Talking more about your mortgage questions!
In this video, Chris Molder, a Toronto mortgage broker, sits down with Lawrence Mak to talk about getting a mortgage when self-employed.
What do I need to know about getting a mortgage when self-employed?
The process of getting a mortgage when self-employed is a bit different than traditional mortgage applications. It’s important to remember that you always have options.
Don’t feel like watching? Find the full transcript below!
Are you an entrepreneur and looking for more information about getting a mortgage when self-employed? This post is for you!
Lawrence: [00:00:00] Hey everyone Lawrence Mak here, real estate broker out of Mississauga, I’m pleased to be joined again by Chris Molder from Tritak Mortgages. Hey Chris!
Chris: [00:00:08] Hey Lawrence, nice to see you again. Thanks for having me.
Lawrence: [00:00:12] Yeah, no problem. Nice to have you here. Today, we wanted to talk about getting a mortgage when self-employed. This seems to be an issue for some of my clients when they’re looking for a place and depending on the qualification, just wanted to go right to the source and ask Chris, what’s going on? You know, if you’re self-employed, what is it that we need that’s different than a regular employee?
Chris: [00:00:35] Yeah, good. Good question, Lawrence. There are certain challenges around qualifying self-employed borrowers. And really the focus of qualification is on trying to determine what is because there are two numbers. When you’re self-employed, there’s what your actual income is. If we were having a drink at a bar post covid, we might have a conversation about what your income actually is. And then there’s another number that you show to Revenue Canada, and those numbers are different.
Income looks a bit different than traditional employment income
So mortgage lenders treated the same way. And there there’s really a fork in the road when it comes to qualification for self-employed borrowers. The starting place is to determine what your personal taxable income is. So a mortgage lender will focus on what’s called line 150 of your tax returns. So they’ll look at it over a two-year period to average it out over that the last 24 months. And based on that taxable income, they will qualify you on that number.
Lawrence: [00:01:50] 150 again is the gross amount that comes in before tax?
Chris: [00:01:54] That’s a gross taxable personal income. . So that is the number that you will pay income tax on as an individual.
Lawrence: [00:02:04] So look at that line 150 on your return.
Chris: [00:02:07] That’s right. That’s right. But that line 150 if your self-employed represents your income after write-offs. So for most people who are self-employed, actually for all people who are self-employed, that net number that you pay taxes on is significantly less than what your true Take-Home income might actually be. And so then the focus turns to what the actual income is of your business. And of course, businesses can operate in many different ways.
There are also different types of self-employment
You could be a sole proprietorship or operating as a sole proprietor. You could be an independent contractor, which is like being a sole proprietor. You’re basically business for yourself and have to do your own deductions and you can also run income through a corporation. Right. And so then the focus of the application will turn to that gross revenue amount. So when you’re self-employed, as a sole proprietor that’s captured in your statement of business activities, or if your commission and your statement of commissions are also sole proprietors will have it on the statement of business activities as well.
So you’ll have a top line, your revenue and then with your accountant, they’ll do all the deductions, home office, your vehicle, etc. There will be a net number that then translates into your personal taxable income and mortgage lenders when looking at that, understands that individuals who are self-employed write off a lot of their personal expenses. So there’s a method where we gross up a portion of the income to capture some of those write-offs.
Corporation structures look a bit different
Chris: [00:03:57] OK, if it’s through a corporation, then the structure is very different. So the corporation you may have you may see yourself as a salaried employee, so you may be T4ing yourself. The other method is to pay yourself a dividend from the retained earnings at the end of the year. So there are many different ways that you can pay yourself back. So at this point, now we have to figure out what is actually showing because if we break the market into two major buckets, bucket A and bucket B, A lenders will focus on that line 150 number or something close to it.
We really have to demonstrate in your tax returns that you’re earning the income and the A lenders will focus on that. And the benefit of working with an A lender is that you get the best rate, best terms and conditions, no additional lender fees. And that’s where most people want to be. But most self-employed. People don’t want to show the income, they want to save money in taxes, right. So they may not show a very strong number in that case. We then have to focus the conversation on what the cash flow is and demonstrate that to the lender and only B type lenders. What we would quantify is B lenders would be willing to be that pragmatic and pragmatic in their approach to considering your self-employed income.
Grossing up your income as a self-employed individual
Lawrence: [00:05:26] Ok, so you’re talking about grossing up for the self-employed people. How exactly does that work or what? I guess how much more can I get from my stated gross income?
Chris: [00:05:37] Right. So it’s typically 15%. If your line 150 is one $100,000, then the lender will allow us to gross up to $15,000 of line 150. Therefore, you could potentially confirm to the lender that your income is 150.
Lawrence: [00:05:57] Ok, so just a little bit more of it. Yeah. I mean, 15% could be good.
Chris: [00:06:02] Yeah, it can, it can push the boundary a little bit. But again, most self-employed individuals don’t want to show that income. So it’s very, very challenging. And so it’s an interesting conversation because on the one side, you either pay taxes and qualify for a low-interest rate or you save you get more efficient with your taxes. And not that you’re doing anything illegal or untoward, but you’re more efficient with your taxes. So you lower your marginal tax rate, but you have to pay a higher interest rate.
Claiming less income might mean paying a higher interest rate
Right. And so there’s that tradeoff. And of course, everybody that I talked to obviously wants the lowest interest rate. But when you consider that you can be self-employed, save money in taxes, and yes, you have to pay a little bit higher and interest rate, the offset of that makes it better and more efficient for you to actually take a mortgage with the lender. So the higher interest rate, you pay more overall, but it’s much cheaper than what it would cost to pay taxes on $150,000of income or $200,000 of income.
Lawrence: [00:07:15] Yeah, that makes sense. So going back to the corporation, then, basically, the corporation pays out just a T4, Would the banks just treat that as a regular salaried employee at that point?
Chris: [00:07:25] Yes, they yes they would. But because it’s not arm’s length, you would have to be self-employed this way for at least two years so that the bank on average about.
Does business health matter?
Lawrence: [00:07:36] Now, Would the bank take into consideration the health of the corporation?
Chris: [00:07:40] They would yeah. So if we can produce strong business statements, business financials, showing retained earnings, because a lot of small businesses, it’s a hobby, right? Money flows. There may not be much in terms of retained earnings, but if we can demonstrate consistent retained earnings and you are 100% shareholder, then the bank will consider that as additional income. Yes.
Lawrence: [00:08:08] Ok, so that would be favourable as well. And how do spouses factor in this?
Chris: [00:08:13] Yeah, so are you talking about income splitting?
Lawrence: [00:08:20] More like if you’re like a self-employed person, but maybe your spouse has a job somewhere that they consider from a bank point of view, like two separate entities, and you add up the amount of mortgage room?
Chris: [00:08:29] That’s right. That’s right. Yeah. So if your spouse is working a salaried position, then that salary would be used. 100% business as usual for salaried individuals is much easier. All we need is a letter of employment and paystub to confirm income so that income would be separate. Then there’s the self-employed income added together to get your household income.
Lawrence: [00:08:55] I see. And are there any other advantages other than employment or from a corporation point of view that can help in terms of making the numbers look better?
You will need to prove your income, but you have options
Chris: [00:09:04] The numbers are what the numbers are. The lenders in general, mortgage lenders do not take anybody’s word for anything. You need to show all the statements and everything. So it’s hard. But there are other types of income that can be added to an application rental income if there’s a rental property. One big one that a lot of borrowers will take advantage of is candidate child benefits. So the CCB payments can be added to the overall household income as well, which is really convenient.
Lawrence: [00:09:43] So if you have the situation, maybe a corporation lends you money or something like that, does the bank look at that more or less favourably or it doesn’t really matter where that particular money came from or you don’t know?
Chris: [00:09:53] Yeah. If they’re lending you money, then that’s not income. Right. Because it needs to be returned. So income really is from income-producing activities. And so it’s either a salary paid or a dividend if it’s flowing through a corporation.
Lawrence: [00:10:12] And you mentioned before that the banks probably look at the last two years, do they go any further than that or basically two years, like pretty much all the time? Is that 90% of the time that’s the case?
Is it always two-years of records?
Chris: [00:10:21] Yeah, it’s almost exclusively 100%of the time that they’ll use the most recent two years. If there is some extreme circumstance that is affecting numbers, they might consider 3. And I think in the context of 2020 and the pandemic, yeah, many businesses were affected. And so it’ll be interesting to see in 2021 and even beyond because it’s going to really beyond 2021 that lenders maybe a little bit more flexible with it and say OK, we understand this was an outlier. Your show us pre-pandemic, what your income looked like so that that is a moving target yet to be determined.
Lawrence: [00:11:03] So that depends on each different financial institution?
Prepare to prove two years of income
Chris: [00:11:06] Yes, yeah. But in general, the guidelines of the lender are always most recent two years,
Lawrence: [00:11:14] Most recent 2 years. But again, we don’t know how it’s going to go with 2020. So if it’s like someone makes two hundred thousand two hundred thousand one hundred thousand, like we don’t know or you have to pretty much go back three years and see what they say.
Chris: [00:11:26] That’s right. I think they would consider the strength of 2018 and 2019. One other comment to make about two-year averages is that if your most recent year is lower than the previous year, then the lender will use the lower two-year average. If it’s increasing, the trend is downward, they just use the lower amount.
Lawrence: [00:11:49] So in this case, if they went $200,000, $200,000, $100,000, it would just be $100,000.
Chris: [00:11:54] Correct.
Lawrence: [00:11:54] And then, yes, you’d have to make some cash and then they’d probably rejected. Is that roughly would you make some case?
Chris: [00:12:01] But for example, if 2020 was an outlier, they would ask us to support that, give some argument that 2021, you’re back on track to do as well as you had done pre-pandemic. So sometimes bank statements, invoices, that kind of thing.
Supporting documents will help with the process
Lawrence: [00:12:18] So sometimes then you can always make a case, I guess that the existing trend is good. I mean in just 2020 for any year really that everything looks good. And so here’s the receivables, here’s the whatever. And so then they have to make a case, case by case basis, correct.
Chris: [00:12:35] Yeah. So yeah, they would focus on typically they would ask for maybe 6 months of bank statements for the business and we would have to demonstrate that there’s regular revenue coming in as per the income that we’re reporting or claiming that you earn.
Lawrence: [00:12:50] So what happens then if the corporation is very new in this case? Let’s just say three months, six months. You know you don’t have two years of financial statements. What do they do or do they have to wait 2 years?
Chris: [00:13:01] Yeah. And I mean, it’s difficult. So that’s where we turn to the B option and B lenders will be a little bit more practical with it. Typically, they would like to see at least six months of banking information for your business to demonstrate that you are earning the income and we can project forward with them earning the income that you claim you are earning in the application.
Lawrence: [00:13:28] Ok, so basically sounds like a lot of A lenders have certain rules and formulas they’re trying to follow and the B lenders just really looking for some profitability, I guess. And so they can make that assessment on a case by case basis on whether or not they’re at risk.
Different lenders have different appetites for risk
Chris: [00:13:42] That’s exactly it. And they consider the overall picture. You know, if it’s a new corporation, for example, three months. What were you doing previously? Is it the same line of business? Were you switching from sole proprietor to new corporation? Are common things or people who are in it? Right. Right. You’re if you’re in the IT industry very often, you can go from salaried I.T. to independent contractor I.T. If you’re a contractor in construction, you could switch between being sole provider into a corporation at a certain point. Very common. Or realtors now.
Lawrence: [00:14:20] Yeah, for sure. Now that realtors can incorporate some of the banks, look at the net worth of the person who’s borrowing or do they not care and they’re just trying to figure out how much to lend you.
Chris: [00:14:30] Generally, no net worth is not a major consideration. The main consideration from a bank’s point of view is debt servicing. They want you to demonstrate that you have the income coming in to support the payment obligations that you have in your life. So that’s mortgage payment, property taxes, condo fees, if it’s applicable, and then servicing your other debts so they don’t care.
Lawrence: [00:14:54] You have a million dollars cash in the bank. Your question to me is that you want to borrow a mortgage of $500,000. And I’m trying to figure out how to justify that using the salary, is that right?
Net worth isn’t always a strong factor
Chris: [00:15:04] That’s correct. That’s where the focus is. Having said that, though, there are some lenders and banks that have specialty net worth programs where we can demonstrate certain thresholds. You can qualify for a mortgage based solely on net worth or I shouldn’t say solely in part with net worth. You still have to have income coming in, but the net worth can help to mitigate. That is not common and it’s not widely spread in the industry. It’s very niche product.
Lawrence: [00:15:32] Ok, I guess I’d have to be a somewhat high net worth individual or family.
Chris: [00:15:37] Yeah, definitely. Definitely, yeah. If the minimum is you need to have at least $250,000 liquid in order to be considered.
Lawrence: [00:15:50] Well, I think those are the questions I have here. Do you have anything else that you can add or is that pretty much everything you got?
Chris: [00:15:56] No, I mean, when it comes to self-employed, it can be a little to navigate through the questions can be a little bit challenging. And so for anybody who considering getting a mortgage when self-employed or wondering what their application will look like, I would invite them to get in touch with myself or any mortgage broker who can guide them through that conversation.
You have options when you’re self-employed
Lawrence: [00:16:17] Yeah, sounds like it has to be done on a case by case basis, because depending on the corporation or sole proprietorship or partnership, you know, everything is a little bit different. And so you need somebody like yourself to look through all the numbers and just get a better sense of how to help.
Chris: [00:16:31] That’s exactly it. The door is always open to anybody. And we’ll I’m sure we’ll include a phone number here, email address at their website every year.
Lawrence: [00:16:42] So what’s the best way for people to reach you?
Chris: [00:16:45] So you can find me at Tridac Mortgage – That’s my website, my cell phone number for 167328020. Call with confidence. I’m always here now.
Lawrence: [00:16:59] Sounds great. So if you guys have any questions about getting a mortgage when self-employed and just need to pick his brain, just give Chris a call.
Lawrence: [00:17:05] And again, I’m Lawrence Mak, real estate broker in Mississauga. See you later.
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