The landscape of employment has seen a significant shift in recent years, as more and more individuals are opting for the freedom and flexibility offered by self-employment or are being forced into being one due to change in hiring practices at large firms. Being your own boss can bring numerous advantages if your skills are in demand, from setting your own schedule to pursuing your passion, but it also presents unique financial challenges. One such hurdle is securing a mortgage. In this blog, we'll delve into the complexities faced by the self-employed when trying to obtain a mortgage and explore strategies to overcome these obstacles.
Traditional employment generally provides a steady income and a clear paper trail of income, making it relatively straightforward for lenders to assess an applicant's financial stability. However, for the self-employed, income can be irregular, from different sources, and documentation may not fit neatly into the standard criteria required by mortgage lenders.
Here are some common challenges faced by self-employed individuals:
Documentation Hassle: Gathering the necessary paperwork to prove income can be a daunting task. Unlike traditional employees who can provide pay stubs or T4 forms, self-employed individuals must rely on tax returns, profit and loss statements, and bank statements, which may not fully reflect their earning potential. Document requirements can be even more onerous for individuals who have structured their business as a partnership or corporation.
Fluctuating Income: Lenders typically prefer stable, predictable income streams. Unfortunately, self-employment often comes with income fluctuations, making it harder for lenders to gauge an applicant's ability to make consistent mortgage payments. All Big Banks and Prime Lenders require at least 2 years of tax returns of the business to qualify the income. Challenges arise when the start of the business doesn’t align with a tax year and so the tax return of the 1st year might not reflect the true income potential. Or, if the income drops in a subsequent year on account of any reason. All these can result in the self-employed having to wait longer to have a sufficient qualifying income.
Perception of Risk: Self-employment is sometimes viewed as a higher risk by lenders due to the perceived instability compared to traditional employment. This perception can result in stricter lending criteria and higher interest rates, making it more challenging for self-employed individuals to qualify for favourable mortgage terms. The insured programs from the likes of CMHC offers some flexibility but it’s still subject to the lender or the bank’s qualification criterion.
Length of Self-Employment: Lenders often prefer applicants with a stable work history, typically requiring two or more years of self-employment before considering them for a mortgage. This requirement can pose a barrier for newer entrepreneurs or freelancers looking to purchase a home.
While obtaining a mortgage as a self-employed individual can present challenges, it can be surmounted with careful planning and preparation. Here are some tips to help you navigate the mortgage maze:
Keep Detailed Financial Records: Maintain thorough and accurate records of your income, expenses, and tax returns. Consider working with an accountant who can help you organize your finances in a way that is favourable to mortgage lenders. Most Prime lenders and Banks will insist you having accountant prepared financial statements and tax returns. Prior consultation with a knowledgeable mortgage broker can also help you organize this in advance instead of realizing key determinants close to buying a home. Important to note: Transactions in "Cash" will not be taken into account for revenue or income by any of the institutional lenders.
Build a Strong Credit Profile: A good credit score can compensate for other perceived risks associated with self-employment. Make sure to pay your bills on time, keep credit card balances low, and avoid opening new lines of credit before applying for a mortgage. Try to keep your business borrowings and credit lines distinct and separate from your personal borrowings.
Save for a Larger Down Payment: A larger down payment can help offset any concerns lenders may have about your income stability. By putting more money down upfront, you demonstrate your commitment to the investment and reduce the lender's risk. All self-employed borrowers need a minimum of 10% of the purchase price as downpayment in addition to funds required for closing.
Consider Non-Traditional Lenders: Explore alternative mortgage options, such as B lenders and credit unions, that may have more flexible lending criteria for self-employed individuals. Their programs generally do not require tax returns or financial statements. However, it is important that you keep your business accounts separate from your personal spending accounts. They will also require a higher downpayment, at least 20% of the purchase price in addition to funds for closing.
Obtain Pre-Approval: Getting pre-approved for a mortgage can give you a better understanding of your borrowing capacity and signal to sellers that you're a serious buyer, potentially giving you a competitive edge in a competitive housing market.
Securing a mortgage as a self-employed individual may require extra effort and patience, but it's certainly achievable with the right approach. By diligently preparing your financial documentation, maintaining a strong credit profile, and exploring alternative lending options, you can overcome the hurdles and achieve your dream of homeownership. Remember, perseverance pays off, and with careful planning, you can successfully navigate the mortgage maze as a self-employed individual.
Comments