Navigating Mortgages for the Self-Employed: Tips and Insights

Embarking on the journey of homeownership as a self-employed individual comes with its own set of challenges. From navigating income documentation requirements to understanding lender criteria, there's much to consider. We'll delve into key insights and tips to help self-employed individuals successfully secure a mortgage and achieve their homeownership goals.

Understanding Income Documentation Challenges:

Many self-employed individuals are tempted to minimize taxable income through legitimate deductions, resulting in lower reported earnings. However, this practice can impact mortgage eligibility, as lenders typically base their assessments on reported income (Line 1500) rather than gross income. Claiming low take-home pay may lead to higher interest rates or even difficulty qualifying for a mortgage.

If you choose to write off as much of your income as legally possible to avoid paying taxes, and claiming low take-home pay, you will end up paying a higher interest rate on your mortgage. – i.e. home buyer is a tradespersons, they earn $70,000/year and legitimately write off their business expenses to $40,000/year on Line 150 of their tax return. Lenders use income from Line 1500, not gross income to determine affordability. – Some lenders allow you to “gross up” your declared taxable income (as opposed to stated income) by adding up to 15%. – i.e. if your declared income on your Notice of Assessment (NOA) is $40,000, the lender could add 15% for a total of $46,000. In most cases, this doesn’t help the business owner, as their income is still too low to qualify for the mortgage they want.

 Adapting to New Mortgage Rules

Recent mortgage rules require a more rigorous assessment of self-employed applicants' income. Lenders now consider factors such as industry sector, business type, and employment history to determine the reasonableness of stated income. Working closely with professionals like bookkeepers and Chartered Professional Accountants (CPAs) can help navigate these complexities and ensure accurate income reporting.

Documenting Income for Mortgage Applications

A robust documentation portfolio spanning two to three years is crucial for self-employed borrowers. Here are four major requirements that all lenders will typically request: 

• Lenders may require 2-3 years of  T1or NOAs to verify your income, including the self-employed income reported as business income. The NOA is also used to see if you owe unpaid taxes. Lenders will consider unpaid taxes a red flag, and the CRA could eventually register a lien against your home or seize assets if you cannot pay the unpaid taxes.  
• Articles of Incorporation, Business Number Registration, or GST/HST Account Number. These provide the lender information about the length of time you have been self-employed or been running your business. Articles of incorporation are limited to corporations only.  If you make more than $30,000 in a quarter of an entire calendar year or the previous 4 or fewer fiscal quarters as either revenue or gross sales, you must register for a GST/HST number.
• Bank statements from your business account can serve as additional proof to solidify your business income claims. Future income from signed contracts can also be included, even if they have yet to be completed. 
• Financial statements can also be used to prove business income. This is especially useful during non-traditional income verification, where you want both your personal income and business income to be considered by the lender. 

These documents help demonstrate income stability and financial responsibility, increasing lending options and access to competitive rates.

Tips for a Smooth Mortgage Application Process

- Prioritize debt repayment to improve mortgage eligibility and affordability.

- Maintain good credit habits to enhance your chances of loan approval.

- Consider increasing your down payment to mitigate lender risk.

- Explore the option of having a co-signer if needed to qualify for a mortgage.

- Work closely with a mortgage broker specializing in self-employed mortgages to access a broader range of lending options and navigate complex requirements.

Exploring Alternative Financing Options

If conventional lenders are hesitant to approve a mortgage based on stated income, self-employed individuals may turn to private mortgage lenders. These lenders offer alternative financing solutions tailored to the unique needs of self-employed borrowers. Working with a knowledgeable mortgage broker can help identify suitable lenders and secure financing that aligns with individual circumstances.

CMHC Self-Employed Mortgage Insurance

OSFI requires borrowers seeking prime lending with down payments of less than 20% to purchase default mortgage insurance in Canada. CMHC self-employed borrowers who can verify their income get the same treatment as traditional mortgage borrowers regarding insurance premiums, mortgage premiums, and qualification criteria. 

The basic CMHC requirements are as follows:

• Maximum purchase price/lending value must be below $1,000,000.
• Maximum loan-to-value (LTV) of 95% or down payment as low as 5% for the initial $500,000 and 10% for the remainder of the home’s assessed value
• At least one borrower must have a minimum credit score of 600.
• A maximum amortization period of 25 years
• Maximum Gross Debt Service Ratio (GDS) of 39% and maximum Total Debt Service Ratio (TDS) of 44%

The major difference between private mortgage insurance and CMHC mortgage insurance is the income verification required by CMHC for self-employed individuals. 

CMHC requires the following to verify the length of business operations:

• Income tax returns (NOA)
• Business credit reports (if incorporated)
• GST returns
• Active business account statements (if incorporated)
• Financial statements and a Review Engagement Report signed by an accountant (if incorporated)
• Business license and/or articles of incorporation
• Audited financial statements (if incorporated)

CMHC also requires the following to verify income:

• NOA, accompanied by T1 General 
• Proof of Income (POI) 
• Statement of Business (T2125)

Additionally, if you have been self-employed for less than 2 years or in the same line of work for less than 2 years, CMHC may require the following additional supporting documentation to determine eligibility:

• Proof of acquiring an established business
• Sufficient cash reserves
• Predictable earnings
• Previous training and education
• Demonstrated history of managing credit
• Previous employment documentation is based on the type of income.
• Recent account statements
• Business documentation
• Signed contracts.

Securing a mortgage as a self-employed individual requires careful planning, documentation, and strategic decision-making. By understanding the challenges, adhering to best practices, and seeking professional guidance, self-employed borrowers can successfully navigate the mortgage process and achieve their homeownership dreams. Remember, perseverance and informed decision-making are key to unlocking homeownership opportunities in the self-employment landscape.