A mortgage is typically the biggest financial commitment any of us makes in our personal lives. With such a sizable loan to be repaid, plus the interest, financial institutions are understandably cautious about who they lend to, insisting their clients provide proof of reliable income, strong credit, and low debt.
Even with interest rates at historic lows, the mortgage application process can still be difficult and daunting. The economic uncertainty and instability created by the COVID-19 pandemic has only made lenders more wary of risk.
The challenges of applying for a mortgage tend to be even greater, however, when the applicant is self-employed, a group that accounts for approximately one fifth of the Canadian workforce.
Unlike people with steady jobs and regular paychecks, a self-employed person may have uneven income from year to year. In addition, self-employed people often use tax deductions and write-offs to reduce their income tax bill. All mortgage lenders tend to notice, however, is the reduced amount that gets entered as the applicant’s reported income.
Still, being self-employed doesn’t have to mean giving up on the dream of home ownership or property purchase. With careful planning, self-employed people can improve their chances of being approved for a mortgage.
Here are some common strategies self-employed people use when applying for a mortgage.
Get your paperwork in order
Lenders typically like to see two or three years worth of documents from prospective borrowers to prove income levels, so get your paperwork ready before starting the application process. Make sure you have balance sheets, bank statements, tax returns, and notices of assessment for both your business and personal finances. You may also wish to provide a list of assets covering any savings or investments.
Consider credit unions and mortgage brokers
If you’ve already got a strong relationship with the institution where you do your business banking, that’s a great place to start when shopping for a mortgage – they’re likely to be more aware of your situation and understanding of any challenges. Needless to say, familiarity can go a long way when deciding whether someone will pay back what they owe.
If you’re not too fond of your business bank, or if you strike out with them, consider applying for a mortgage at a smaller institution, such as a credit union. You may find your situation requires you to work with a mortgage broker, possibly someone who specializes in arranging financing for self-employed people. Mortgage brokers have access to multiple lenders and can often find options for self-employed homebuyers who haven’t been approved elsewhere.
Think before you deduct
Many self-employed people attempt to reduce their income tax bill by deducting as many costs as possible from their business income. While this may be smart practice at tax time, it can work against you when it’s time to apply for a mortgage, because your income doesn’t look as impressive to lenders. If a home purchase is in your near future, you might consider accepting a slightly higher tax hit in the short term in exchange for the more favourable mortgage terms potentially available to a higher-income earner.
On the subject of taxes, make sure all your past tax bills are paid off before you go shopping for a mortgage. It reflects poorly on your reliability if a potential lender takes a closer look at your business and discovers an overdue balance for income or sales tax.
Purchase with your partner
If your spouse or partner has a steady job with regular income, and you’re applying for the mortgage together, lenders will be less concerned about your self-employed status, and more likely to approve the two of you for financing.
Save for a bigger down payment, cash savings, or both
One sure-fire way to make yourself more attractive to lenders is by coming up with a bigger down payment. If the standard is 10 percent, see if you can strengthen your credentials by putting down 20 percent or more.
Likewise, if you’ve got an emergency fund stashed away somewhere, say three to six months worth of living expenses, then lenders will feel comfortable knowing you’ll still be able to make mortgage payments if your business income shrinks or vanishes.
Keep your credit score high
In a recent blog, we wrote about several ways to increase your credit score. If you’re self-employed and planning on applying for a mortgage, make sure you’ve got a healthy credit score by paying off any credit card debt or outstanding loans.