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The rise of self-employment

According to the last census in 2018, over 2.9 million Canadians identify themselves as being self-employed, which represents over 15% of the Canadian workforce. Since 2018, the world has obviously changed a lot too. COVID-19 has forced many Canadians to change the way they work, from job locations to the jobs themselves. As a result, we are seeing a big rise in self-employment across the country.

Self-employment and your mortgage

There are lots of attractive features of being self-employed that have drawn many Canadians in. Being your own boss means you have more flexibility with your hours and work location. You have more freedom with work decisions, and you have the independence to live your own lifestyle.

Of course, self-employment also comes with some risks and uncertainties. 30% of small businesses don’t survive their first three years, and only 50% make it to 10 years. This is often a cause for stress among the self-employed, and not just in terms of their business lives. Many Canadians are also concerned about applying for a mortgage when they are self-employed.

Banks and mortgage lenders are notoriously picky when it comes to qualifying self-employed borrowers, which is why it’s super important to understand your options. Whether you are a commissioned salesperson, a sole proprietor, a partner, or an independent contractor, there's something here for you. Let's explore what mortgage options are available if you fall into the business for self (BFS) category.

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If you're self-employed and applying for a mortgage, you're going to fit into one of two buckets. Bucket number one is what we call qualified business for self, and bucket number two is called stated income business for self. Let's explore each of these buckets separately.

Bucket #1 - qualified business for self

Bucket number one is where everybody wants to be. Qualified business for self borrowers get the benefit of the most favourable rates, terms, conditions, and features of a mortgage from a lender. However, in exchange for those benefits, lenders need to see very specific information from you. Your income for a qualified business for self mortgage is focused entirely on your personal taxable income, not your business income. This is the number you pay personal incomes taxes on and work hard to keep as low as possible.

A lender will ask for a two-year average of your line 150 from your Notice of Assessment. They will use this to determine what your annual income is for mortgage application purposes. However, anybody who is self-employed will know that they want to keep their reported personal income as low as possible for tax purposes. They aim to have as many write-offs as possible or shield as much income as possible in a corporation.

Bucket #2 - stated income business for self

Due to the issues above, the second bucket of mortgage qualification exists, which we call stated income business for self. This bucket takes the focus away from your personal income taxes and instead examines your overall business application and business operation. It recognizes that the lines between personal and business expenses and income are very often blurred for self-employed individuals. A lender will look at your business in its entirety to determine your creditworthiness for a mortgage, so there's a lot more flexibility. But in exchange for that flexibility, there's more risk from the lender's point of view. Therefore, there are higher interest rates and fees that are typically applied to stated income business for self applications.

The thought of higher rates and fees can be unappealing. However, what's worse than higher fees is paying more income tax on higher-income to Revenue Canada. These mortgage fees are worth it to avoid higher income tax, if necessary.

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As you now know, a self-employed mortgage is different from a conventional mortgage. You also know we have both qualified business for self mortgages, and stated income business for self mortgages. Now, we’re going to dive deeper into the documents that are required for a qualified business for self mortgage, and how a lender will determine your income.

Qualified business for self mortgage products

As you learned in the last chapter, qualified business for self mortgage products gives borrowers access to the best mortgage rates, and the most favorable terms and conditions. This makes it a desirable product for self-employed borrowers. Unfortunately, qualifying for this product is difficult because it requires a lot of information and documentation from you. Lenders need to see very specific details to approve you for this product.

How income tax affects your application

The main focus of this application depends almost entirely on your net personal income. Your net personal income is the number you get after you consider all your write-offs and deductions. Obviously, nobody wants to pay more income tax than they have to. However, when you apply for a mortgage, a lender wants to see you pay enough income tax to show you make enough income for a mortgage. This is when applying for a self-employed mortgage becomes tricky. Saving money as a business owner can interfere with your mortgage application.

If you run a corporation, you can pay yourself personally dividend income and perhaps a T4 salary income. If you're a sole proprietor, this income is typically reported on your business activity statement, which shows up in your T1 General. This is a very simple balance sheet that shows the income that you've generated, minus all of your expenses, which will show your net business income.

What documents do you need?

There are two main documents you need to show for a self qualified mortgage application. The first are your two most recent T1 Generals. The second are the corresponding notices of assessment from Revenue Canada. These assessments confirm that the numbers on the T1 General have been reviewed by Revenue Canada, and that your personal income taxes have been paid for the most recent year.

A mortgage lender uses those documents to establish a two-year average of your past income, and decide what a reasonable income is for the current year and for your mortgage application. Now, businesses can have fluctuations, especially as you're building your business, which can present some challenges. That’s why we have the second category of mortgage qualification for self-employed borrowers, called stated income.

Stated income mortgage products

If you’re a self-employed borrower, you might think it’s enough to run and own a corporation, and have profit or retained earnings showing on your books. However, from the mortgage lender's perspective, again, the focus is entirely on what you pay yourself personally, not in your corporation. This means that income won't be considered under a qualified business for self mortgage application. Of course, there's a lot of personal items that can be written off under your business. In general, though, the lender is looking entirely at the net amount after all those deductions. This makes the stated income category a more realistic and achievable option for many self-employed borrowers.

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Stated income business for self mortgages is another type of mortgage product for self-employed borrowers. Here’s how lenders determine your income with this product, and how the application process works.

Stated income business for self mortgage products

Separating business expenses from personal expenses is tricky because the two are often intermingled. This is why the stated income business for self program exists. While qualified programs look at your personal taxable income that you report to the CRA, stated income programs look at your overall business operations. This means different documents and proof of income are required.

What documents do you need?

Business bank statements

You need to provide 6 to 12 months of business bank statements when you apply for a stated income mortgage product. As long as the statements come from the account where your revenue flows, it can be from a personal or corporate account. Mortgage lenders are then going to compare your business revenue to your expenses to determine an average annual net income. This income will help determine the mortgage amount you will qualify for.

Supporting documents to prove income flow

You will also need to prove where your income is coming from. This could mean submitting invoices or contracts, or any other documents that show how your revenue exists. However, this flexibility with proving income comes at the cost of higher interest rates for you as a borrower. Lenders are taking more risk with these mortgages, so you will pay higher interest rates, as well as a one per cent lender fee.

Some self-employed borrowers might object to the idea of paying higher fees. However, the alternative to these fees is reporting more personal taxable income, and therefore paying more income tax to qualify for a mortgage. Income taxes will be higher than these interest rates, so paying these increased rates is worth it for your mortgage application.

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Some mortgages for borrowers that are self-employed come with higher rates, and extra fees and costs. Let’s explore what borrowers can expect to pay with this type of mortgage.

Qualified business for self programs

Qualified business for self borrowers get the benefit of the best terms, the best interest rates, and the best products. Most importantly, there are no lender fees. For these borrowers, it’s pretty much business as usual, and mortgages are a much simpler process.

Stated income business for self programs

Now, for borrowers who must apply via one of the stated income mortgage programs, the pricing model is going to be a little bit different. Mortgage lenders are taking on more risks with this type of application because they’re not using a borrower’s fully taxable income. In exchange for that risk and flexibility, the lender wants to be compensated. There are two big costs to be aware of here.

Number one, borrowers can expect higher interest rates. Usually, these rates are about one to one and a half per cent higher than prevailing fixed rates in the open market. Number two, these lenders are also going to charge borrowers a lender fee. This is typically one percent of the mortgage amount. The mortgage term length of these stated business for self programs are also shorter, usually a 12-month or 24-month term. The benefit here is that after each year, lenders are able to reassess a borrower’s application to see if they can move from a stated income program to a fully qualified program.

Are stated income lenders “subpar” ?

When people apply for a stated income program, they sometimes wonder if they will be dealing with a "B" lender, or a subpar lender. The good news is no. Most lenders offer both fully qualified and stated income products, so the only thing that changes is the mortgage type. The lenders themselves usually stay the same. It’s important to know that self-employed borrowers are not working with subpar or inferior lenders. Plus, these lenders provide pathways to move from the less desirable stated income program to the fully qualified program over time.

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Are you an independent contractor who is looking to apply for a mortgage? Here, we’re going to share four tips to help you prepare for your mortgage application, give you a successful approval, and maximize your mortgage qualification.

Four tips for a successful mortgage application

1. Be consistent. A lender is going to want to see that you have been employed or working as an independent contractor in the same industry, in the same role, for at least two years.
2. Prepare your T1 Generals. A lender will ask us to provide two years of your two most recent T1 Generals, with a specific focus on your Statement of Business Activities. This is going to show the amount of income you earned, minus your write-offs. The focus will be on the net number that you personally pay for your income taxes.
3. Show your income taxes are paid and up to date. We rely on the notice of assessment to do this. A lender is going to be interested in seeing that the numbers match the numbers on your T1 General and that your taxes are paid up to date.
4. Show that you're still earning the same income. The T1 Generals and notices of assessment we rely on will be from the last tax year, so a lender will also want us to confirm that you're still working. This can be done via bank statements, invoices, or contracts to show you're still earning the income that you have earned in the past.

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Are you self-employed as a sole proprietor and looking to apply for a mortgage? If so, there are some big tips that you need to know to help prepare for a successful mortgage application. Here’s what you can do to maximize the mortgage amount that you qualify for.

Focus on your T1 Generals

First, we're going to focus on your T1 General, and more specifically, a schedule in the T1 General called the Statement of Business Activities. This takes your revenue minus your expenses and comes up with a net income, which you claim personally for your income. As you prepare for a mortgage application as a sole proprietor, a lender will look for two years of your T1 Generals to review your personal income.

Often, when you're self-employed as a sole proprietor, some of your personal expenses get buried as business expenses. In order to ensure that you can show the best income possible, lenders will consider adding back 15 per cent of your net income to represent those personal expenses that you're writing off. This little bonus shows more income to the lender, which is going to help you qualify for more mortgage money.

Consider stated income programs

Now, how can you prepare an application if your net income isn't high enough to qualify for a mortgage? Luckily, there are what we call stated income mortgage qualification programs that allow us to take a more flexible approach to qualifying for your sole proprietorship income. You can review these programs in Chapter 2.

If you’re going to commit to a stated income qualification, you must be prepared to show your bank statements. In general, a lender will ask for 6 to 12 months of bank statements to show the regular income coming in from your business activities. They will also ask for invoices, or other supporting documents like contracts to confirm the money is being earned through your business activities. Once that income is established, we can then come up with a reasonable net income for you personally to qualify for your mortgage. Very often, this is how self-employed individuals apply for mortgages.