I work with many clients who are self employed and I always get this question from them: I'm self employed, how do I qualify for a mortgage?
When self employed, the qualifying criteria is the same as the qualifying criteria for an employee. That is, lenders use up to 39% of your taxable income for your housing costs to calculate your qualifying mortgage amount. There are, however, income verification programs available to self employed borrowers that are not available to employees.
These programs could allow a self employed borrower to qualify for a higher mortgage amount.
The way these programs work is that they allow lenders flexibility to:
- add back business expenses, or
- use higher incomes than what is reported on your personal income tax return, or
- remove business expenses that are reporting against you personally
Although, as a self employed borrower, you have to provide more documentation to get a mortgage, the extra documents could make it easier for you to qualify for what you want.
What are the qualifying criteria?
I've talked about qualifying in another article called "How much mortgage do I qualify for?", but I'll summarize the information here briefly.
Assuming your credit is good, meaning a credit score above 650, and assuming you have access to enough down payment. The main qualifying criteria that lenders use is based on your income and is called the Gross Debt Service Ratio (GDS) and the Total Debt Service Ratio (TDS).
The GDS is calculated as the amount of all your home related costs, namely the mortgage principle and interest payment, the property tax payment, the cost of heating your home and half of the cost of the condo fees if you have those. The GDS ratio can not exceed 39% of your total gross taxable income (line 150 on your income tax return).
The TDS is calculated as amount of all your home related costs as well as debt payments, namely minimum credit card payments, line of credit payments, lease payments, loan payments, etc. The TDS ratio can not exceed 44% of your total gross taxable income (line 150 on your income tax return).
Let's compare an employee and self employed individuals earning the same income:
You are an employed, you have a salaried income of $85,000. You have no debt. You have saved $25,000 for your home purchase. You would qualify for a home purchase of $400,000 with 5% down ($20,000).
You are self-employed (sole proprietor), your taxable income is consistent year over year at $85,000. You have saved $25,000 for your home purchase. You would qualify for a purchase of $480,000 with 5% down ($24,000).
Why are these numbers different when both make the same income?
Employees earn a salary and there isn't much they can do to reduce the taxable income on line 150 of their income tax return. However, when you are a self employed sole proprietor, you can write off some of your expenses that an employee can not.
For example, a sole proprietor can write off lease costs and interest costs for a vehicle used in business. A sole proprietor can write off a portion of her home costs if her business uses her home. A sole proprietor can also depreciate assets that she owns and claim this expense on her income tax returns, to name a few.
Because of this, lenders will increase your income by up to 15% when calculating how much you qualify for to purchase a home.
I'll go into more detail about how this works below.
What programs are available?
There are a few different programs depending on how your business is structured and how you structure your income.
- Sole Proprietor Income Gross Up
- Insured Stated Income
- Uninsured Stated Income
- Equity Lending
Sole Proprietor Income Gross Up
For the sole proprietor, the example I just gave is available, where the lender will increase the income on line 150 by 15%. A sole proprietor has the ability to write off things that an employee can not. She can write off the use of her car, a portion of her home expenses, interest costs related to the business, lease payments, cell phone costs, etc.
Some of these expenses are costs that an employee also has but can't write off, therefore a sole proprietor's income can be increased by 15% to make the qualifying income more accurately reflect true gross income when qualifying for a home purchase.
In the example above, the sole proprietor declared an average income of $85,000 on her income tax returns. Fifteen percent of $85,000 is $12,750, which would result in a total income of $97,750. That's why the maximum home purchase price for a sole proprietor with a taxable income of $85,00 is $480,000.00
Insured Stated Income
Whether you are self employed sole proprietor or you work for a corporation that you own, you can also use a stated income program
This program is based on your gross revenue after cost of goods but before other expenses and requires a minimum down payment of 10% of the purchase price. Your credit score is also important. To qualify for this program, you must have a credit score above 680.
Many self employed people don't draw out all the income from their corp. They do this to reduce their tax burden and to have the money available to use in their business or for a number of other reasons. However, by doing this the self employed person's taxable income isn't completely accurate. Their income is often substantially lower, as reflected on their personal income tax return than they could actually draw (and declare on their tax return) on an annual basis.
The state income program is designed for this type of business owner.
Under this program, the business owner states to the lender how much they actually have access to on an annual basis. The lender then reviews the personal and corporate financials to determine if this amount is reasonable.
For example. A business owner has Gross Revenue of $1,000,000 per year. She has cost of goods of $500,000, therefore net revenue of $500,000. She consistently draws dividend income of $85,000 per year, as reflected on line 150 of her income tax return. She has $85,000 savings for her home purchase. She has cash in her business of $250,000, but doesn't want to use it in case her business needs this money in the future. She states that her income is $150,000.
Under the stated income program, this self employed client would qualify for a home purchase of $750,000 with 10% down ($75,000). She would pay a higher default insurance premium than a traditional high ratio mortgage, but she has much more purchasing power than an employee earning the same $85,000.
The insured stated income program can be set up with as little as 10% down. There is a default insurance added to the mortgage balance with the insured stated income program. This program is available with as little as 10% down and as much as 35% down.
If you have 20% or more down, then you could potentially choose an uninsured stated income program as well. The qualifying criteria is less stringent with respect to verification of income and the credit criteria.
Uninsured Stated Income
If you have more than 20% down, then it's possible to state your income and get financing without the default insurance.
With this program, the interest rates are typically higher but the credit score requirements are much more flexible. The documentation require to verify the reasonableness of your income is also more flexible. With this option, some lenders only require 6 months bank statement to confirm your stated income.
This is a great option when there have been some bumps and bruises to your credit.
I will summarize the documents required for self-employed programs below.
With the Uninsured Stated Income Program, some lenders will not require require personal income tax returns or notice of assessments or even financial statements. These lenders will only require 6 months bank statements for income confirmation.
There are some lenders who will consider financing a home if the self employed applicant has enough down payment.
Typically, equity lending applications would require at least 35% to 50% down. There is still a requirement to ensure that the borrower has the means to make the payments, that is, the payments for the mortgage are reasonable for the income that is documented. Each lender has very different criteria for this program.
For this, it's best to speak with a professional to see if this is an option that you would want to pursue.
What documents do I have to provide?
There are a number of documents required to qualify for mortgage financing. Here, I will just summarize the income documents that you will have to provide as a self employed applicant:
- Most recent 2 years of Personal Income Tax Return (all the pages)
- Most recent 2 years Personal Income Tax Notice Of Assessment
- Proof of Self Employment (GST Paperwork, Business License, Corporate Search, etc.)
- Most recent 2 years Business Financials
- Last 6 months business bank statements
As you can see, it's not necessarily more difficult to qualify when you are self employed, however you want to work with a mortgage broker who is aware of all the potential programs that are available to you.
Not ever bank underwrites and subscribes to these programs the same way. Some lenders are more picky about certain things than others are. Although I have described these programs in some detail, there are a lot of differences between programs and there are a lot of differences from lender to lender.
If you are self employed, then I would suggest that you always seek the advise of a professional to see how your situation fits and what is best for you.
If you have more questions about how much you qualify for when you are self employed, connect with me by email or give me a call.
- How many years do you have to be self employed to get a mortgage?
- Do mortgage lenders use gross or net income for self employed?
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