If you’re among the 2.7 million Canadians who are self-employed, then your income may not be as easily documented as someone who’s traditionally employed. Since 2008, mortgage regulations in the US and Canada have made it more challenging (but not impossible) for those who work for themselves to qualify for a mortgage due to tighter restrictions on “stated income” loans.
Here’s what you need to know about income verification and documentation for self-employed borrowers.
What’s a “Stated Income" Mortgage?
Prior to the US housing bust of 2008, many lenders in the US and Canada offered “stated income” loans, where borrowers could qualify for a loan based on the amount of income they claimed to earn without producing a paper trail to verify that income. Small business owners often claim as many deductions as they can to lower their taxable income, so “stated income” mortgages allowed them to essentially have their cake and eat it too – qualifying for a mortgage even on a small taxable income.
However, the US mortgage crisis raised concerns about this practice and whether it allows people to borrow more than they can actually afford. New regulations in both countries have made “stated income” loans less common. Two years ago, Canada’s Office of the Superintendent of Financial Institutions introduced Guideline B-20, which requires federally regulated banks to evaluate applications for residential mortgages and home equity lines of credit with more scrutiny.
Options for Self-Employed Applicants
Some Canadian banks still offer “stated income” mortgages. If you’re trying to secure a “stated income” loan for a half-million dollars or more, it becomes more difficult.
Under B-20, some lenders will only lend two-thirds of the property’s purchase price, so you may need a down paymentof 35 per cent or more (compared to the typical minimum of just 5 per cent). Some lenders will allow a “stated income” loan with as little as 10 per cent down, but this is rare and your income must be considered reasonable.
Many lenders will use an online salary estimation website to see what would be reasonable salary for someone in that type of work and with that level of experience. Business deductions lower a self-employed borrower’s taxable income, so in some cases, they might “gross up” your declared taxable income (as opposed to stated income) by adding up to 15 per cent. For instance, if the declared income on the Notice of Assessment (NOA) is $50,000, the lender would use $57,500. In many cases this doesn't really help the business owner, as their salary is still too low to qualify.
While a few lenders still offer "stated income" mortgages, it's helpful to have a large down payment and/or a paper trail documenting your income and sources. Earlier this year, CMHC stopped insuring self-employed mortgages without third-party income validation. However, Genworth and Canada Guaranty will still insure these mortgages up to 90 per cent of the property’s value (in other words, you’d need to put down a minimum of 10 per cent).
For self-employed borrowers, being able to document income for the past few years will give you more lending options without requiring a down payment larger than 10 per cent.
Here are some of the documents your lender may request:
- Proof that you have paid HST and/or GST in full.
- Personal and business credit scores.
- Personal tax Notices of Assessment (NOA) for the past two to three years.
- Financial statements for your business prepared by an accredited accountant.
- Contracts showing your expected revenue for the coming years.
- Copies of your Article of Incorporation (if applicable).
- Explanation of what your business does.
On top of reviewing the documents above, lenders may also consider the average income for your industry and other factors to assess your creditworthiness. Given today’s lending environment, my advice to self-employed borrowers is to be diligent about preparing any paperwork that could help verify income, building up a good-sized down payment, or both, if possible.