Statistics Canada reports that there were 2.7 million self-employed Canadians in 2013, up from 2 million in 1993. While self-employment is increasingly common and these individuals have a higher median net worth than salaried workers, new mortgage regulations have made it more challenging for some self-employed Canadians to qualify for a mortgage.
“Stated income” loans, in which borrowers qualified for a mortgage without a paper trail verifying their income, were somewhat common in the U.S. and Canada prior to 2008. Self-employed earners often try to maximize their personal and business deductions to reduce their tax liability, so this approach allowed them to qualify for a mortgage even with a small taxable income (after taking deductions).
More recently, however, new mortgage regulations in both countries sought to reduce defaults and prevent borrowers from taking out larger mortgages than they could afford. In 2012, Canada’s Office of the Superintendent of Financial Institutions launched Guideline B-20, requiring federally regulated banks to stiffen their guidelines for evaluating residential mortgages and home equity lines of credit.
Some banks in Canada do still offer “stated income” mortgages, but the borrower may need a down payment of 35 percent or more, since under B-20 some lenders will only lend two-thirds of the property’s purchase price. Brokers can still write “stated income” loans with only 10 percent down through some lenders, but it is harder and the income must be reasonable. It becomes even more difficult to secure a “stated income” loan for a mortgage over $500,000. Understanding that business deductions lower a self-employed borrower’s taxable income, some lenders will “gross up” the borrower’s declared taxable income by adding up to 15 percent (not if you work on commission). Most don’t offer a lot of leeway on income requirements.
As of May 30, 2014, CMHC stopped insuring self-employed mortgages without third-party income validation. Genworth and Canada Guaranty still insure those mortgages up to 90 percent, however. If you’re a self-employed borrower, then being able to document your income for the past few years will open up more lending options without requiring a down payment larger than 10 percent.
Here’s a look at the documentation your lender may look at:
- Personal tax Notices of Assessment (NOA) for the past 2-3 years
- Proof that you have paid HST and/or GST in full
- Personal and business credit scores
- Financial statements for your business prepared by an accredited accountant
- Contracts demonstrated your expected revenue for the coming years
- Copies of your Article of Incorporation (if applicable)
- Explanation of what your business does
In addition to evaluating the documents above, lenders may also consider the average income for your industry and other factors to assess your default risk.
In today’s tighter lending environment, self-employed borrowers should be diligent about preparing their financial paperwork and may need to adjust expectations about the size of their mortgage.