When I speak with self-employed clients, they seem to have heard so many horror stories about getting qualified to purchase a home. One of the questions that I often get asked is, "How many years do I have to be self-employed to get a mortgage?"
If you're self-employed, to qualify for a mortgage with a traditional lender like a bank, credit union or trust company, you must have 2 years of income tax returns and business financial statements. You can, however, qualify with a non-traditional lender by providing as little as 6 months business bank statements.
Self-employed home buyers have many more financing options than employees. Your options can be categorized by risk and the interest rate you might pay as well as the type of documents you can provide to verify your income.
To pay the lowest possible interest rate with the lowest possible down payment, then you will have to provide 2 years of financial statements and 2 years of personal income tax returns. The 2-year average income that is shown on line 150 of your personal income tax return will determine how much mortgage you qualify for.
The more money you have down, the more lenient a lender can be confirming your income. For example, with 10% down, a lender could add back some expenses and/or evaluate your income based on your net income after cost of goods in the qualification process, instead of using just line 150.
With 20% or more down, a few lenders might just ask for 6 months bank statements. These lenders will ask you how much you earn then review the bank statements to see if your stated income is reasonable. Interest rates offered in this situation would be higher than if you provided your financial statements and income tax returns to confirm your income.
Let's look at a few different down payment and credit-related scenarios and examples.
Purchase With 5% Down, How Many Years Should I Be Self-Employed?
With 5% down, you must provide 2 years income tax returns, financial statements and Notice of Assessments. Lenders will use a 2 year average of your income tax return line 150 to determine how much mortgage you qualify for.
In this situation, your income is based on your historic taxable earnings. Using taxable income could be a good reflection of your actual income if your income is stable and you draw most of the profits from your corp.
A lender will check your credit, for this type of mortgage you should have a credit score over 620. Although lenders say 600 is the minimum, they always find reasons not to approve clients with a credit-score below 620.
When you qualify with 5% down, you will have access to the lowest interest rates available. There will be a mortgage default insurance premium added to the mortgage at the time of purchase. This premium is the same for self-employed purchasers and non-self-employed purchasers (employees).
For various reasons, self-employed client's income tax returns don't always reflect total income. There could be depreciation of assets or return of shareholder loans or a variety of other expenses that reduce the taxable income you declare on your Income Tax Return.
Because self-employed clients have these accounting options available, lenders have created programs to help reflect your "real" income.
Purchase With 10% Down, How Many Years Should I Be Self-Employed?
With 10% down, an option opens up for self-employed clients called Insured Stated Income. It's also called Low Document Advantage Program. These programs are offered by two of the three default insurers in Canada. Lenders can subscribe to these programs or they may not.
I have found that lenders who offer the stated income and low doc advantage programs all have a slightly different interpretation of the rules and guidelines.
If you ask your bank about stated income, it's likely that their rules are different than another bank. I suggest that speaking with a mortgage broker is better because they can provide you with choice and explain the nuances of the program through different lenders.
In general, the stated income program requires that you have 10% down. You will also need to provide documentation confirming you are self-employed. This could include GST return or business license or articles of incorporation, etc.. For income verification, you must provide at least 1 year (2 years for some lenders) of financial statements, notice of assessments and personal income tax returns.
When reviewing your income, the lender will calculate your net income after cost of goods and compare that to your taxable income (line 150). Your stated income should fall between these 2 numbers. The insurer and the lender will evaluate whether your stated income is reasonable compared to these 2 numbers.
For this program, you must also have very good credit. Your credit score must be 680 or higher. 679 is not high enough.
The default insurance premium is higher for this program than it would be for an income-qualified application with 10% down. You can find the premium chart for each lender here:
- Genworth Stated Income Insurance Premiums: Source
- Canadian Guarantee Low Document Advantage Premiums: Source
If you are self-employed, this can be a great option if you want to purchase a home where your taxable income doesn't allow you to qualify under standard criteria.
Purchase With 20% Down, How Many Years Should I Be Self-Employed?
If you have 20% down, you have more options. Lenders are a little more flexible with how many years you are self-employed. If you are in the same line of work, they will make exceptions to your length of employment. Two years is still the standard for A lenders, like banks, trust companies, credit unions, etc., but exceptions are available on a case by case basis.
"A" Lender Mortgage Financing
For these "A" lenders, you must still have good credit and your income should be close to that needed to qualify for the mortgage. With 20% down, the lender can calculate qualifying payments with an extended amortization of 30 years. With less than 20% down, the maximum amortization is 25 years.
If you qualify with an "A" lender, then you will be receiving best rates, or very close to best rates. Today, interest rates for non-default insured mortgages are higher than for default insured mortgages.
Why? Great question! Changes to default mortgage rules in January 2018 have created an increased cost to lenders for conventional mortgages and therefore they pass that cost on to consumers.
Alternate Lender Mortgage Financing
With 20% down, if you don't qualify with an "A" lender, then you could qualify with an Alternate Lender. The interest rate will be a little higher, typically ranging from 1.5% to 3% higher than mortgage rates offered by a bank, trust company or credit union.
With an Alternate Lender, income documentation requirements are much more lenient. These lenders are also more lenient toward bruised credit.
Many of these lenders will ask for 6 months to 12 months of business bank statements to review your cash flow. They want to make sure that the mortgage payments will be affordable for you. They also want to check that the income you claim to earn is reasonable based on your business bank deposits.
The interest rates are generally based on your credit score, which means the risk. The more bruised your credit, the higher the interest rate you will pay. These lenders also rely on the property.
The 5C's of Credit: 1 - Character; 2 - Credit; 3 - Capacity; 4 - Capital; 5 - Collateral
I talked about the 5C's of credit in this article, "How Much Mortgage Do I Qualify For?" Basically, lenders use these 5 C's when determining risk. The first three C's form a stool. If one of the 3 legs of the stool are weak, then lenders use the 4th C and 5th C's to shore up the first 3.
Under this philosophy, if you have weak credit and or weaker income confirmation, the lender will evaluate their exit strategy. The lender wants to be able to sell the property to get their money back.
Therefore, these lenders prefer to lend on properties that are in more salable locations. Questions they may ask:
- Is the property in good condition?
- Is the property in a remote location with limited sales activity
- Is the property a house or a condo?
The answers to these and similar questions will determine whether a lender will accept 20% down. They could ask for more down, 25% or 35% or 50%. They may just decline the application altogether.
If that happens with the Alternate Lenders, then the next option would be private lenders, some people call them hard money lenders.
Private Mortgage Financing
Depending on what you are doing, it might be the right choice to finance with a private lender. The interest costs are higher than alternative lenders. Lender/broker fees are also higher for this type of financing. It's not always in your best interest to arrange private financing for a purchase, but it could be.
I would suggest that you evaluate your situation to see what's best for you. Sometimes, it's best to rent for a little longer. Grow your business a little more and then qualify with better rates, better fees, and better cash flow.
Private lenders look at every situation differently. They want to know how they will get their money back. They want to balance the risk they are taking with the potential return. They don't really care how long you have been self-employed. Private lenders will look at you, your history, hear your story and then decide whether they would take that risk or not.
Let's take a look at some examples.
Investment Property Purchase
A client wishes to purchase a home. He found a property that needs renovations, he is a contractor. He can do much of the work himself. He has connections with other trades who he trusts to complete work he can't.
The private lender doesn't care how long he has been self-employed. The private lender will look at the property. The lender will also review the quotes for improvements and determine the value of the property once upgraded (per the quotes). This lender will offer the client 75% of the value of the improved value.
The client is purchasing this home for $310,000, the property is appraised with a present value of $325,000 and an improved value of $400,000. In this case, the private lender will finance $300,000, less fees. The investor must use his cash to pay for the improvements. He expects to generate a profit of $30,000 over 60 days, the anticipated completion & sale date of this project.
It's worthwhile for the investor to pay the higher interest rates and fees in this case so that he can get in and out of this project quickly with a tidy profit.
Self-Employed Client, Trying To Collect on a Lawsuit
A self-employed client has been in a lawsuit for several years related to his business. He hasn't filed with CRA and doesn't qualify with a traditional bank. He needs the money within the week. His lawyer is going to court and wants a large retainer. This client feels he will win and finally receive several hundred thousand dollars back. He needs $100,000 now.
This client owns a home. The value of his home is $1,200,000. He has a mortgage on the property already for $700,000.
A private lender would provide $100,000 financing plus fees. Interest rates are higher than a traditional bank and alternative banks, but he will receive this money in 4 days.
The lender doesn't care how long this client has been self-employed. The lender evaluates the situation, determines the risk and offers an interest rate and fees based on his evaluation.
These are just a few examples. There are many different scenarios where a private mortgage is a good option. Speak with a mortgage broker who has access to many sources of funds and can help provide insight into the best financing options for you.
I Own My Home, How Many Years Should I Be Self-Employed To Refinance?
If you own your own home, mortgage financing is slightly different than when you purchase. With traditional lenders, A lenders that I described before, you still need to be self-employed for 2 years. They will, however, make exceptions on a case by case basis.
Exceptions are made depending on how long you have been in the same line of work. Three to six months may be enough time if you were an employee for 5 years, then converted to a contractor for the same company. Three to six months may work in the same scenario if you switch companies but again, you are in the same line of work for many years.
Financing on an existing home with an A lender is capped out at 80% of the value of that home. If you want to finance more than 80% of the value, then we have to look at private financing.
The length of time required to be self-employed when you are financing your own home will vary. Two years is the bank standard. Exceptions can be made depending on your credit and your circumstances.
If you want to borrow higher than 80% of the value of your home, then some sort of combination of traditional financing and private financing will be required. Pricing, costs, etc will depend.
I always suggest speaking with a mortgage broker who can review everything and provide more options and choices than if you approach just one lender.
I Have Bad Credit, Do Years Self-Employed Matter?
If your credit is bad, bumped and bruised, then we will often have to turn to alternate lenders and private lenders. For these lenders, your length of time self-employed doesn't matter as much as the overall picture itself.
You could be self-employed just 6 months with a good strong cash flow. Even with bad credit, many alternative lenders would consider financing for you. The cost and interest rates will generally get higher the more bruised your credit is.
As you can see from all these examples, you have lots of options. When you are self-employed, the programs and choices open up for you much more than for an employee. If you have 2 years history, you can get the best pricing and lowest down payment. If you have less history or bruised credit, there are still options.
Speak with a mortgage broker who works with all the different types of lenders so that you can get a complete picture of what's available to you.