Are you self-employed in Canada and thinking about buying a home? You’re not alone! The self-employed workforce has grown significantly in recent years, and many are finding the dream of homeownership is within reach. But, getting a mortgage when you’re self-employed can be a bit tricky. Lenders see you differently compared to traditional salaried workers, and that means you need to be well-prepared. So, what do you need to know before applying for a mortgage? Let’s dive into the details.
What Does it Mean to Be Self-Employed?
In Canada, being self-employed means you work for yourself instead of being employed by a company. This can take many forms. You might be a freelancer, a contractor, or even run your own small business. Whatever the case, you are responsible for generating your income, paying your taxes, and managing your business expenses.
Self-employment can offer great flexibility and independence, but it can also make things a little more complicated when it comes to getting a mortgage. Lenders typically like to see steady, predictable income—something that can be a challenge for many individuals.
Challenges Self-Employed People Face in Securing Mortgages
The biggest challenge self employed individuals face when applying for a mortgage is proving income stability. Unlike salaried employees who receive a regular paycheck, self-employed individuals often have fluctuating incomes. This makes it harder for lenders to assess your ability to make consistent mortgage payments.
Moreover, self employed individuals undergo higher scrutiny. Lenders may require more documentation to verify your income and financial health. This means that the mortgage process may take longer, and you’ll need to be patient and thorough in your preparations.
Why Mortgages for Self-Employed Individuals Are Different
When a lender assesses a traditional mortgage application, they look at your employment income as a key factor. For self-employed individuals, lenders see more risk because income might be less predictable. Even if your business is thriving, lenders may question whether you can maintain that level of income in the future.
Lenders typically require more financial documentation from self-employed individuals to verify income. This can include tax returns, financial statements, and more, which isn’t always the case for salaried employees.
The Importance of Income Verification
When you’re self-employed, verifying your income becomes critical. Lenders usually ask for multiple years of financial documentation, such as your Notice of Assessment (NOA), T1 General tax returns, and possibly even business financial statements.
This is where things get tricky. If you’ve been minimizing your taxable income through write-offs and deductions (as many business owners do), it could affect how much mortgage you qualify for. Lenders base their decisions on your net income, not your gross income.
Credit Score and Its Role in Getting a Mortgage
Your credit score plays a huge role in getting a mortgage, whether you’re self-employed or not. In Canada, a good credit score generally falls between 660 and 900. The higher your score, the more likely you are to be approved for a mortgage and get better interest rates.
If you’re self-employed, a strong credit score becomes even more important because it reassures lenders that you’re financially responsible, even if your income fluctuates. So, if your score is on the low side, you may want to take steps to improve it before applying for a mortgage.
Down Payment Requirements for Self-Employed Mortgages
Another factor to consider is the down payment. In Canada, the minimum down payment for a home is 5% of the purchase price, but self-employed individuals might need to put down more—sometimes as much as 20%.
Why the difference? Lenders view self-employed borrowers as higher risk, and a larger down payment reduces their risk. Plus, having a bigger down payment shows the lender that you’re financially stable.
Types of Mortgages Available for Self-Employed Canadians
There are several mortgage options for self-employed individuals in Canada:
- Traditional Mortgages: If you can provide sufficient income verification and meet all the criteria, you might qualify for a regular mortgage, just like any other borrower.
- Stated Income Mortgages: This type of mortgage allows you to “state” your income without providing traditional income verification. However, these are less common and often come with higher interest rates.
- Alternative Lending Options: If traditional lenders aren’t willing to work with you, there are alternative lenders who specialize in self-employed borrowers. They tend to be more flexible but often charge higher rates.
Preparing Your Finances Before Applying for a Mortgage
Getting your finances in order before applying for a mortgage is crucial. Here are a few tips:
- Pay down debt: The less debt you have, the better. Lenders like to see that you aren’t over-leveraged.
- Save for a larger down payment: The more you can put down, the better your chances of approval.
- Organize your financial records: Make sure your income is well-documented, including tax returns, NOAs, and financial statements.
How to Improve Your Chances of Getting Approved
Want to boost your chances of getting a mortgage? Here’s how:
- Build a strong credit history: Make sure your credit score is solid by paying your bills on time and managing your debt responsibly.
- Stabilize your income: If possible, show consistent income over at least two years. This will give lenders confidence that you can handle mortgage payments.
- Choose the right lender: Some lenders are more flexible with self-employed borrowers than others. Consider working with a mortgage broker to find the best options.
Lenders’ View of Self-Employment Income
Lenders look closely at your income, often averaging your income over the past two years to get a clearer picture of your financial situation. They may also consider the health of your business, your industry, and other factors.
Some lenders are more open to working with self-employed individuals, while others may be stricter. It’s important to shop around and find the lender that’s the best fit for your situation.
Mortgage Stress Test and Its Impact
The mortgage stress test is a requirement in Canada that ensures borrowers can afford their mortgage payments if interest rates rise. The stress test applies to all mortgages, but self-employed individuals may find it more challenging to pass because of fluctuating income.
Lenders will use the higher of the Bank of Canada’s benchmark interest rate or the mortgage rate you’re offered, plus 2%, to assess whether you can handle potential future payments.
Using a Mortgage Specialist
An expert mortgage specialist can be a valuable ally when you’re self-employed. They have access to a wide range of lenders and can help you find the best mortgage options for your situation. They also know which lenders are more likely to work with self-employed individuals and can guide you through the entire process.
Common Mistakes Self-Employed People Make When Applying for Mortgages
- Not having enough documentation: Make sure you have all the paperwork ready before applying.
- Failing to prepare for the mortgage stress test: Be aware of the stress test requirements and ensure you can meet them.
Conclusion
Securing a mortgage as a self-employed individual in Canada is certainly possible, but it requires extra preparation and documentation. By understanding the requirements, improving your credit score, and working with the right lender or broker, you can set yourself up for success. Don’t let self-employment hold you back from owning your dream home—just take the time to plan ahead!
FAQs
- What are the best lenders for self-employed individuals in Canada? Some of the best lenders for self-employed individuals include TD Bank, Scotiabank, and BMO. However, alternative lenders may also offer competitive options.
- How long should I be self-employed before applying for a mortgage? Most lenders prefer that you have been self-employed for at least two years before applying for a mortgage.
- Can I get a mortgage without showing my tax returns? It’s challenging but possible. Some lenders may offer stated income mortgages, but these often come with higher interest rates.
- What if my income fluctuates from year to year? Lenders typically average your income over the past two years to account for fluctuations, but this can still make getting approved more difficult.
- Are there special programs for self-employed mortgage applicants? Some lenders offer tailored programs for self-employed borrowers, but they usually require higher down payments or come with stricter terms.
