Mortgages For Self-Employed Individuals
Did you know that the mortgages available to self-employed individuals are different from those individuals who a company employs? They are offered a different kind of mortgage due to their income, which may fluctuate depending on their earnings per month. If you’re a part of the self-employed community looking for funding to buy a new home, you’ve come to the right place. In this blog, mortgage broker Boychuk Mortgage Group has explained mortgages for self-employed individuals and how they work. Keep reading to learn more.
What is a self-employed mortgage?
Self-employed mortgages are created for individuals who earn self-employment income or business income instead of traditional employment income. This means that their income is different from regular borrower’s income. The self-employed mortgage considers this difference and has a set of requirements unique to traditional mortgages.
Self-employed individuals include sole proprietors, corporations, and partnerships. Self-employed business owners can incorporate their business if they want to for tax benefits. But, remaining a sole proprietorship or partnership also comes with unique tax advantages. These benefits all change self-employed individuals’ income and their tax returns.
Under a regular mortgage, lenders will consider the borrower’s net income after tax. But, for self-employed individuals, their income amount can be artificially low due to the tax deductions and business expenses claimed. Fortunately, a self-employed mortgage allows for flexibility in how the borrower’s income is reported. In certain circumstances, they may not be required to verify their income with mortgage lenders.
Who is considered self-employed?
A person is considered self-employed when they work for themselves by acquiring contracts and serving clients. They do not have an employer and do not earn a fixed wage or salary from a third-party employer. Incorporated business owners are considered self-employed if the corporation employs them as their own, in which they earn a salary from.
Requirements to qualify for a mortgage when self-employed
Traditionally, self-employed borrowers need to provide tax returns (both personal and business), bank statements, business income statements, and other documents for the last two to three years. Additionally, they need to submit proof of income and proof they have been working in the same business during that time.
To ease the pain of acquiring these documents, some alternative lenders follow a streamlined process whereby borrowers can complete a self-employed attestation form in lieu of providing several documents. This form allows their brokers to calculate their self-employed income with less paperwork. For example, to make calculations, only six months of bank statements and three invoices would be sufficient instead of two year’s worth of lengthy documents.
But that isn’t all! To qualify as a self-employed borrower, lenders will look at their income and more closely at their debt servicing ratios, credit scores, and down payments.
The debt servicing ratio helps lenders determine the borrower’s financial obligations and how much they can afford to borrow. Their credit score shows their creditworthiness, such as credit history or timeliness of payments. Finally, their source of the down payment will be scrutinized. Most lenders require 20% or more as a down payment from a self-employed borrower with no default insurance. There are also alternative solutions to those who have less than 20% down.
Challenges faced when seeking a mortgage as a self-employed individual
Based on the details we’re covered so far, it’s pretty clear that obtaining a mortgage as a self-employed individual isn’t as straightforward as expected. There can be different obstacles along the way. Some of the most common challenges include:
1. Difficulty in proving income earned through one’s business.
2. Lenders not understanding that self-employed business owners are motivated to expense as much as possible to minimize taxes payable.
3. Lenders requiring personal tax Notices of Assessment from the past two to three to support the mortgage application. Those who cannot provide this should have a good credit history and provide a minimum down payment of 10%.
4. Additional supporting documentation may also be required for a self-employed mortgage application. For example:
a. Financial statements for the business
b. Personal and business credit score documents
c. Contracts showing expected revenue for the coming years
d. Proof that the borrower is a principal owner in the business
e. Proof that the business HST or GST is paid in full
f. A copy of the borrower’s business or GST license or Article of Incorporation showing they are licensed.
g. Proof that the down payment was not gifted
How is self-employed income verified?
There are three types of incomes considered for a self-employed mortgage. This includes:
- Traditional income refers to income received from employment. It is usually verified through the personal income tax filed by the individual. But it is challenging for most self-employed business owners to confirm their “real” income traditionally.
- With non-traditional income, the self-employed individual’s business financial statements and bank statements can prove their actual income. As a result, this is the most common way to verify the income of self-employed individuals.
- Stated income is also known as “no income verification mortgages.” if an individual cannot verify their income. Anyone can state their income. With stated income mortgages, lenders will not verify the borrower’s income. They won’t consider tax returns, financial statements, or even bank statements. Based on the income you pay yourself from your business, we will be able to top up that income to a reasonable amount, based off the revenue your business shows year over year.
- The stated income should be a reasonable amount as it will be compared to the individual’s industry and business. That said, stated income isn’t promoted as much as it increases the possibility of fraud where borrowers may overstate their income to qualify for large mortgages.
Types of self-employed mortgage lenders
Traditionally, there are two types of mortgage lenders. They are “A” lenders and “B” lenders. “A” lenders are mainly the 6 largest big banks in Canada, as well as credit unions and mortgage finance companies.. Their lending criteria are the most stringent when it comes to mortgages. They require borrowers to pass a mortgage stress test, show good credit history, and maintain a stable income. But they are willing to work with self-employed individuals provided the latter can produce the supporting documentation required. For example, Notice of Assessment for two to three years, financial statements, and articles of incorporation if the business is incorporated.
If an “A” lender rejects a self-employed individual’s mortgage application, they can approach a “B” lender. They are far less stringent with their requirements and almost always provide a viable solution to self-employed individuals. Compared to the big banks such as Scotiabank’s (an “A” lender) with Gross Debt Ratio of 39%, the Total Debt Service Ratio with most “B” lenders traditionally will be closers to 50%. This means the higher the ratio, the less income the borrower must maintain compared to household debt and living expenses.
To apply for a mortgage from a “B” lender, applicants must approach a mortgage broker. This is because these professionals have good knowledge about all of these lenders and their products. Accordingly, they can help borrowers find the perfect lender and mortgage product for their specific situation.
The downside is that as “B” lenders need to bear more risks, they generally charge a higher rate of interest compared to “A” lenders. That rate is generally only about 0.5 to 1.0 percent higher than the A side rate. Additionally, if the mortgage is insured, borrowers can secure a lower rate. Or they can take advantage of a “B” lender loan and then opt for an “A” lender loan once they’ve improved their credit score and collected the relevant documents needed for an “A” lender mortgage. Many times, using an alternative B lender is a short-term strategy to getting you into that A mortgage where you will save money long term. This is why it is important to speak with your mortgage broker who can help you with a strategic plan to helping you secure mortgage financing while saving you as much money as possible.
3. Private lenders
These lenders must be used as a last resort as they charge the highest interest rate. This can be between 7% to 18% of the total property value. They also charge a private mortgage fee, including the broker’s fee. But, as the lenders are not part of the regulated lending market, their approval processes are not as strict as the above two mortgage lender groups. Private lenders usually consider the property value and the borrower’s creditworthiness, along with the equity the borrower has in the property. They are not very strict about the income levels they accept, so even stated income is suitable for these lenders. But, they will use the income stated to determine the mortgage amount the borrower will qualify for.
If you’d like to learn more about self-employed mortgages, reach out to us at Boychuk Mortgage Group. As your dedicated and accredited mortgage broker in Burnaby, British Columbia, we work with well over ninety lending institutions and have access to over five hundred mortgage products to suit your specific needs. Moreover, we know what lenders are looking for and will do our best to help you meet their criteria so that you can obtain the mortgage that you want.