When it comes to taking out a mortgage, once a bank finds out you’re self-employed, the rules change.
This is the challenge Jim Colta* (not his real name) has faced every time he has tried to buy a house. And it’s only getting harder.
“My son, who is 25, bought a house a year and a half ago when he was working for me,” says Colta, who has run his own kitchen and bathroom renovation business since 1987. “He sold that house and wants to buy a new home. But now he is self-employed and he can’t get approved for a mortgage, even with a large down payment.”
According to Statistics Canada, 2.76 million Canadians, or 15 per cent of the workforce, are self-employed. With losses in full-time jobs, the desire for better work-life balance and millennials who simply want more flexibility, that number can only be expected to rise.
Mary McFarlane, a mortgage broker in Hamilton, says that prior to federal changes in mortgage rules in 2012, self-employed individuals could qualify for a mortgage with what they stated as their income, along with a credit score over 680 and a Notice of Assessment showing they did not owe taxes.
But in the summer of 2012, the Office of the Superintendent of Financial Institutions introduced Guideline B-20, which requires federally regulated banks to tighten the requirements for approving mortgages and home equity lines of credit. Banks must now examine incomes more carefully before approving a mortgage application.
McFarlane says a self-employed individual who owns a company must show a certificate of incorporation, three years of financial reports prepared by an accountant and two years of personal tax returns. A sole proprietor must show a business licence, two years of most recent personal tax returns prepared by an accountant and most recent two years of Notice of Assessments and business bank statements.
“You also need proof that your down payment has not been gifted. So a minimum of three months’ bank statements are required to confirm an accumulation of savings from your own resources,” says McFarlane.
Self-employed individuals can still apply for a mortgage at some banks but can borrow only 65 percent of the purchase value, which is 10 percent less than was allowed before B-20. If you have less than 35 percent of a down payment with a stated income, you must purchase mortgage default insurance.
Dustan Woodhouse, a mortgage broker in Coquitlam, British Columbia, says B-20 was introduced to protect us from ourselves, when we arguably did not need protecting.
“Canada has a 0.27 percent arrears rate. And that just means missing two mortgage payments in a row. Our actual default rate is much lower. Canadians don’t miss mortgage payments,” he said.
“But they want to see your personal income. I have a client with a $2.5 million clear title on a home, half a million dollars in the bank and impeccable credit. But she is collecting a $60,000 pension so she won’t qualify for a mortgage. Equity lending is gone. They will not give you one dollar unless you can show you have the income to make the payments.”
That is the biggest stumbling block, according to Colta, because self-employed workers usually lower their taxable income by maximizing business expenses and personal deductions.
“A lot of self-employed people write off everything they can. So what happens is you make $100,000 a year, but you are discounting gas, insurance, meals, work boots, whatever you can do to get your income down to as little as possible,” he said. “So maybe $100,000 becomes $50,000.”
Woodhouse agrees. “Your accountant’s job is to minimize your income. But the more creative the accounting, the more unlikely you are to qualify for your mortgage.”
So what’s a small business owner or freelancer to do?
Here are some tips:
Have a two to three-year plan to buy a house. In that time, write off fewer expenses or draw a higher income from your business to show you can meet mortgage obligations.
Set your finances up through a certified accountant.
Plan with income in mind. Rethink any extended holidays or sabbaticals within the two years prior to purchasing, as this will decrease your two-year average income.
Consider an alternate lender, such as a trust company. You will generally pay a two percent higher interest rate and a higher down payment but may be able to qualify for a mortgage.
You may want to use a mortgage broker, as no lender offers a carbon copy of policies. A broker will know which lenders are doing what and how your file might get approved.