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Updated
While self-employment represents freedom and flexibility for a growing number of Canadians, it comes with some drawbacks. Chief among them is the difficulty in obtaining a conventional mortgage. In this guide, we’ll explore an increasingly popular alternative: the self-employed mortgage.
Securing a mortgage involves submitting detailed financial information to a prospective lender. That includes your assets, debts, credit background, and – most importantly – your income. These loans are built for traditionally employed people who make a consistent annual salary.
But for self-employed people who run their own business, meeting these requirements can be difficult. Business owners usually deduct as many expenses as possible to keep their taxes low, but this has the unfortunate side-effect of lowering their official income. Mortgage qualifications that would be fairly easy for people with traditional employment to attain can thus be out of reach for the self-employed.
Enter the “self-employed mortgage” – a home loan designed specifically for people who are self-employed. These mortgages can have more flexible income guidelines and document requirements than a conventional mortgage.
You’re considered self-employed if you’re a business owner – whether you’re a partner or the sole proprietor. In other words, you make money by securing your own contracts directly from clients and are not paid by an external employer. This can include people who work in commission sales, as well as freelance creative workers, farmers, etc.
Mortgage lenders verify self-employed income with a variety of strategies. They may consider Line 150 of your income tax filings for the past two years, which reports your income directly. And for some self-employed people, this number is high enough (even after-tax deductions) that no other form of income verification is necessary.
In most cases, however, the lender will end up considering additional documentation to verify your income. This can include your Notice of Assessment, bank deposit slips, customer invoices, and other internal corporate financials.
In the eyes of your lender, there are two distinct income channels to consider: The first is your personal income as a self-employed person, and the second is the income of your business itself.
Your personal taxable income is how much the business “pays you”, so to speak. In some cases, this may be an officially designated term – i.e., the salary you make as a business partner. The income of your business may be different (and much larger) – it’s the total revenue brought in by your business. A self-employed mortgage may consider both of these numbers to better understand your financial picture and your ability to make consistent mortgage payments.
One mortgage option for self-employed people is the “stated income” mortgage[JS2] . This means you simply state your income and do not need to provide documentation to prove it. The stated income must be reasonable – i.e., generally aligned with your industry – but beyond that, there are almost no documentation requirements.
Note that “stated income” mortgages are seen as highly risky and thus carry much greater down payment requirements for you, the borrower (often 35% or higher). They also have much higher interest rates, meaning they cost significantly more over the life of the loan. Stated income mortgages are not available from any of Canada’s “big six” national banks. To attain one, you’ll likely have to deal with a broker or private lender.
Mortgage lenders can be divided up into three categories: “A Lenders” (i.e. Canada’s major banks), “B Lenders” (which are smaller and more loosely regulated), and private lenders, which are even smaller and unregulated.
The major banks (A Lenders) offer the lowest interest rates. They’re also the most selective, meaning they turn down mortgage applications. B Lenders are less selective but can have higher interest rates as a result. And private lenders may be willing to lend to those even B lenders would not for a chance to profit. Their interest rates are the highest, ranging from 7-18% – an incredibly high cost over the life of the loan.
If you’re considering a self-employed mortgage, it’s essential to understand that requirements vary tremendously between different lenders. That said, here’s a rough guide to the guidelines you can expect:
Like any complex financial decision, the question of whether to get a self-employed mortgage is a very personal one. Many different factors could push you in one direction or another. While you’ll need to do your own research and weigh these factors carefully, here are a number of things to consider:
The total amount you can borrow for a self-employed mortgage varies greatly by lender. Some lenders cap their total self-employed mortgages at $500,000 and up. Some have no policy on the upper limit and will make discretionary decisions. These company-wide policies are determined by the lenders themselves and can change at any time.
In any case, how much you can borrow will always hinge on the financial specifics of your situation. That includes your annual income, the size of the property you’re purchasing, your credit, and so on.
Here are some questions you may have about self-employed mortgages.
Bank lenders look for 2-3 years of self-employment history to qualify you for a self-employed mortgage. Less regulated lenders may be more flexible and allow less than 2 years of history.
Lenders typically look at net income during the mortgage qualification process. This can pose a problem for self-employed people, who typically lower their net income for tax purposes by deducting as many legitimate business expenses as possible. Some lenders who issue self-employed mortgages are willing to look at other financial documentation to ascertain your financial stability.
Even if you’re a self-employed borrower, you may be able to access low interest rates. It depends on how high your income is, how much debt you’re carrying, how good your credit is, and a number of other factors. If your overall financial picture is strong enough, you can qualify for a mortgage from the A lenders (i.e., Canada’s major banks), which typically offer the lowest interest rates available.
The answer to this question depends on what kind of mortgage you’re applying for. A self-employed mortgage is probably not available to you. As we discussed above, most lenders will want to see at least two years of self-employment history before issuing your self-employed mortgage.
If, on the other hand, you’re applying for a traditional mortgage, your income from the previous two years as a traditional employee may be sufficient for lenders to be convinced of your earning power. As always, it depends on which lender you’re dealing with, how large a down payment you can afford, and how much you’re willing to pay in high interest rates.
A stress test is a tool that lenders use to ensure that you’ll still be able to afford your mortgage if the economic situation changes. It requires a little bit of math, but the gist is that you calculate what your mortgage would be if interest rates were set significantly higher, at the so-called “qualifying rate.” If you can still afford the loan at that elevated rate, you pass the stress test
To determine the qualifying rate for your stress test, add 2% to whatever interest rate your prospective lender has offered you. (For instance, if a bank is offering to finance your mortgage at 4% interest, add 2% for a total of 6%.) Now compare that number to 5.25%, which is a benchmark pegged to official Bank of Canada rates. Whichever of those two numbers is higher (6% in our case) is your qualifying rate.
Now you’ll need to prove that you can afford your mortgage at that 6% rate. If so, you have passed the stress test and can proceed with your mortgage.
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