Self Employed Mortgage Can Be Complicated (but this mortgage guide will help simplify and guide you to mortgage success)
If you are a business owner, a contractor, or an entrepreneur who wants to buy a home or refinance a home and is trying to get approved for a mortgage — this up-to-date mortgage guide is for you!
First, there is no better time to be self-employed!
With the convenience of the internet and the rise of the Gig Economy, it’s now easier than ever to be your own boss.
There are many perks of being self-employed, like:
- earning potential
- tax benefit
However, getting approved for a mortgage is not one of them. It can be a hassle and complicated.
This is why we have produced our the Self-Employed Mortgage Guide.
It’s harder for self-employed borrowers to qualify for a mortgage due to the following reasons:
- As a business owner, you may choose to keep money the company to reinvest into the business. You may also write off a lot of expenses. This means your income will look a lot less than what you actually make.
- Unlike a salaried employees, the earning of a business can fluctuate. Therefore, it is difficult for a lender to assess your income level.
- You may also have certain cash income that’s not accounted for.
As a result, self-employed borrowers often cannot get qualified for a big enough mortgage to meet their needs. That’s why we are here to help! First, let’s look at how Banks qualify self-employed mortgages.
How do banks determine income for self-employed?
- Standard Income Programs Offered by Banks: This is the personal income you report. The lender will look at the income reported on your T1 general. If you pay yourself a salary, the lender will use the 2 year average of the income on your T4 slip. If you pay yourself a dividend, the lender will look at the line 120 on your T1 General, averaging for the past 2 years. These are referred as “Standard Income”, i.e. if the income your reported is deemed enough to cover your mortgage payment, you are good to go! See this article for how much you can afford as a homebuyer.
- Stated Income Programs Offered by Banks: This option allows you to use more than the reported income on your tax return to qualify for a mortgage. If your personal income on your tax return is not enough to cover your mortgage payment, the lender will also look at the overall profitability of your business to determine the actual “usable income”. The lender usually looks at your business tax returns from the past two years, GST/HST returns, and bank statements. Lenders will typically “gross up” the income reported on your personal tax by 15% to qualify for the mortgage. Some lenders allow you to “gross up” more if you have 35% down payment or higher. However, each lender’s requirement and risk tolerance may be a little different.
How much income is “enough” to qualify for a self-employed mortgage with Banks?
- Lenders use Debt Servicing Ratios to assess whether your income is “enough” to cover your mortgage payment
- Gross Debt Servicing (GDS) and Total Debt Servicing Ratio (TDS) and are the two commonly used metrics by the lenders.
- GDS is your monthly mortgage payment, property tax, and heat, divided by your monthly income
- TDS is your monthly mortgage payment, property tax, heat, and other debt payments (credit cards, car loans, etc.), divided by your monthly income
- The general rule used by lenders to determine eligibility is to ensure GDS<35% and TDS<44%.
- Sometimes a lender may be willing to go up to 49% TDS. The upper limit of the ratio varies depending on the lender and the overall strength of your application. You want to use an experienced mortgage professional who understands the merits of each lender’s self-employed mortgage program and can help you present a strong business case.
- Some B lenders allow your GDS and TDS to go up to 60% of your verifiable income.
- Below is a screenshot from the official website of the Canada Mortgage and Housing Corporation on how to calculate TDS and GDS.
How to Qualify for a Mortgage Using Business Deposits/Cash Flow Only?
Yes, you can use your business deposits/cash flow to qualify for a mortgage, as opposed to how much you report on your tax return. It’s called “self declared” income. It’s a program offered by B Lenders.
How does Self Declared Income Program Work? (B Lending)
As indicated by the name of this program, you declare your own income rather than follow the numbers on your tax return. Here are the steps to calculate the income you can use.
- Step 1, we need to add up the business deposits based on your 6-months bank statement to get to your gross income of the past 6 months.
- Step 2, we annualize your gross income by multiplying the gross revenue of the past 6 months by 2
- Step 3, we will take out the key business expenses to get to your net income
How Much More Mortgage Can You Qualify with the Self Declared Income (B Lending)?
Steve is a licensed electrician who owns a contracting company. His business is incorporated. He reports $70k income on his tax return after all the write offs, but his company makes more than that.
a. Gross Revenue: Steve deposited $200,000 service revenue into his bank account in the past 6 months. In this example, his gross income of the past 6 months is $200k. To annualize it, we need to multiple it by 2 to get to his annual gross revenue, i.e. $400k.
b. Business Expenses: Steve’s main expenses are materials, office, and car expenses, which add up to about $280k.
c. Self Declared Income: Subtract Steve’s Business Expenses from his Gross Revenue, you will arrive at the Self Declared Income you can use on your mortgage application. In this example, Steven can use $400k -$280k = $120 (a-b=c) as his gross income.
If Steve applies for a mortgage at a bank, he will only be able to use $70k as his income to qualify for a mortgage (he may be eligible for 15% gross up of the $70k, ,which will increase his income to $80.5k). Assume Steve has no other debt, he will be able to qualify for a mortgage around $350,000-$400,000.
To qualify for a bigger mortgage, we can help Steve get approved with a B Lender by using $120k as his income. B Lenders also allow you to have higher income ratios. It means with the same income, B Lenders allow you to carry a bigger mortgage payment. In this case, Steve will be able to qualify for a mortgage around $900,000 to $1,000,000. Big difference if we compare the amount Steve can qualify with a Bank vs. a B Lender.
What are the B Lending Terms and Interest Rates for Self-Employed Mortgage
B Lender interest rates for self employed mortgages are typically 0.5% to 1% higher than Banks. However, sometimes it can be quite comparable. Take November 2021 time period for an example, many banks are offering 2.6% – 2.8% for 5 year fixed interest rate. B Lender rates are around 2.6% to 2.9% for self-employed borrowers with a strong profile. B Lender rates many vary based on your credit score.
B Lenders offer 1 to 5 year terms, with options to choose 25-year or 30-year amortization. 1 year term is the most common for B Lender mortgages.
B Lenders do charge s 1% lender fee at the time of mortgage closing. It’s a one-time fee that will not be charged again at renewal.
What Else May Be Asked by B Lenders?
Many B Lenders require you to fill out a “Self Declared Income Letter” and create a “Business Case” for self-employed mortgage applications. Some also call it “lender notes”. These are rationales submitted by your mortgage advisor to argue why your mortgage should be approved. Sounds complicated? Don’t worry, we have experienced Mortgage Advisors who specialize in self-employed mortgages. We are happy to guide you through the process.
To help you be more prepared, here are some elements usually included in a business case for a self-employed mortgage:
- Details of the business operation, such as industry, time since incorporation, location, business license, how do you advertise to get new clients, business website, etc.
- Invoices – B Lenders may ask 3 or more sample invoices matching bank deposits
- Expenses – B Lenders may ask for receipts matching the expenses filled out on the “declared” form you submitted
- The gross business revenue and cost structure supported by financial statements
- The amount of liquid assets, such as stocks, GICs, and other investments the borrower or the business holds
What Documents Do I Need to Provide to B Lenders for a Self-Employed Mortgage?
Here are some of the common documents required by lenders.
The documentation requirements differ from lender to lender and are subject to
- T1 Income Tax Return for the most recent 2 years
- Corresponding Notice of Assessment (NOA)
- Business Tax Return for the most recent 2 years
- Financial Statements for the most recent 2 years
- Article of Incorporation
- Business License (if applicable)
- GST or HST returns (if applicable)
- Business Credit Report (if applicable)
How Much Down Payment Do I Need?
It depends on the type of income you use to qualify for your
mortgage and the property value. We summarized the minimum down payment
required under each scenario below:
|Income Used||Property Value||Minimum Down Payment Needed|
|Standard Income (per personal tax return)||< $1 Million||5%|
|Standard Income (per personal tax return)||> $1 Million||20%|
|Stated Income – B Lenders||Any Value||20%|
|Stated Income – Banks||Any Value||35%|
To Sum It Up
Now you probably get the picture – that it’s not easy for a self-employed borrower to qualify for a mortgage with the big banks.
Further more, many lenders change their lending criteria based on government policy changes and their changing risk tolerance.
Effortless Mortgage works with all types of self employed borrowers. We also provide our own in-house private mortgage lending (with $0 broker fee) – not restricted by income or credit verification – if that’s the only option at this time with a plan to move our clients from private lending to subprime or prime lending in a year or two. It’s a win-win.
We welcome you to speak to one our Senior Mortgage Advisors – no obligation – to learn more…
We take the time to thoroughly understand your situation and your business.
Let us help you present a strong business case to multiple lenders to get you the best mortgage!