Self employed? We have financing for that

There are a lot of myths and misconceptions that float around Canadian dinner tables when it comes to financing, but by far the most confused questions I get as a Mortgage Broker are around the financing rules for self employed people. So let's unpack the options here.

If you have read any of my previous blog entries, you will no doubt be catching on by now that mortgage financing rules are complex with a lot of 'if this - then that' scenarios. Self employed financing is likely the most grey zone area in the mortgage world as there are so many different paths we can take depending largely on your self employment set up.

Traditional lending guidelines I'll start with the basic guidelines for traditional lending options. 2 years of self employment is required and we qualify you based on a 2 year average of the net taxable income (if you file as sole proprietor) with a little bit of a gross up. Or 2 year average of what you pay yourself from your corporation if you are incorporated. We can use T4 employment income or T5 dividend income or a combination of the 2.

Yes, you can qualify with the minimum down payment rules in this instance.

If you are putting more than 20% down payment, some of our traditional lenders will allow us to look at business financials and add some of the write offs or retained earnings from the business to your personal income to increase your approval amount. These amounts vary greatly from lender to lender, which means that while one bank might not approve you for as much as you need, another bank might approve you for quite a bit more which makes working with a broker who has access and a knowledge of many different lenders policies an advantage to the self employed client looking for their best options. The amounts they can add back are limited under these programs, so typically this works for clients who pay a healthy amount to themselves from their business but just need a little bit more income to help get across the finish line of qualifying. Essentially lenders are analyzing your company to see that you could have paid yourself more if needed and then take a portion of that to top up your personal income. If you do not fit into this category because you have a solid accountant who saves you a ton of income tax, then good news, we have more options.

Stated Income

You might hear the term 'stated income' in mortgage talk or finance circles and this is where things get a bit more complex. We have 2 different types of stated income in the mortgage world. Insured stated income is available when you are purchasing a property under 1 million price point, it will be your primary residence and you pay the insurer (CMHC/Sagen/CG) premium to insure the mortgage to reduce the lenders risk. Under this program, you need a minimum of 10% down payment and you must have good credit (no past consumer proposals or bankruptcies). This program looks at your business financials and adds back to your personal income a large amount of the write offs or retained earnings in order to qualify you more on the company income rather than what you have historically been paying yourself from your business. The good news about this program is that the trade off for paying the insurer premium is that you get the lowest interest rates on the market and saves you the most in interest, it might also mean that you saved a good chunk in personal income taxes by not needing to pay yourself as much from your corporation just to qualify for the mortgage you are hoping for. The bad news is that the insurers don't do pre-approvals for this program so we won't know for sure that you will be approved under this program until we have an offer on a property and can submit the file with our fingers crossed, we are capped at the maximum 1 mill purchase price fitting within the insurer guidelines and this program is not available for anyone with commission income (sorry Realtors). So this program works when we are in a pinch, but I would not be basing a tax planning strategy around this if you are planning for future mortgage applications.

The second type of stated income is on the alternative financing side and is called the bank statements stated income approach, this is where you will be required to have a minimum of 20% down payment, you will pay a lender set up fee of 1% typically and interest rates will be higher than the traditional lending side. On this side, the lenders do not care what you paid yourself from your corporation at all and base their approval on your business bank statements where they add up your income, deduct some reasonable expenses for your business and qualify you on the difference. This approach may cost you more on the interest and fee front, however, many clients opt to stay in this rate category due to the huge amount of personal taxes they save by not paying as much out of their corp to themselves as might be required to qualify traditionally for the mortgage. The tax savings could potentially outweigh the extra interest costs by tens of thousands a year.

Newly self employed

If you are less than 2 years self employed this can create more of a challenge for you. On the traditional side, you would need to be in the same line of work as previously and if you are willing to pay an insurer premium there is an insured newly self employed program you can look to be approved under. for example, if you are an electrician who opened your own company a year ago after being an employee as an electrician for 10 years, this program might work for you. Lenders will look at a combination of your prior employee income and your new self employed income to see what they are comfortable using for an income to qualify on and just like the other insured program, they do not do pre-approvals meaning this program is also hard to confirm in advance that it will work. Lots of fingers and toes crossed when we apply under this program. This program is available with the minimum down payment as well giving a chance to folks who have short tenure as self employed the chance to buy without 20% down payment.

If you have more than 20% down payment, you can choose to pay the insurer premium to be approved under the newly self employed program or you will be hooped for traditional lending without the 2 years history. If you do not have previous experience in the same line of work, then you will also be hooped without a 2 year history on the traditional lending side. That said, there are alternative lending solutions for clients who have been self employed for more than 6 months and less than 2 years under the previously mentioned bank statements approach. Often we use these alternative lending solutions as interim financing solutions while waiting for the history so that we can qualify the clients on the traditional side again.

Private lending

The third tier of financing if you do not fit into any of the above is the Private lending space - this is what I like to call the wild wild west. They are mostly concerned with the property, the equity stake and your ability to repay the debt. Rates will be higher and set up fees will be higher but the flexibility in qualifying is also the highest. Alternative and private lending options also give more flexibility around credit issues if required.

Docs, taxes and debts

Expect to provide a lot of documents to your broker/lender. They will need to see (some or all of these docs) your full T1 Tax returns for 2 years, Notice of Assessments, proof of all CRA taxes paid (you will not get approved for a mortgage while owing the CRA past due taxes with the traditional or alternative lending options), Corporate financial statements, proof that you own the company (articles of incorp) and potentially business bank statements, copies of invoices for large deposits, business license and more depending on the combination of your lender, the program you are approved under and the type of business you run. Traditional lenders require these documents to satisfy government income verification.

So if you have not filed your taxes in a few years, you might have no choice but to either get your taxes done or go with alternative financing using business bank statements.

Another area that might be of interest focuses around personally guaranteed business debts. Typically, any debts reporting to your bureau we need to debt service into your application, and a business loan that you personally guaranteed would report to the bureau which means less qualifying for you as we need to factor that debt payment into your maximum debt ratios. However, with some history of those debts being paid from your business account (typically over 6 months history) we can occasionally remove those debts from your personal liabilities to help you qualify for more mortgage as well. We have also worked with vehicle refinance companies who have taken business debts like this and removed the personal guarantee so that the debt no longer needs to be accounted for on the personal liabilities.

One item that also comes up is the option to purchase property in a holding company or operating company. This is a whole other kettle of fish that needs to be flushed out for maximum tax savings offset against the higher interest rates and limited lender choices that might accompany this type of financing depending on what you are buying or its intended use. Strategies around renting property from your personal name or holding company to your operating company for example can be a great way to reduce taxes but can create complexities with financing that will want an expert mortgage professional to help you set up.

....Capital gains taxes in a corp vs in your personal name... rental property portfolios and taxable rental income... debt servicing of existing properties when done as residential mortgages personally guaranteed vs commercial financing without a personal guarantee... Sound confusing enough? Yep, it is. Lots of routes one can go down which makes it imperative to have a strong team between broker and accountant.

Summary

Your accountant's job is to save you as much tax as possible but our lenders don't always look at that as a win when they are trying to qualify you for as much mortgage debt as you might want. In mortgage financing it is not often that we get to save the most amount of taxes possible and then also get the lowest interest rate possible, so be prepared going into your mortgage application that as a self employed person, your main priority is the right strategy and product to suit your needs and that does not always mean the lowest rate even though it might mean the most savings.

A good broker has lots of tricks up their sleeve to help you create a financing strategy that saves you both taxes and interest though patience and a plan will get you where you need to be on both fronts.

As always, feel free to reach out to Jill Moellering at 780-720-4034 or Jill@JillMoelleringMortgages.com with any questions about this or any mortgage related topics.