There are a lot of advantages to being self-employed. For one, you’re the boss, so you can decide how much – or how little – you want to work each day. And, if your business takes off, you’re the one who reaps all the benefits. But there are some downsides. One of the most notable is how difficult it can be for self-employed people to qualify for mortgages. Here we look at some of the reasons why, and provide some tips to improve your chances.
The main reason banks have traditionally been reluctant to loan money to the self-employed is uncertainty. Unlike those who are employed by traditional methods, the self-employed, and those who work on a commission basis, don’t receive regular pay or printed T4s at the end of the year. Besides that, their income can be best described as inconsistent. While one month might be exceptionally busy, the next might be unpredictably slow. For this reason, major financial institutions view the self-employed as ‘too risky’ and therefore, often deny them financing altogether. For example, a busy retail shop may gross tens of thousands of dollars in the months leading up to Christmas, but then have income dry up to next to nothing for weeks or months after that. Bankers like to see the numbers in black and white, ideally in the form of ink printed on a bi-weekly paystub.
(That said, I’ve often noted that as freelance writer and editor, I have way more job security than any of my friends and colleagues with fulltime staff positions at magazines and newspapers. How? If one of the publications I work for suddenly shuts down, I lose one of my dozen or so regular gigs, while the staffers lose their one and only job. But the banks don’t buy it.)
More recently, banks have become even more reluctant to consider the self-employed as mortgage material.
Understanding B20, B21 and Changes to CMHC Mortgage Insurance
Nope, those are not bingo numbers. B20 and B21 are new rules implemented by the Office of the Superintendent of Financial Institutions, a federal government agency tasked with trying to tighten Canada’s mortgage market.
B20, unveiled in the summer of 2012, required lending institutions to take a more detailed look at all loan applications. B21, while still open for public review, is a continuation of that process. In short, the two sets of guidelines require banks and other mortgage providers to take a higher degree of scrutiny when assessing applications.
Then, the Canada Mortgage and Housing Corporation (CMHC) followed up with an announcement that, as of May 30, 2014, the federal mortgage insurance provider would no longer provide coverage to the self-employed without third-party verification of income. (At the same time, the CHMC is discontinuing mortgage insurance on recreational and income properties.)
But all is not lost. As a self-employed individual you, and the three million or so other Canadians in the same boat, can still qualify for a mortgage. You just might have to do a little more work to make sure you qualify. First up, get your finances organized long before you start popping into open houses.
Keep Your Credit Pristine
Having a good credit rating is even more important for the self-employed than most. If a previous venture failed and you were forced to declare bankruptcy, or you’re in default on business loans or credit accounts, a bank isn’t likely to lend you any money. Before you apply for a mortgage pay off as many of your outstanding debts as possible, and cancel any unnecessary credit cards.
Fine Tune your Taxes
Next, look at your tax return. You wouldn’t try to cheat the taxman, would you? We certainly wouldn’t encourage it. But if you’re in a largely cash business and not claiming all of it, you’re not only running the risk of facing hefty fines and penalties for tax avoidance, you’re reducing your eligibility as a borrower.
You should speak with your accountant and/or financial advisor about how to legitimately minimize your tax burden, while maximizing your reported income. For example, if you were thinking of splurging on a new car lease or some expensive office equipment just before the end of the year to bring down your taxable income, you might want to hold off on that purchase for now. You’ll pay a bit more in taxes for the previous year but will also show a higher income after deductions. Plus, rather than adding another loan to your credit history, you’ll (hopefully) have additional cash available for that ever-more-important down payment.
Save a Bigger Nest Egg
Finally, deferred leases or purchases aside, the more money you have available for a down payment, the less risky the banks will view you and, therefore, less restrictive the terms will be.
Create a Paper Trail
You’ll need to have a lot of documentation to seal the deal. Typically, bankers will ask for:
- Three years’ notices of assessment to get a sense your average current income.
- You’ll also need to provide proof (in the form of a CRA Statement of Account) showing that your income and GST/HST is paid up-to-date.
- Bank statements from your business account showing regular, significant deposits also help.
Incorporating your business, which would enable you to pay yourself a former salary, may also help put your banker’s mind at ease. But bear in mind that incorporation takes time and money. Incorporation fees alone start at about $1,000, and you’ll incur higher accounting fees to cover the additional filing requirements. Finally, pull together details on all your other assets: RRSPs, TFSAs, stocks, bonds, equity in business assets, and so on.
Look Beyond the Bank
As much as you may get along with the loan officer at your local bank branch, working with a mortgage broker is far more likely to yield you positive results. Each of the big five banks has a limited number of mortgage offerings for the self-employed. A mortgage broker could find you the best fit of any of those, plus has access to a variety of other alternative lenders, who are trained to work with candidates of all kinds, including the self-employed. The more complex the candidate’s situation is, the more it makes sense to work with a mortgage specialist. The self-employed can be excellent and reliable mortgage candidates, but they can also be risky. It’s the job of the lender to carefully assess that risk. Rates, although commonly believed to be high for the self-employed, are always best when risk is lowest.
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How to Lower Your Level of Risk to a Lender
Mortgage lenders want to feel that they have chosen a viable candidate. They want to make sure that you can make your monthly payments, no matter what business is like. Here are some of the things business owners can do to minimize risk, thereby becoming a more desirable candidate in the eyes of mortgage lenders.
- Provide proof of income. Typically, mortgage lenders want to see that you have had a steady income for at least 2 years prior to applying. If you are self-employed, you can do this by providing a 2-year average of line 150 on your tax return. Small business owners often claim expenses, making their income appear a lot lower than it actually is. A good lender will look at the amount you bring in before such claims are made.
- Provide other paperwork, including HST returns, incorporation papers and business registration papers. Your lender may require any number of documents. Make sure that everything is up to date and that you can provide copies, if necessary.
- Have a good, strong credit history. This is necessary for all candidates, but especially true for those who are considered riskier candidates. A good credit score will get you far – and it will get you a better rate. It shows that you don’t have problems managing money and therefore increases your level of desirability as a mortgage candidate.
- Be prepared to make a significant down payment. While 10% is usually acceptable, if you are able to put down 15% or 20% the risk for the lender will decrease making your a more favorable customer.
- Location of the business should be near a busy, urban centre. While it’s certainly not important criteria for every lender, depending on the small business, proximity to a busy, urban centre could certainly play a role in whether or not you qualify for a mortgage. Your business’s location could be thought to determine its busyness.