If you are self-employed and you are considering buying your first home or taking some equity out of your current home, then this article is for you.
We will explain the underwriting policies that affect you, tell you what you need to you know before you make a decision and how you might be able to save $1,000’s while also getting your loan much sooner……
Table of Contents
- Underwriting policies that affect self-employed in Canada
- How big of a mortgage (LTV) can you get if you’re self-employed?
- How do you get a mortgage if you don’t have a 35% down payment and you’re self-employed?
- Will it cost me more to use private lending?
- I want to talk to an expert about this
- How do I apply?
To discuss this, there are a few terms that you need to be familiar with:
Underwriting policies are essentially the rules and guidelines that a bank uses to decide whether or not they provide you with a mortgage and how large of a mortgage they are willing to give you. Major banks’ underwriting policies are dictated by the Office of the Superintendent of Financial Institutions OSFI. This means that they might be willing to lend, but are restricted from doing so.
Underwriting policies of major banks are influenced by several factors:
- Type of income – different underwriting policies apply to the self-employed
- Income levels (the higher the better)
- Credit Rating (the higher the better)
- Other Debts such as credit cards, lines of credit, etc. (the lower the better)
Loan-to-value (LTV) is the size of your mortgage divided by the value of your house. The higher the number, the less of your home that you own and the more the bank owns.
Larger mortgage = Higher LTV
The higher the LTV, the more risk the bank is carrying and the tighter their underwriting policies. Conversely, the riskier the bank believes an individual to be, the lower the LTV they are willing to give them (smaller mortgage).
So, because banks consider self-employed persons to be riskier, the max LTV a bank is willing to give a self-employed person is lower.
Stated income is when you simply state your income. This means that the bank is not using your tax returns (notice of assessments) to verify your income. Think of it as how much money you could pay yourself from your business.
Stated income is particularly relevant to self-employed persons, as the net income stated on their tax returns is kept as low as possible to avoid taxes. This creates a discrepancy between how much you actually earn and your earnings as reported on your tax return. This is a discrepancy that does not exist for salaries employees.
For the self-employed in Canada, your stated income is more reflective of your actual income, because it hasn’t had write-offs removed (car payments, rent, internet, etc.). Unfortunately, major banks deem this to be riskier and, as such, will not lend as much using a stated income
Writing off as much as you can via business expenses is smart personal finance and saves a lot of money, but it also makes it more difficult to get a mortgage through a bank.
Stated income = Lower LTV from major banks
How Underwriting Policies for the Self-Employed in Canada Have Changed
We won’t bore you with details, but at some point in the not-too-distant past, the OSFI dictated that major banks had to tighten their underwriting policies.
Much of these changes relate to how banks use stated income:
- A stated income mortgage now caps out at 65% LTV. Is used to be 75% max LTV (you now need to put down a larger down payment if you are self-employed)
- If you don’t have a 35% down payment you can still use stated income, but only if you have been self-employed for less than 3 years
- If you have been self-employed for more than 3 years, you have to use your net taxable income (what is reported on your tax returns) to qualify for your mortgage with less than 35% down
- The most a bank will ever give you is a 95% LTV (5% down). This is for salaried employees buying a home that costs less than $500,000
- If you are buying a home between $500,000 and $1 million, your max LTV will run between 92.5% and 95% (5%-7.5% down). This is the result of recent changes to Canada’s down payment scheme. For more details on this, check out our post on the topic
- If you want to buy a house that costs over $1 million, you can’t get insurance on your mortgage. This means that you have to put down 20% (max LTV of 80%)
- If you are self-employed and using stated-income, you can only get a 65% max LTV (35% down payment)
Of course, this is only if you use a major bank. Private lenders are not subject to the same underwriting policies and can help you get a mortgage with a lower down payment or take more equity out of your existing house.
If you are self-employed and want to put less than 35% down through a major bank, then you have to get your mortgage insured.
If you have been self-employed for more than 3 years, then you have to use the income on your tax returns. Essentially, you have to report higher net income to CRA for two years and pay the corresponding income taxes. By paying more to CRA, banks will be convinced that you have more money (I know, but that’s how it is).
This option will take two years and can be extremely costly. Here’s an example:
- Let's say you want to buy a home for $1 million and have 25% to put down (so you want a $750,000 mortgage)
- You currently report a net income to CRA (after deducting business expenses) of $80,000 and you split this with someone else
- Your annual income tax on this would be a little over $16,000 (if you live in BC – it will vary from province to province)
- If you want to qualify for a $750,000 mortgage, you would need a gross income of about $155,000.
- At that income, you are paying about $38,000 in taxes($76,000 over two years)
- This means that you are paying $22,000 more in taxes, totaling $44,000 over the two years necessary to qualify for your mortgage
Essentially, you will have to pay CRA $44,000 so that bank will think you have enough money to afford your mortgage. We don’t recommend this option.
Option 2) Wait and Save
If you have a 25% down payment, you can simply save the remaining 10% to get you to a 35% down payment.
In the example above, this would require an additional $100,000 in savings. The ease/difficulty of acquiring this is highly individual, so we will leave that to you. Keep in mind though, that in some markets, house prices are already over $1 million and rising, meaning that the required down payment is rising too and quickly.
Option 3) Use Private Lending
This last option is where we can step in. Essentially, we “top you up” by lending you the remaining 10%. The vast majority of your mortgage is still through your bank, we just lend you a small portion.
The beauty of this method is that you can typically roll your private loan into your mortgage after about a year.
What option is best for you? That depends on how much you earn, what you are looking to buy, how much you have to put down, how much you are currently reporting on your tax returns, etc.
Essentially, the answer isn’t the same for everyone. But we want to stress that major banks are not the only way to get a mortgage and can, in some cases, cost you a lot more. Explore your options, do your research, and find what works best for you.
If you want to speak with one of our experts to find what works for you, you can schedule a phone call by clicking here.
Private lending charges higher interest rates for a mortgage than a major bank, which will cost you a bit more. However, you need to compare this to the money you would have to pay to CRA in order to qualify for a lower interest loan through a major bank.
The table below describes the savings under a few examples:
- From the - calculations above, we know that the cost of declaring the necessary income to put 25% down on a $1 million dollar home can easily be $43,000
- In comparison, a private loan would cost about $20,700 for the year, including all fees and interest rates, saving you around $23,100
- Just as importantly, using a private loan can put you in your home right away, rather than waiting 2 years.
In general, the less you report on your income taxes (more business deductions) and the more expensive the home you are looking to buy (or the more equity you want to take out), the more money you can save with private lending.
This is because a larger mortgage through a major bank requires a higher net income. This means that you have to declare more income at higher income brackets and pay more taxes.
The chart below shows the cost of buying a home using a private loan to top up your mortgage for a year versus reporting higher income to CRA for two years:
- For less expensive homes (under $700,000), declaring more income is less expensive than private lending
- For homes that are more expensive than this, private lending is cheaper
- The more expensive the home, the more you can save with private lending
We assume that you split your income and that you are currently reporting $80,000 and live in BC.
Changing these assumptions will alter the numbers, but won’t really change the end result – private lending is much cheaper than declaring more income on your taxes.
Crucially, if you speak with us and we can save you more money by setting you up with a traditional mortgage, then we will. If you speak to a bank and they can save you money by setting you up with private lending, they won’t.
If you would like to speak with one of our experts, we would be happy to arrange a phone call. We are experienced mortgage brokers and can answer all of your questions, whether they be about private lending or traditional mortgages.