Big Banks & Self-Employed Individuals
By: Sarah Colucci, Mortgage Expert
Yes, now read on.
Many self-employed borrowers apply with major banks for mortgage financing but they are turned away because they don’t claim enough income to qualify.
There are advantages and disadvantages to being self-employed, of course, but when it comes to getting a mortgage, the benefit of using tax-write offs to pay fewer taxes can interfere with obtaining the most competitive mortgage interest rates or even a mortgage at all.
Major banks are strict when it comes to using self-employed income. To qualify applicants, they only use the average of the last two years of claimed income and not gross income. Some banks may allow self-employed income to be grossed up by 20 percent, but if the base income being used is already low, this may prove to be uneventful when qualifying for a mortgage.
Therefore, “claimed income” is basically "net income", which means income AFTER write-offs related to running one’s business. Net income determines how much someone will pay in personal taxes and is reported as Line 150 on the T1 General and subsequent Notice of Assessment.
Recently, banks have become more creative in finding ways to service these types of clients. For example, high net worth programs tend to help borrowers get financing if they can prove their net worth is substantially higher than the mortgage they are applying for. Additionally, equity programs are also available for borrowers who have a lot of equity in their property which ultimately helps serve those with a healthy amount of property equity but minimal self-employed (and even pension) income.
Mortgage brokers also have access to these programs and a borrower can still work them to obtain big bank equity or net worth products.
If Big Banks Say No.
Some borrowers stop applying for a mortgage after being declined by their bank while others will go on to apply through the broker channel. In the case of being self-employed, it’s imperative for one to understand that alternative lenders exist for this precise reason: to service those borrowers big banks won’t.
Brokers have exclusive access to alternative lenders that, in most cases, consider and appreciate gross income (with some reasonable write-offs) instead of solely relying on claimed personal tax amounts. This means that alternative lenders can consider bank statements to determine what income is coming through their account over a 12-month period for example, and also rely on a "Declaration of Income", rather than Notice of Assessments.
Therefore, if a person is only claiming $20,000 a year, for example, they may qualify for the financing they desire if they can prove they are, in fact, earning more.
Yes, rates are higher because the application is gauged on risk and having minimal income on paper does partake in this risk.
But how much higher are mortgage interest rates when it comes to alternative lenders?
Considering most self-employed people can use their operating expenses to reduce the amount of taxes they pay to the Canadian Government, a fair trade for *slightly* higher interest rates is in order. We say slightly higher because the mortgage rate can still be comparable to prime rates. For example, if the prime rate is 2.84%, the alternative rate can be 3.69%. - it’s higher but it’s not too much higher.
Some people get confused between a private lender and an alternative lender. A private lender can either be a private corporation, an individual or a Mortgage Investment Company, also known as a MIC. With these lenders, a borrower can expect to pay more than 7%, interest-only, with large fees on both the front and back-end.
Alternative lenders, on the other hand, are still Mortgage Finance Companies that are used on the prime lending side and therefore, are still regulated by the Government. This also means that they will still follow the bond market curve to determine their interest rates which keeps them competitive within the alternative space.
Of course, alternative lenders also determine their interest rates based on the assessed risk of each application they receive which differs from big banks that don’t do this. For example, if you have a credit score of 680 and above, you will get the best rate. If you have a credit score of 600 and lower, the rate will be less favourable. The gray areas are why working with a mortgage broker can make things easier and more understandable and increases a person’s chances of getting the best deal.
What about pension income?
Many borrowers who are on CPP, Old Age Security and work pensions, for example, wonder if they can qualify for financing. Again, I'd like to reiterate, there are many programs that can assist a person with getting the appropriate and desired financing.
As a mortgage professional that works directly with over twenty lenders who are changing their products to accommodate the needs of Canadian mortgage borrowers, I can help you navigate the process.
So, before you start withdrawing RRSPs to fund your living expenses, talk to a mortgage professional.
Sarah A. Colucci
Mortgage Agent Lic. M14000929
Mortgage Edge, Broker 10680
Direct: (647) 773-4849
By: Sarah Colucci