advisor well before you need that mortgage approval.
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