Self-employment financing brings several questions to mind, and we will provide answers for often-asked questions in this article.
Business-for-self persons find frustration when the many write-offs they receive also, in effect, lower their overall income.
Often, the conversation surrounding alternative mortgages compares the taxation rate with the bank’s mortgage rate, when in fact, the tax rate should be compared to the interest rate, when looking at the larger picture of saving money.
The following tips will help you maintain your self-employed status, while finding either a traditional or private mortgage lender suitable for your situation.
Problems Faced by Self-Employed Borrowers
When looking at private lending, we should first consider some of the pitfalls of traditional borrowing.
With almost 3 million Canadians happily positioned as their own boss, they are also unhappy once they learn that their loan application has been denied because lenders see the instability of their income as a credible risk.
The variables involved with managing one’s business – sales, contracts, business costs, etc. are seen as unpredictable when compared to the stability of a fixed income.
Lenders, however, are becoming much more accepting of the independent contractor, particularly as most business owners are simply directing their business expenses towards their taxable income to reduce it.
How to Secure Your Self-Employed Mortgage
Typically, the varied income of the self-employed individual disqualifies that person from meeting the criteria to obtain a mortgage loan. Fortunately, there is a solution in the non-traditional path. If you are a full-time or part-time business owner and have owned your business for two years or longer, you may qualify for such a mortgage, as a Sole Proprietor, Partnership or Corporation.
Self-employed mortgages are like other more traditional loans in that they may be variable or fixed or may be arranged for varying term periods. The choice to make a down payment of 20% or higher or pay a premium is up to the borrower. Generally, you will pay a higher premium with private lenders than with standard financing. This will be added to the mortgage amount and paid off along with your mortgage payments.
A self-employed individual may find that a mortgage broker with experience can be very beneficial when applying for a mortgage. Mortgage brokers can connect you to trustworthy private financial institutions and lenders that specialize in providing financing to the self-employed.
The Self-Employed Mortgage Application
A traditional mortgage, though a relatively straightforward process, requires proof of employment income, bank statements and a reasonable credit score to gain approval. For self-employed persons, the process of applying for a mortgage is slightly more complicated so patience will be your friend!
More documentation is required for self-employed loans as they are seen as riskier investments. The ability to make payments must be evident from the documents submitted to the lender. The following items are some of the documents that a lender may request as proof of responsibility:
· Financial statements related to your business income.
· Notice of Assessment or “NOA” from the past two or three years. (You will have a better chance of receiving the same mortgage rate pack as a traditional borrower by providing your NOA).
· Personal credit score and history.
· Proof that your personal tax returns are paid and up-to-date.
· Proof that you are the principal owner of your business.
· Some lenders might also require contracts proving expected revenue.
· GST license or Article of Incorporation for your business in Canada.
· Some stricter lenders might request proof that your down payment was income-based and not a gift.
Sound Advice for Self-Employed Borrowers
Before applying for a “freelance” mortgage, it is necessary to own your business for two years, minimum. This is not a guarantee of a success but will greatly improve your chances of acceptance.
It is imperative to keep detailed and accurate records of your income and contract history. Often, business owners choose to pay for business expenses out of their income, thus decreasing their pay for income tax purposes. This can work but it can also give a misleading impression to potential lenders that your income may not cover your mortgage loan payments. Quality accounting of your records will show that you are responsible and capable of meeting your mortgage requirements.
These documents are permitted by the CMHC (Canadian Mortgage and Housing Corporation) as proof of your net income to your lender:
· Pay stubs
· T4 slips
· Copy of your Federal Tax Return
· Business statement of professional activities known as a T2125
· Proof of income statement from the CRA (Canada Revenue Agency)
Filing these documents every year is highly recommended as it will not only be advantageous for your tax return but any potential home loan applications down the road.
A solid credit score between 690-900 goes a long way to show you are capable and willing to pay off your loans. A good way to improve your credit is by taking out a conventional loan such as a car loan or a credit card and making the required payments on time each month. It is also important to not carry too high of a debt load. For example, if your credit limit on a card is $10,000, it is best not to leave the amount owing hovering close to the maximum of $10,000. This shows that perhaps you do not have the ability to take on further debt.
Ideally, it would be great to have a 20% down payment to show financial responsibility and to avoid paying for mortgage loan insurance. Default insurance premiums can add between 2.8% and 4.0% of the purchase value to your mortgage. Saving money for a down payment can be tough but, if you are not under any time constraints, it is to your overall advantage.
How Can a Private Mortgage Lender Assist a Self-Employed Business Owner?
Put simply, private mortgage lenders do not have the same qualification criteria as conventional lenders. Most traditional lenders are most comfortable when the applicant has a consistent, regular source of income. Private lenders are much more flexible and will look at your total income amount, recognizing that often small-business owners actually have higher income than full-time employees of a company.
One more advantage of a private lender is that they generally do not penalize you for a bad credit score, providing you can commit to the down payment and closing costs of the mortgage. This really works in favour of small-business owners.
Lastly…
Don’t hesitate to call with any questions you may have regarding private mortgage lending. Whether you require a home equity, non-resident, or no-income mortgages mortgage product we are here to help find the best solution for you.