There seems to be so much confusion about how self employed applicants qualify for a mortgage. The truth is, there are several different programs and options for self-employed clients to qualify for a mortgage.
One question I get is, "do mortgage lenders use gross or net income for self-employed clients?"
It depends. If a self-employed applicant declares enough income on her personal income tax return, then the lender may not look at the gross and net business income. If a self-employed applicant states she earns more income than her personal income tax return is showing, then a lender will review the gross and net business income.
For self-employed, there are more ways to confirm your income available to a lender compared to a client who is salaried or hourly. For the hourly (salaried) employee, a lender will ask for an employment letter and a pay stub to confirm income.
For self-employed clients, your business is often very different than other self-employed clients. You may receive high revenue but also spend a lot on the cost of goods.
Your accountant may be able to claim some expenses on your personal tax return that lowers your taxable income. For example, Vehicle expenses, cell phone costs, some housing costs. A salaried employee would use the same items and potentially have the same expense but are not allowed to deduct these expenses.
This is why programs have been created to allow lenders more flexibility to review your documents to determine your income.
Side Note: Each lender will have a slightly different interpretation of how to evaluate your income.
The first documents a lender will review when you are self-employed are the following:
- 2 recent years of personal Income Tax Returns
- 2 years of notice of assessments
- 2 years of financial statements
If you qualify for a mortgage with these documents, then they won't have to consider your gross and net business income in detail because your taxable income is sufficient. When your personal income is less than the income you state, your lender can review your gross and net business income.
Your lender will compare your personal income, the gross and net business income to determine if the income you state is reasonable. They can then use the income you state to qualify you for a mortgage.
Lenders and insurers have slightly different guidelines. You don't always get the full picture by visiting only one or two lenders.
If you want the full picture, I recommend you speak with a mortgage broker rather than visiting just one or two banks on your own.
When Could A Lender Use Gross and Net Business Income?
Lenders use gross and net business income if you don't qualify for a mortgage when they use a traditional income qualifying method.
Let's look at 4 different non-traditional income qualifying situations:
- Good Credit, Insured Purchase (under $1 million) with 10% down
- Good Credit, Purchase with 20% or more down
Let's review each of these situations and how they work...
Good Credit, Purchase under $1,000,000 with 10% down payment
The first review that I do when I meet my self-employed clients is to determine if they qualify for a traditional mortgage. What I mean is that if my self employed client shows enough income on her income tax return to qualify for the mortgage she wants. I check her credit and credit score, that's also important.
Once we determine that a traditional mortgage, like an employee would, at best rates with 5% or 10% or 20% or whatever amount down doesn't work, then I look at other options.
The next option for a self-employed client is an insured self-employed mortgage. With an insured program, the minimum requirement is 10% down and good credit (a beacon score over 680).
The insured program can be set up with 10% to 35% down and any amount in between. The premium charged reduces the more down payment is applied to the purchase. The insured program is not available for refinancing an existing mortgage.
Qualification calculations are made based on gross and net business income and are compared to personal taxable income. The lenders asks the self-employed client how much income they "actually" earn. This number is also compared to industry averages to evaluate how reasonable that income is.
There are a number of lenders who will qualify you for a mortgage under the self employed insured programs. However, only 2 of the 3 insurers offer specific insured programs for self employed applicants.
Genworth and Canadian Guarantee (CG) are two of these three companies who have created specific programs for self-employed clients. Each insurer has slightly different from the other. CMHC also has a program, but it's more of an exception program. It doesn't really offer the same options as the first two I mentioned.
Genworth and CG are called stated income and income advantage. These programs will look at your gross and net business income when evaluating your income. With gross and net income, the lender will evaluate whether those numbers can support the income that you tell them you make.
Ideally, you have been in business for at least 2 years, but they will make exceptions to this depending on your employment history.
You will have to provide the documents that I described earlier for the lender to review and evaluate your income. Namely, 2 years personal income tax returns, 2 years business financials, 2 years notice of assessments.
Let's compare a couple of situations to see how a lender may evaluate your income.
For example. You are self-employed. Your gross revenue is $500,000 and net revenue is $50,000 and your cost of goods is $100,000. Your personal income tax returns shows a taxable income (line 150) of $75,000. You state to the lender that you earn $150,000.
The lender will review these numbers and determine if the $150,000 is reasonable or not. In this example, it would likely be reasonable.
If we used the same example above, except your cost of goods is $400,000. The lender may not accept $150,000 as a reasonable income. The gross revenue minus cost of goods is only $100,000 and is much lower than $150,000.
With this program, the lenders will also evaluate whether the income is reasonable for the industry that you are in. All of these criteria are a little more subjective and the numbers aren't concrete. Therefore, these mortgages are a little higher risk.
The insurance premium for these self-employed programs have higher premiums because of the higher risk. Sometimes the interest rates are a little higher as well, but not always. The rate is determined by the lender.
Good Credit, Purchase With 20% or More Down
The more money you have down the more flexible lenders can be. If you can't use traditional income confirmation with 20% down, then either we choose to insure the purchase and go with an insured self-employed program. You would, therefore, pay the premium.
The advantage to that program is that the rates are very close to best rates. There is a premium but it's reduced when you have 20% down. The same criteria apply as described above. Gross and net business income will be used to determine whether your stated income is reasonable.
If your credit is bruised or isn't high enough to qualify for an insured self-employed mortgage, then another option is to work with an alternative lender.
With an alternative lender, they use a little more common sense. Not a lot more, but a little bit more. They will evaluate your business income. Most of the time, they want to see your business bank statements. They will look at the deposits to see if there is enough going into your business account to justify the income you told them you earn.
For alternative lenders, you will be looking at interest rates from 1.5% higher than best rates or more. The rate really depends on your credit. The worse your credit, the higher the rate you will pay. There will also be lender fees and broker fees. This could be 1% to 5% of the mortgage amount in total.
All thing being equal, if your credit is good, then the insured program is often better because you get a better interest rate. In the long run, this saves your money every single year.
If your credit is a little bruised. If you want to set up the mortgage over an extended amortization, like 30 years, then the alternative lender is the way to go.
If you are self-employed and don't qualify, like an employee, with traditional income confirmation methods, the you have options.
The insured purchase is an excellent option with very good interest rates. The maximum amortization is 25 years and this program can be used with as little as 10% down and more if you wish.
Once you have 20% down, more choice opens if your credit is a little bruised. A lenders will consider some exceptions when reviewing your application and offer good rates, not the lowest rates available but very close.
With bruised credit or worse then you can also consider an alternative lender. Rates will be 1.5% or higher than the best rates available and there will be some setup fees (lender and broker fees) and you could choose an amortization up to 30 years.
When you are self employed, you actually have more choices than you might have been lead to believe if you just listed to your local bank.