Historically, sole proprietors and self-employed individuals with a good credit score were approved mortgages from banks, however regulation has changed things for the 2.75 million self-employed Canadians.
A credit score of 680 was enough to apply for a mortgage, and given that those who are self-employed have a higher median net worth than their peers who work for someone else, banks could feel confident in making that loan.
Today’s regulations require self-employed individuals use their stated income to apply for a mortgage if they’ve been working for themselves for three years or less, otherwise they are supposed to use their net taxable income from the business on their applications on the mortgage.
The net taxable income isn’t an accurate reflection of how much the employee made during the year, because typically employees will try to maximize their deductions in order to pay less tax. The stated income is a better reflection of earnings, and it can be obtained with a signed income declaration and proof of self-employment.
Previously, up to 75% of the home’s value could be borrowed without default insurance, but the figure has decreased to the 65% it is now. If you don’t have a 35% down payment, you are required to purchase the CMHC insurance, which becomes an added expense of home ownership. Compared to an individual employed by a business, for a home under $1 million, only a 20% down payment is needed to avoid default insurance.
Improving your Ability to Borrow
Providing your bank or lender with as much information about your business and income is your best chance at convincing them to give you better terms on your mortgage. Explaining business, inventory, and sales cycles may also help them see how your finances change throughout the year. Be prepared to answer questions and assure them of your financial standing. The more information you can provide, the better. They’ll likely add back tax expenses like capital cost allowance and other prepaid expenses in calculating your income.
Another option would be to borrow outside of banks, such as going with a credit union. The legislation B-20 doesn’t apply to credit unions, and sometimes borrowers may be authorized for a mortgage of up to 80% of their home’s value.
As with any financial decision, it’s important to shop around for your best rates! When adding back expenses, some credit unions will give you credit for up to 15 percent to the business’ reported income.
A final suggestion would be to pay yourself a salary, and in order to do so, you would have to incorporate your company. The decision to incorporate shouldn’t be taken lightly, and you should investigate the consequences that such a change would bring. For example, incorporating would lower your business’s tax rates, which are far more favourable than personal tax rates. However, you will also have to pay personal income tax on your salary.
You can get a salary if you’re self-employed, but the process is much more difficult than it is for someone with a traditionally earned income. Research your options before committing yourself to a mortgage to ensure you’re getting the best deal possible!
Clinton Haglund who rose from Toronto in the year 1981. He completed his Masters in Business Administration from Rot man school of management in Toronto. He had a great passion to business and currently he is running a business in Ontario. Clinton has a knack for helping ambitious business people and to determine how they can get more with less by focusing and refining their business strategy and processes. For more updates you can follow him in twitter @clintonHaglund.