Empowering Entrepreneurs: The Self-Employed Mortgage Playbook

In the dynamic real estate market of Ontario, securing a mortgage is a pivotal milestone on the path to homeownership. For self-employed individuals, however, the journey can be riddled with complexities due to fluctuating incomes and unique financial circumstances. In this article, we'll dive deeper into the nuances of self-employed mortgages while providing a comprehensive understanding of how they operate.

Understanding Self-Employed Mortgages

Self-employed mortgages are custom-tailored financial products designed specifically for individuals whose income streams differ from traditional salary structures. Unlike employed individuals who receive consistent paychecks, self-employed individuals often experience income variability, stemming from entrepreneurial ventures, freelance work, or ownership of small businesses. The varying income streams of self-employed borrowers requires specialized mortgage solutions that accommodate their unique financial profiles. These mortgages are offered by a variety of lenders, including A, B, and Private lenders, each focusing on different borrower profiles and risk tolerances. Whether you're a sole proprietor, freelancer, contractor, or small business owner, self-employed mortgages provide the flexibility and tailored approach necessary to navigate the complexities of homeownership as a self-employed individual.

Qualifying for a Self-Employed Mortgage

Qualifying for a self-employed mortgage hinges on several factors, primarily revolving around the nature of one's business and the stability of income streams. Self-employed individuals typically fall into four distinct categories, each with its own set of qualification criteria.

Sole Proprietor with Verifiable Income: This category encompasses individuals who operate businesses as sole proprietors and can substantiate their income through documented financial records, such as T4s and Notices of Assessment (NOA), spanning a minimum of two years.

Sole Proprietor without Verifiable Income: For self-employed individuals lacking traditional income documentation, such as T4s, lenders may require alternative evidence of income stability, often in the form of a minimum six-month history of business deposits.

Incorporated Individual with Qualified Income: Incorporated individuals must provide comprehensive financial documentation, including corporate T4s and business financial statements, spanning at least two years, to validate their income.

Incorporated without Qualified Income: Individuals operating corporations without verifiable income documentation may still qualify for a mortgage by showcasing a minimum of six months of consistent business deposits or opting for stated income verification.

Types of Income Verification

Income verification methodologies vary depending on the lender's requirements and the borrower's unique financial circumstances. Let’s break it down.

Traditional Income Verification: Relies on documented proof of taxed income over a specified period, typically averaging earnings over two consecutive years. This method is widely used by lenders to assess the financial stability and capacity of borrowers to repay their mortgage loans.

Verification Methods:

-           Tax Returns and Notices of Assessments (NOA)

-            Pay Stubs and Employment Verification

-            Bonus or Commission Statements

Non-Traditional Income Verification: This method encompasses alternative income sources beyond conventional salary structures. These methods allow lenders to assess income stability from diverse sources, such as dividends, rental income, or business deposit histories.

Verification Methods:

-            Dividend Income

-            Rental Income

-            Alimony or Child Support  

-            Investment Income

Stated Income Verification: Primarily utilized by B or Private Lenders to accommodate self-employed individuals who may have difficulty providing traditional documentation of their income. With stated income mortgages, borrowers can declare their earnings without the need for extensive paperwork, but lenders may require additional evidence to validate the reasonableness of the stated income.

Verification Methods:

-            Bank Statements and Financial Records

-            Client Invoices

-            Contracts for Future Work

-            Profit and Loss Statements

Sole proprietorships and partnerships applying for mortgages through the Canada Mortgage and Housing Corporation (CMHC) have the advantage of increasing their self-employment income by 15%. This adjustment, known as a "gross up" or "add back," is implemented to offset deductions that may have been made, such as capital cost allowances or business expenses. By allowing for this adjustment, CMHC aims to provide a more accurate representation of the borrower's income, enhancing their eligibility for mortgage financing.

Insured vs. Non-Insured Mortgages

The differentiation between insured and non-insured mortgages plays a critical role in determining borrowing parameters and eligibility criteria for prospective homebuyers. Understanding the distinction between insured and non-insured mortgages is essential for borrowers navigating the homebuying process, as it directly impacts the amount of financing available, the associated costs, and the requirements for approval.

Insured Mortgages: Offer higher loan-to-value ratios, allowing borrowers to finance up to 95% of their home's purchase price. However, borrowers must secure default insurance from agencies like CMHC, Sagen, or Canada Guaranty, particularly when unable to provide traditional proof of income.

Non-Insured Mortgages: Typically feature lower loan-to-value ratios, capping borrowing at 80% of the property's value. While these mortgages do not require default insurance, borrowers must verify their income through conventional means to qualify.

When it comes to borrowing for your home purchase, the amount you can borrow depends on various factors, including your ability to prove income. Typically, borrowers can secure loans for up to 80% of the home's purchase price without default insurance, and up to 95% with default insurance. This is where proving income becomes crucial. By providing documentation such as pre-filing (T4s) and post-filing (NOAs) over two tax years, self-employed individuals can qualify for the same borrowing amounts as those with traditional employment. However, if traditional proof of income isn't attainable, borrowers still have options. With mortgage default insurance, they can borrow up to 90%, and by working with lenders partnered with Sagen or Canada Guaranty, they can access financing even without traditional income verification.

Managing Documentation

Documentation plays a pivotal role in the mortgage application process, enabling lenders to assess borrowers' financial health and creditworthiness effectively. Essential documentation for self-employed mortgage applicants includes the following.

Sole Proprietorship or Partnership:

• Notice of Assessments – Provide last 2 years Notice of Assessments FULL COPY, ALL PAGES

• Confirmation of Self-Employment - Master Business License (if it has been renewed during last 5 years, provide original and renewal)

• Full T1 Generals / Personal Tax Returns for last 2 years. Please provide FULL COPY, ALL PAGES

• Last 12 months’ business bank statements

Corporation:

• Notice of Assessments – Provide last 2 years Notice of Assessments FULL COPY, ALL PAGES

• Confirmation of Self-Employment - Provide Articles of Incorporation, FULL COPY, ALL PAGES

• Full T1 Generals / Personal Tax Returns for last 2 years. Please provide FULL COPY, ALL PAGES

• Last 2 years Financial Statements

• Last 2 years T4’s

• Last 12 months’ business bank statements

Securing a self-employed mortgage without traditional proof of income is possible through specific mortgage default insurers such as Sagen and Canada Guaranty. This option is typically available for stated income mortgages, where borrowers declare their earnings without extensive documentation. To qualify, borrowers must provide a minimum down payment of 10% and work with a lender partnered with one of these insurers. It's important to note that CMHC-insured mortgages for self-employed borrowers mandate proof of income, emphasizing the significance of demonstrating financial stability to secure financing.

Stated Income Mortgages

Stated income mortgages, also known as "no-doc" or "low-doc" loans, are designed for borrowers who may have difficulty providing traditional documentation of their income. These mortgages are particularly popular among self-employed individuals, freelancers, contractors, and business owners who may have fluctuating income or non-traditional sources of revenue. With stated income mortgages, borrowers can declare their earnings without the need for extensive paperwork, making them an attractive option for those with non-traditional income streams.

Key Points to Consider:

Down Payment: Stated income mortgages offer flexibility in securing financing, typically requiring a minimum down payment of 10%. However, to avoid mortgage default insurance premiums, a larger down payment of 35% or more may be necessary. These options provide borrowers with choices depending on their financial situation and preferences

Lender Options: Stated income mortgages are most commonly offered by B or Private Lenders, although some A Lenders may accept this verification method through programs like the Sagen Alt-A Program. It's important for borrowers to explore their options and understand the lender requirements associated with stated income mortgages.

Credit Score Requirements: Due to the higher risk associated with stated income mortgages, lenders may impose stricter credit score requirements on borrowers. A strong credit history and high credit score can improve the chances of approval and help borrowers secure more favorable terms. A less than great credit would have to be mitigated with increased income (lower debt-to-income ratios) or higher down payment (lower loan-to-value ratios) to increase the chance of approval.

Flexibility for Self-Employed Borrowers: Stated income mortgages offer flexibility for self-employed borrowers who may have difficulty verifying their income through conventional means. Rather than relying on tax returns or pay stubs, borrowers can declare their earnings based on their own assessment of their financial situation.

Reduced Documentation Requirements: Unlike traditional mortgages that require extensive documentation, stated income mortgages typically have reduced documentation requirements. Borrowers may only need to provide basic information about their income, assets, and employment status, simplifying the application process.

Default Insurance: Stated income mortgages, while not insured by CMHC, can still be obtained through private mortgage default insurers like Canada Guaranty or Sagen. These insurers provide an alternative option for borrowers seeking financing without traditional income verification.

Higher Interest Rates and Fees: Stated income mortgages often come with higher interest rates and fees compared to traditional mortgages. Lenders may charge higher rates to compensate for the increased risk associated with limited income verification. Borrowers should carefully consider the long-term cost implications before opting for a stated income mortgage.

Additional Verification Methods: While stated income mortgages allow borrowers to declare their earnings without traditional documentation, lenders may still require additional evidence to validate the reasonableness of the stated income. This may include bank statements, business financial records, or invoices showing regular income streams.

Consideration of Future Income Potential: Borrowers should carefully consider their future income potential when applying for a stated income mortgage. While current income may be sufficient to qualify for the loan, fluctuations in income or unexpected expenses could impact the ability to repay the mortgage in the long term.

Overall, stated income mortgages can provide a valuable financing option for self-employed individuals and others with non-traditional income sources. However, borrowers should weigh the benefits and risks carefully and explore alternative financing options before committing to a stated income mortgage.

Special Considerations for Recently Self-Employed Individuals

For individuals embarking on entrepreneurial ventures or transitioning to self-employment, navigating the mortgage landscape may pose unique challenges. However, several avenues exist to facilitate homeownership, even in the absence of a lengthy operating history.

CMHC Self-Employed Mortgages: Tailored for recently self-employed individuals lacking a 24-month business history, these mortgages offer viable pathways to homeownership by considering alternative income verification methods and mitigating risk factors through stringent credit assessments.

Income Verification Strategies: CMHC may explore various income verification strategies, such as analyzing signed contracts for future work, assessing previous employment income, or scrutinizing bank statements to gauge income stability and borrower creditworthiness.

Co-Signer or Joint Application: In cases where recently self-employed individuals face challenges in meeting traditional mortgage eligibility criteria, considering a co-signer or joint application with a spouse or partner who has stable income and strong credit can improve their chances of mortgage approval. A co-signer or joint applicant with a solid financial profile can strengthen the overall application and provide reassurance to lenders.

Cash Reserves and Credit History: For individuals who have recently transitioned to self-employment and lack a substantial operating history, having sufficient cash reserves and a strong credit history can bolster their mortgage application. Lenders may view a healthy financial cushion and a demonstrated track record of responsible credit management as indicators of financial stability, mitigating concerns associated with limited business history.

Conclusion

Navigating the realm of self-employed mortgages in Ontario necessitates a nuanced understanding of income verification methodologies, documentation requirements, and lender preferences. By familiarizing yourself with the diverse options available and seeking guidance from knowledgeable mortgage professionals like myself, you can embark on your homeownership journey with confidence, leveraging tailored mortgage solutions to realize your real estate aspirations, even as a self-employed individual in Ontario.

If you’re a self-employed individual looking for guidance on your home buying journey, book a meeting with me so we can get you started on the path to success!