Being self-employed has its pros and cons: you may have a more flexible schedule, but you also have a lot more responsibility, especially when it comes to managing your own finances.
According to Statistics Canada, 2.76 million people were self-employed in 2016. And with the swelling ranks of the self-employed, you’ll likely find many lenders are weary of handing out money to those who don’t fit their idea of the “perfect borrower” with a steady, predictable income. Banks and lenders are not always too fond of risk, so as a self-employed borrower, you’re going to have to convince them that lending to you isn’t as risky as it seems, and that you can pay your debts on time.
1. Apply before you quit your day job
First and foremost, if you still have a 9-to-5 job, you may want to apply for refinancing or that personal loan or that auto loan or that mortgage before leaving your current position. It’s relatively straightforward to get approval for a loan when you have a regular paycheque, but if you are self-employed, things are more complicated.
For those who are just starting out on their self-employed journey, you may not qualify to take out a loan for the next two years. So if you know you’ll need credit readily available for your new business, apply now before leaving your stable job.
2. Be prepared to show two years’ worth of income
Before lending to you, lenders typically want to see two years of tax returns to prove your income. From there, they’ll usually take your average income over the past two years to decide how much they can credit you.
Even if you recognize that your business is taking off and your income has recently increased by a significant amount, this may not be reflected on your tax returns yet. Or if you have a contract from a client showing guaranteed revenue in the near future, lenders won’t always take this into account.
This makes qualifying for a loan difficult for those who have just become self-employed or for those who are maybe in the midst of reinvesting their income to grow their business.
In addition, lenders may also want to know more about your business before handing you a loan. They may request things like a balance sheet, income statement, earnings and revenue statement, or a report of your expenses. This will give them a better idea of your financial prospects.
So if you’re self-employed but want to buy a home in the next two years, be prepared to work a little harder and maybe write off fewer expenses – anything to help increase your income and make lenders more likely to approve your loan.
3. Or you may qualify to show stated income instead
When getting a mortgage or other loan, there is an option to declare what’s known as stated income. In this case, a lender will allow you to simply tell them how much you make instead of proving your income with two years’ worth of tax returns.
However, this may only apply if you were in the same profession for the two years prior to you becoming self-employed. Lenders will then typically estimate the average income within that profession to determine your income. Stated income, however, is a more complex way to prove your income, and not every lender is willing to accept this as proof.
4. Prepare yourself for higher rates
Because you’re not the traditional borrower, you may also have to pay a higher interest rate on your loan since lenders see you as a bigger risk.
Also, if you are taking out a mortgage and require mortgage default insurance because you don’t have a 20 per cent down payment, you will likely have to pay more for that too.
The Canadian Mortgage and Housing Corporation offers different rates for self-employed individuals who can prove their income, or private insurers like Genworth offer coverage and rates for those who borrow using the stated income method.
5. Work towards making a larger down payment
If you are currently looking to buy a home, you could potentially avoid the hassle of mortgage default insurance payments by increasing your down payment to 20 per cent.
Lenders are also more likely to provide flexibility and approve a mortgage or auto loan if you increase your down payment. There are also some banks that offer simplified mortgage approval for business owners and self-employed individuals if they provide an even larger down payment of 30 per cent or more.
6. Opt to work with a mortgage broker
If you are having a hard time getting approved for a mortgage or loan, it may be time to look into working with a mortgage broker. They know which lenders are more likely to approve you for a self-employed mortgage based on your particular situation.
7. Protect your credit score
If you’re planning on taking out a loan or getting a self-employed mortgage, having a good credit score is critical. This means making all of your payments on time, not using too much of your available credit, and doing other things that will help improve your score. This will boost your chances of getting approved for a loan at a reasonable rate, as lenders will see you as less of a credit.