More self-employed hitting mortgage wall because of recent rule changes
Posted on 03-28-2014 01:03
Summary: For years, most of Marg Green’s self-employed clients could count on getting a mortgage on the strength of their credit score, and on their word that they were earning enough from their business to repay the loan.
For years, most of Marg Green’s self-employed clients could count on getting a mortgage on the strength of their credit score, and on their word that they were earning enough from their business to repay the loan.
These days, because of rules brought in almost two years ago by the regulator of the country’s chartered banks, borrowing money to buy a home has become harder for many of the country’s 2.75 million self-employed workers – a group that, according to Statistics Canada, has a higher median net worth than paid employees.
“We went through years and years when my clients who were self-employed could get a mortgage if their credit score was 680 or higher, with next to no documentation,” says Ms. Green, director and broker at Concierge Mortgage Group, based in Mississauga. “Today I’ve got clients going in to their bank for mortgage refinancing and they’re shocked because suddenly they’re no longer approvable.”
In the summer of 2012, the Office of the Superintendent of Financial Institutions introduced Guideline B-20, which required federally regulated banks to tighten their processes for approving mortgages and home equity lines of credit. As part of B-20, banks must now look more closely at incomes before approving a mortgage application.
This presents a problem for self-employed workers, who typically lower their taxable income by maximizing business expenses and personal deductions. Because of the discrepancy between what’s on their tax return and how much money they actually earn, self-employed workers have typically obtained their mortgage through “stated income” applications, which required a signed income declaration and proof of self-employment such as a business registration number or articles of incorporation.
Today, self-employed workers can still apply for a stated income mortgage at some banks, but under B-20 they can borrow only 65 per cent of the purchase value – 10 per cent less than what was allowed before B-20 – without requiring default insurance from Canada Mortgage Housing Corp., Genworth Canada or Canada Guaranty.
“If you have less than 35-per-cent down payment, your mortgage now has to be insured, and insurers have specific guidelines that you need to meet,” says Ms. Green. “For example, CMHC will allow a stated income application as long as you have been self-employed for less than three years. More than three years and you have to qualify according to your net taxable income.”
So what can self-employed workers do to improve their chances of qualifying for the mortgage they need, on terms that work for them?
Jeff Brown, vice-president for delivery initiatives and business integration at Toronto-based Meridian Credit Union, says coming in with complete and current financial and tax documents is critical. Meridian usually asks for the latest notice of assessment from Canada Revenue Agency and financial statements from the past two years.
“We may also ask to see bank statements to show regular income going into your bank account,” says Mr. Brown.
Raza Hasan, senior vice-president for retail lending and wealth-management risk management at Canadian Imperial Bank of Commerce, says self-employed borrowers need to make sure they are up-to-date with income and sales tax returns, and that they don’t owe taxes.
They also need to be ready to explain their business.
“It’s very important that you be able to discuss the details of your business – your income, expenses, at what point in time you will break even, your business milestones,” Mr. Hasan says. “Then we can look at that and find the right solution for you.”
The more information a bank has, the better it can help self-employed borrowers qualify for the mortgage they want, says Ms. Green, whose client base is made up largely of self-employed workers.
“Certain lenders allow add backs of things like car expenses, capital cost allowance or housing expenses,” Ms. Green says. “These add backs then enable the applicant to qualify for what they want to buy.”
Some lenders take a different approach to increase the mortgage eligibility of self-employed workers. Vancity Credit Union in Vancouver, for one, adds 15 per cent to reported income and will boost the percentage if the self-employed borrower provides financial statements showing deducted business expenses totalled more than 15 per cent.
Ms. Green notes that credit unions are not affected by B-20 and many still extend a mortgage of up to 80 per cent of purchase value to stated-income applicants without the need for default insurance.
For sole proprietors or owners of an unincorporated business, making the leap to incorporation could also help, says Jeff Hull, senior financial adviser at Manulife Securities Inc.
“Most banks prefer salary, and if you have a corporation you can pay yourself a salary,” he says. “That may make it easier for a self-employed individual to qualify for a mortgage.”
Incorporating could also reduce tax rates and allow the business owner to collect a higher salary or dividend payout, Mr. Hull adds.