It’s hard to know exactly how many Canadians are self-employed because more and more of us are every time you check. At the end of 2015, 2.76 million Canadians were self-employed—more than 15% of the labour force—according to Statistics Canada.
It’s probably more than that by now. About half a million Canadians enter the ranks of the self-employed every year. Pinpointing a precise number is also a challenge because of the definition of self-employed is so vague. Self-employed people might be running their own businesses, have professional careers, be freelance, be on commission, run their own farms, or have other entrepreneurial vocations of various kinds. We do know from Statistics Canada data that this group has a higher median income and net worth than paid employees.
As this contingent of the self-employed grows, lenders still haven’t figured out how to make it easier for them to obtain a mortgage (and sometimes the best mortgage rates). In fact, it’s become more complicated. At the end of 2014, the Office of the Superintendent of Financial Institutions (OSFI)—the country’s banking regulator—introduced Guideline B-21, which requires federally regulated banks to look more closely at self-employed incomes before approving a mortgage application.
“For borrowers who are self-employed, a FRMI [federally regulated mortgage insurer] should outline reasonable steps for lenders to obtain income verification (e.g., Notice of Assessment) and relevant business documentation. In determining the reasonableness of the documentation used to support the income, sound practice suggests that:
- The income amount is verified by an independent source;
- The verification source is difficult to falsify;
- The verification source directly addresses the amount of the declared income; and
- The income verification information and documentation does not contradict other information provided by the borrower in the underwriting process.”
Under Guideline B-21, a federally chartered bank can only lend 65% of the purchase value of the property to the self-employed—10 percentage points less than previously allowed—before requiring mortgage default insurance. As an alternative, some credit unions—which aren’t federally regulated an therefore don’t need to follow Guideline B-21)—may lend up to 80% without the need for default insurance, though often at a higher interest rate.
Lenders want to be sure that you will be able to pay your loan back. They basically assess you based on three factors: Income, net worth and credit score. Your financial stability is easy enough to prove if you have a job. As an employee earning a salary you can show your T4 slips, a letter from your employer showing how much you earned, and a few recent pay stubs. If you don’t have a boss you don’t get a T4 slip, making it harder to verify how much you make and whether or not that income is sustainable.
Self-employed workers typically obtain their mortgage through stated income applications, which require a signed income declaration and proof of self-employment. Stated income is how much you claim to earn. And for the lenders sake, you’ll need to back it up with the following documents:
- Your income tax returns and notices of assessment for the previous two to three years. Try not to show a loss for the previous two years. You don’t have to show a big positive income but a loss tends to be a deal-killer;
- Your Notices of Assessment from the Canada Revenue Agency to confirm you have no tax liability. Keeping up your tax payments shows your reliability;
- Proof that your HST and/or GST is paid in full;
- A copy of your business license or articles of incorporation showing you’re licensed;
- Financial statements for your business. You have to ready to explain your business—your income, expenses, and when you’ll break even;
- Proof that you are a principal owner in the business;
- Client contracts showing expected revenue for the coming years; and
- Have a down payment available of at least 15%.
As well as being able to prove your stated income, your lender will look at your debt service ratios to qualify you. The debt service ratios calculate how much you can afford to pay monthly to own a home. Also, you should have a good credit score. If you’re not sure what your credit score is, check with the credit bureaus, Equifax and TransUnion. They can tell you your score or clear up any mistakes. Pay down your credit cards and lines of credit before you let the lenders score you. For self-employed individuals, it’s important to have less debt than someone who is salaried.
Mortgage insurer Genworth Canada, further classifies the self-employed as commissioned sales, corporations, partnerships and sole proprietorship, with nuances of qualification for each. Sole proprietors or owners of unincorporated businesses can benefit from incorporating because then you can pay yourself a salary and you get the same consideration as any other employee.
The primary difference between self-employed (or commission-based positions) and salaried employees is that lenders will treat your gross earnings differently. As a rule of thumb, a lender will only consider 80% of gross earnings as well as the average of last tax year’s income for commissioned sales people. For self-employed individuals, net income (instead of gross income) is the yardstick. A lender is restricted by Canada Mortgage and Housing Corporation rules to use only the last three years of self-employment income.
Certain lenders may allow you to add back some tax deductions to your income, like car expenses, advertising, capital cost allowances and housing expenses. Other lenders may agree to simply add a percentage to allow for business expenses.
Having a spouse who’s salaried helps to reassure the lender and he or she can co-sign to instill even more confidence. Having another co-signer is also an option. But remember, a co-signer gets title ownership to the property as well so it has to be somebody you really trust.
For the self-employed, the path to homeownership may seem pitted with land mines. But preparation, the help of a knowledgeable mortgage broker, and perseverance can clear the way.
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