Statistics Canada shows approximately 15% of the labour force is self-employed. This will continue to rise with our changing economy. Lenders are definitely paying attention and many are moving towards filling this niche. Recently CMHC (Canadian Mortgage and Housing Corporation) announced more support for the self-employed, but we still need more time to see how this will be implemented by lenders.
Self employment can come in various structures, like sole proprietorship, limited partnership, commissions, incorporated. Verification of self-employed income is a bit more complex than salaried or hourly income. In general, the easier it is to verify the income, the better the rate category. Each additional interpretation of income raises the risk for the lender, and is more work to review, hence the possible bump in rate.
General list of self-employed income verification, shown in order of complexity
1. For sole proprietors and limited partnerships, using the lesser of the prior year or 2 year average of net self-employed income reported on taxes.
2. Using the above, but applying ‘gross up‘ (typically 15%, but could vary) or an ‘add back‘ of eligible deductions.
3. For corporation, reviewing past 2 years audited financial statements and using what is reported on your personal income taxes, for example dividends or T4 income. But it has to make sense, you can’t pay yourself more than you make. Or may use ‘add back’ of eligible deductions shown on the financial statements.
4. Lenders like to see consistent or increasing income, any significant drop in most recent year may need an explanation. Not necessarily a deal breaker, but you need to tell your story.
5. Supplementary documentation to show proof of business tenure, like articles of incorporation, business license, HST registration. Ideally, as noted above, minimum 2 to 3 years existence.
6. The income verification may resort to reviewing typically 3, 6 or 12 months worth of business bank statements. This is done, for example, when there is a cash component to the business, you need to rely on your most recent income rather than a 2 year average, or you have been in business less than 2 years. This review is case by case, and a common sense approach is used. What income is accepted and what expenses are deducted is discretionary to the lender, but in general, it is a more forgiving approach.
7. Lenders apply a ‘reasonability test’ on the income you submit with your application. They compare to what is typically expected from your industry.
8. In lieu of submitting tax returns, a lender, in addition, can ask for a ‘self-declared income form’ to be signed. This also may include a declaration that you have filed taxes up to date and do not owe any income taxes or taxes greater than a specified amount (like $2000, but this varies).
No income verification means lenders are relying on the property equity alone. This is private lending territory.
Mortgage planning tips for self-employed borrowers
Do your taxes, submit on time and pay your taxes.
Have at least a 2 year history, if you can.
Have good records: financial statements, bank statements, tax returns, business licenses, articles of incorporation.
Lenders like consistency and stability. Varying income, especially decreasing, needs an explanation.
Decide what is more important, tax benefits of self-employment or recording higher income on tax return for the purpose of fitting into a more conventional mortgage product. Remember also that mortgage rules are always changing.
Building up your documented income from new self-employment takes some years and planning, that is why a conversation with a mortgage broker should be started early in the process, so you know how to best execute you plan. Consultation with your accountant and lawyer should also be done at this time.