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Provable vs. Stated Income

Your guide to understanding the difference between stated and provable income mortgages

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Written by Alexandra Bosanac

Provable vs. stated income mortgages

For many Canadians, homeownership can greatly improve your financial security and psychological well-being. But for the growing number of self-employed small business owners, homeownership comes with an extra hurdle: qualifying for a mortgage. In this guide, we’ll explore why the mortgage game is stacked against small business owners and how a stated income mortgage can help level the playing field.

Mortgage basics and why income matters

When buying a house, most people only pay a small portion of the total cost upfront. This is called the down payment and the minimum in Canada that’s required is 5% for amounts under $500,000, 10% for those between $500,000 and $1 million, and 20% for those more than $1 million For the remainder, the homebuyer takes out a long-term loan called a mortgage. This means a lender (such as a bank) covers the rest of the home cost. The borrower then repays the lender based on the loan’s term, with five-year terms being the most popular in Canada. Payments are based on loan amortization, with longer amortization periods having smaller payments. Twenty-five years is the most common amortization length in Canada.

The buyer also pays the lender interest on the loan, which is determined by the mortgage rate set during the term. Interest rates determine how much money you’ll spend over the life of the loan. A home mortgage with a slightly lower interest rate could save you tens or even hundreds of thousands of dollars over the time you spend paying off your mortgage.

So how do mortgage lenders choose which customers get their best interest rates? They rely on a variety of signals to ascertain your “trustworthiness” as a borrower. After all, if a lender believes you’re more likely to default on your loan payments, they consider financing your home a higher-risk venture – and they charge more to compensate for that risk. Of all the signals that banks assess, income is one of the most significant. And this can spell trouble for small business owners.

The tax trap for small business owners

If you run your own business, you’re likely diligent about itemizing and deducting your legitimate business expenses. Generally speaking, this is a very savvy financial move. It shelters you from taxes by lowering your reported net income (as listed in line 150 of your tax return).

Unfortunately, a high net income is exactly what lenders want to see when they’re considering you for a mortgage. The more expenses you report, the lower your net income falls, and (in the eyes of lenders) the less qualified you are for a low interest-rate mortgage. To be fair, this isn’t just a problem on paper. The money you’re spending to run your business can’t also be used to pay your monthly mortgage premiums!

For salaried employees with traditional jobs, this isn’t a concern. They may pay a higher overall tax rate than a small business owner, but their greater net income allows them access to the very best mortgage rates. This is what “provable income” means: They can simply present a mortgage lender with pay stubs and other financial documentation proving their annual salary. Small business owners have to take another approach. Enter the “stated income” mortgage.

“Stated income” mortgages: what are they?

A “stated income” mortgage is one in which the borrower simply states their income, providing little or no documentation as evidence. As long as the stated income is roughly aligned with industry standards (i.e. the borrower’s claim makes sense given the type of work they do), the lender takes them at their word. These mortgages typically carry a high interest rate – i.e. 5.99 - 14.99% (if not higher), with 2-3% in lender fees (up to 5% in some cases).

Today, major lenders are no longer willing to qualify you for a mortgage simply because you report a large income. Instead, you’ll need to work with a private lender.

Between the stated income mortgage and the traditional, fully qualified mortgage, there’s a third option: the “non-traditional income confirmation” mortgage. In this scenario, the lender will still verify your income, but they’ll do so using alternative documentation. Rather than strictly looking at your declared income, they might review your bank statements, transaction records, customer invoices, and so on. This option will give you lower interest rates than a “stated income” mortgage, though not as low as a conventional mortgage. The required down payment may also be higher than for a conventional mortgage.

Three major mortgage types for small business owners

See the three major mortgage types suited for small business owners.

Mortgage type

Down payment required

Interest rates

Documentation needed to apply

Conventional, fully-qualified mortgage

5-20%

2-4%

  • Notice of Assessment (NOA) from the Canada Revenue Agency to demonstrate that you have no tax arrears.
  • Proof of self-employment, such as your business license and articles of incorporation.
  • Full tax return for the last two years with accompanying T1 Generals. Note that your total income as reported in Line 150 will be the key factor.

Non-traditional income confirmation mortgage

10-20%

Depends on lender, but generally higher than conventional mortgage rates

  • Notice of Assessment (NOA) from the Canada Revenue Agency to demonstrate that you have no tax arrears.
  • Proof of self-employment, such as your business license and articles of incorporation.
  • Documents showing the financial activity of your business, including corporate financials, bank statements, and invoices.

Stated income mortgage

20-35%

7-18%

  • Notice of Assessment (NOA) from the Canada Revenue Agency to demonstrate that you have no tax arrears.
  • Letter stating your income. Your income must be reasonable for the industry in which you work and the total mortgage amount for which you’re applying.

Which mortgage is right for you?

For self-employed Canadians, the lowest-rate borrowing option is always going to be a conventional, fully-qualified mortgage. If your Line 150 income, averaged over the past two years, meets your lender’s qualification threshold, then you’re in luck: As long as you meet the other qualifications (e.g. good credit, manageable debt, etc.), you will likely qualify for the mortgage. Just like a conventionally employed home buyer with an equivalent salary, you’ll have access to low interest rates and smaller down payment mortgages.

If you cannot meet the income requirements due to tax deductions lowering your net income, a mortgage with non-traditional income confirmation is likely your next best option. This alternative allows you to present invoices, bank deposit slips, and other internal financial documents from your company, thus demonstrating greater financial liquidity than your tax returns would have suggested. Again, these mortgages tend to require greater down payments and have higher interest rates than their conventional counterparts.

If neither of the above options are available to you, the next best alternative may be a “stated income” mortgage. The only documentation required is a letter in which you state your income and a Notice of Assessment from the Canada Revenue Agency proving that you have no tax arrears. These mortgages are only offered by private lenders (i.e. not major banks). They carry much higher interest rates and require much greater down payments than the two options described above.

Is a stated income mortgage worth it?

As we’ve discussed, stated income mortgages tend to be costly. They often require a 35% down payment, and can carry interest rates up to 18 percent. This is a much greater financial burden for you, the borrower, which reflects the greater risk perceived by the lender in backing your mortgage.

Does this mean stated income mortgages are a financial mistake? Not necessarily. The question borrowers need to ask is: What are my alternatives?

If you’re currently renting an apartment, you’re not building equity. Your rent payments go away and (obviously) never come back. But when you’re paying down a mortgage – even if it takes a long time to do so – you’re building equity in a home. Eventually, you can cash in on that equity by selling the home, or leverage it to finance business expansion, among many other options. In the long run, these strategies may be much more lucrative than continuing to rent.

It’s also important to note that Canada’s housing market has grown by about 6% annually for the past 15 years. If it continues to grow (which is not guaranteed), your home equity becomes even more valuable over time. This is why homeownership has long been seen as the key to financial prosperity for so many Canadians.

Ultimately, the question of whether to take out a stated income mortgage is a very personal one. It hinges on many factors, including your current housing situation, your savings and debt, your ability to raise funds for a down payment, and the growth prospects for your business. But despite their relatively high cost, a stated income mortgage may be a healthy and positive part of that financial picture

Will I need mortgage insurance?

In some situations, you will be required to get mortgage insurance (a.k.a., mortgage default insurance). This is an insurance policy that protects your lender in case you ultimately default on your mortgage and can no longer make payments.

To maintain your insurance, you’ll need to make monthly premium payments in addition to your mortgage payments and any associated costs and fees (e.g., property taxes). This can end up adding several hundred dollars per month to your housing costs, so it’s important to plan for it in advance. Calculate your mortgage payments to get a better idea.

Typically, mortgage insurance is required for all high-ratio mortgages. (This simply means that you’re borrowing more than 80% or more of the home’s value.) The Canada Mortgage and Housing Corporation (CMHC) writes insurance policies for many Canadian homeowners, but this agency is not an option for stated income mortgages. The two insurance companies which will insure your stated income mortgage are Sagen and Canada Guaranty.

Note that your mortgage insurance policy will require much of the same financial documentation needed for your mortgage application. You’ll need to show a certain level of income, a minimum credit score, a reasonable debt level, and so on. And remember: The higher the down payment you make, the lower your insurance premium percentage will be.

What other criteria do I have to meet for a mortgage?

Here are some requirements you may encounter, both from the lender that issues your mortgage and the agency that issues your mortgage insurance (if necessary):

  • Total debt service ratio (TDS): The TDS ratio is a measure of your total debt (how much you’d owe annually in your mortgage payments, property taxes, credit card debt, child support, etc.) to your gross annual income. Many lenders look for a TDS in the 32% to 42% .
  • Credit score: Good credit is another requirement for many lenders, though they draw the cutoff line in different places. For some, it’s as low as 600. For others, the benchmark is 680.
  • Home value: Some agencies will only insure homes up to a certain value. The Canada Mortgage and Housing Corporation, for instance, places the ceiling at $1 million.
  • Stress test: To qualify for a federally regulated bank loan, you’re required to pass a so-called "stress test". This is the government’s way of ensuring that you’re capable of affording the mortgage. The specifics of the stress test are a little complex and vary depending on the value of your home and the size of your down payment.

A crucial thing to understand about mortgages – whether stated income or traditional – is that every lender has different requirements. The most stringent standards are upheld by the so-called “A Lenders”, otherwise known as the “big six” Canadian banks. These are National Bank of Canada, Royal Bank of Canada (RBC), the Bank of Montreal (BMO), Canadian Imperial Bank of Commerce (CIBC), the Bank of Nova Scotia (Scotiabank), and Toronto Dominion Bank (TD).

As we discussed above, meeting the high standards of “A Lenders” will allow you to secure the lowest interest rates and smallest down payment requirements. So called “B Lenders”, and the private lenders beneath them, have looser requirements and costlier mortgage products.

In other words, don’t worry too much about whether you can meet these requirements upfront. There are many different lenders with flexible terms who may still be able to finance your home on a “stated mortgage” basis. Connect with an accountant and some prospective lenders today and see what offerings are available.

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