Why it’s harder for self-employed to get a mortgage

Self employment is more common, but banks are more cautious about giving mortgages to people who fall into this category Although it is still possible for self-employed to get a good rate, there is a few more hoops to jump through.

Where mortgage applicants with steady, salaried jobs can document their annual income with a T4 slip, the self-employed — entrepreneurs, small business owners and freelance professionals with a changing clientele and no regular paycheque — are assessed based on stated income, or the amount the borrower claims to earn, which they must prove with tax returns, contracts and financial statements.

There is not a lot of verifiable pieces of paper that substantiate income, so the bank or mortgage broker is going to have to do more due diligence to gain comfort about their numbers.

Self employment is becoming more common these days as economic upheaval leads to job losses and career reinventions. Banks, nevertheless, approach these customers with caution.

The banks consider it a riskier proposition with the self-employed, compared with somebody who has a regular paycheque.

Before the federal government tightened up mortgage rules last year, lenders would assess the risk level of a self-employed borrower based on that person’s credit-rating and the size of their down-payment. They’d also factor in the applicant’s savings, debt repayment history and whether their business had healthy cash-flow. If it all made sense and sat well with the underwriter, they would move forward with the file.

New mortgage rules mean the assessment of a self-employed applicant’s income has become far more rigorous. Lenders will now analyze the average income for the industry a self-employed applicant works in, and study the person’s employment history and earnings in the field. The stated income needs to be reasonable based on the industry sector, the type of business and the length of time the operation has been in business.

Banks are scrutinizing the tax documents of self-employed applicants more carefully, and focusing more closely on the expenses being written off — the cost of a vehicle or of advertising, for example — and how this might explain discrepancies between the applicant’s stated income and how much they end up reporting to Canada Revenue Agency (CRA). Mortgage brokers must understand and explain to the lender’s underwriter how the client’s income shifts from, say, $80,000 to $40,000 (on your their return)? The client must provide us with your business financials to show what they’re writing off.

Although there may be more people self-employed these days, it doesn’t mean lenders will be making it any easier for them to secure a mortgage. The banks unfortunately haven’t figured out a system on their end to help them navigate through (self-employed peoples’) issues.

Tips for applying

Applying for a mortgage is no picnic for the self-employed. Here are a few tips to ensure the process goes smoothly:

Get your finances in order. Pay down debt. Debt-service ratios are a major factor in a loan-approval assessment. Maintain good credit. You don’t want to be an avid credit-seeker taking on every credit card under the sun. Consider bumping up your savings to make a larger down-payment. If a self-employed person has liquid assets in the bank that they’re keeping for a rainy day, it might be the time to use them. If you run into difficulty, having someone co-sign for your mortgage might help sway the lender. Just remember: a co-signer gets title ownership to the property as well.

Prepare supporting documentation. Have on hand two to three years’ worth of notices of (tax) assessment, which show your reported income, how much tax you owe and what you’ve written off. Provide three years of T1 General tax returns. You’ll also need your business license, articles of incorporation and financial statements that (ideally) show a steady flow of cash into your business. Use client contracts and work-orders to demonstrate sources of revenue.

Stay consistent. Lenders prefer that self-employed folks who work in a business that’s tried and tested, and have expertise in the field.  The same goes for residential history; it doesn’t look good to lenders if you’ve lived in 10 different places over the past two years. The idea is to show consistency and stability. That helps us offset and mitigate “risk” the lenders may perceive.

To Your Wealth

Gord

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