As of 2014, Canada had 2.75 million people who were self-employed; a pretty big number for a country whose population is significantly less than that of California. Added to that, last year’s numbers from Stats Canada show there are 1.14 million small businesses (1-99 employees), with 176,014 in BC alone. And yet, despite the fact that many of these individuals have a higher median net worth than those who are working for someone else, many are running into a number of problems obtaining a mortgage.
Rules of Engagement
If you’re a Canadian who owns your own business, there are a few things to consider before you march out to get that mortgage. The first is that the rules have changed (for everyone) as of February this year. Home buyers are now required to set down a 10 per cent down payment on the portion of the price of a home above $500,000. This may seem like a steep price tag, but in Vancouver and Toronto – the two markets the new regulations were meant to temper – half a million is pretty standard. With two-thirds of small business owners earning less than $73,000 a year, it is crucial not to overextend yourself – not only so that you have adequate income to qualify for a mortgage, but also to ensure you have money to reinvest in your business.
As a small business owner, you do have other options such as stated income or grossing up your income to qualify for a mortgage. The key is reasonability and if you are stating your income, you should be able to show the extra income you are claiming to make whether that be in retained earnings in the company or your investments.
We all know that even the uncreative among us can get pretty imaginative income tax time. Traditionally, self-employed workers had a pretty easy time lowering their taxable income by increasing expenses as much as possible. (Witness the birth – and death – of the Stated Income mortgage, in which borrowers qualified solely on the amount they declared on a stated income form). Although it is still possible to get this type of mortgage, approvals are much sparser and the process is more challenging.
This type of problem can be avoided by ensuring you have a solid paper trail that includes:
- accountant-prepared business financial statements for the last 2 years;
- business license documentation;
- accountant-prepared personal T1 general tax returns;
- most recent Notice of Assessment and proof that taxes have been paid;
- corporate bank statements that illustrate your current cashflow (not necessary, always a good supplemental document); and
- bank statements showing regular incoming income.
Do Not Owe Taxes!
Capable of hurting you much more than not having any of the above ducks in a row, owing taxes is to lenders what the death rattle is to the Grim Reeper. If you do owe taxes, pay them off immediately.
Know Who Your Friends Are
With many lenders feeling a bit panicky after the introduction of the B-20, credit unions and some monoline lenders represent a much stronger option for small business owners and self-employed borrowers. Depending on your credit, and the way your business is registered (ie, sole proprietor or incorporated), some lenders may be able to add anywhere between 15 and 20 per cent to your total income as a way of “adding back some expenses.”
If you are issuing a T4 to yourself as an employee of your company, the lender will use whatever income you are reporting. Given that a two-year average is consistent or increasing, you may be able to qualify for a mortgage with as little as five per cent down payment, even as a small business owner, so long as the property purchase is under $500 000.
There are Options – But Reasonability is Key
Even though a traditional source may not fund your mortgage, there are alternative solutions. Stated income is a possibility but the emphasis stands on reasonability. Your lender would look at what an average salary for someone of similar experience would be. You also cannot be stating your income higher than the gross business income.
Other options may income alternative lending. Being self-employed could potentially mean quite a bit of tax savings, which should be taken into account when a higher rate mortgage is offered to you. Most small business owners are still better off paying the higher rates/fees vs what they would have paid in income tax.
Bottom line is that the best rates are for those who are income qualified and are reporting their income, but if you look at overall savings (taxes and all), self employed borrowers are also getting a pretty good deal.