A mortgage is inevitably the largest credit product many of us will ever take on. A mortgage brings on significant changes to the family budget. A mortgage is also accompanied by additional monthly payments for property tax, utility bills, possibly maintenance fees and more. It’s no wonder getting approved for a mortgage can be a challenge with the bank.
When applying for a mortgage, the bank’s task is to ensure the applicant can afford this high level investment. It’s the bank’s responsibility to ensure the applicant is not “in over their head”. That is why there are rules and regulations in place to guide the mortgage application process. The absolutely last thing the bank wants is to repossess your house due to default on payments. Think of how costly, disappointing and devastating it will be not only for you but also the bank. At the end of the day, the financial institutions are not in the business of repossessing, therefore they’d like to avoid these scenarios at all cost.
Applying For A Mortgage When You’re Self Employed
The mortgage application process is slightly tougher for individuals who are self-employed. Being self-employed means the income can vary year to year. The bank sees this variance as instability and unpredictability. In order for the bank to satisfy the income criteria and ensure the applicant will honour the monthly mortgage and property tax payments proof of income is required.
Proof of income for the self employed is composed of:
- 1040 Individual Tax Return Form – for the last 2 years (USA)
- T1 Personal Tax Return Form and/or Notice of Assessment for the last 2 years (Canada)
The above proof of income will show your earnings for each year. The bank will normally take the average of two years. In some cases the bank will add up to an additional 15% to the income to account for the expenses that were written off against your income. Keep in mind, the bank looks at net income (line 150 on the Canadian Notice of Assessment). This makes it more difficult to qualify because many self employed individuals write off many expenses causing their bottom line income to decline.
For example, if your before expenses income was $50,000 and the expenses written off totalled $20,000, then you’re showing $30,000 bottom line income for that year that is subject to tax. The bank will look at the $30,000 which may not be enough to qualify for a mortgage. This process then gives the incentive for self-employed individuals not to write off certain expenses or in reverse try and earn more business.
Unfortunately the bank will not consider the monthly statement print outs of income deposited. Many argue that there is proof of higher income going through their business checking account, however this is not official proof.
The options to overcome this self-employed barrier is to:
- Deduct less expenses to increase your annual income
Businesses run into all kinds of expenses, many of which are deducted at the end of the year tax return. Deducting expenses lowers the bottom line income, which the banks consider when assessing the mortgage application. Subtracting less expenses will increase the overall annual income, and may qualify the applicant for a higher amount of mortgage.
- Attain more business to increase your income
Consider taking on extra marketing initiatives for your service or product to gain more exposure and increase sales. Increasing income will potentially qualify your application for a higher mortgage amount.
- Apply for a mortgage with a 2nd or 3rd tier lender
There are the top banks with stringent rules and regulations, which are considered top quality, low risk lenders. There are also BB lenders, which may consist of credit unions, smaller private financial corporations and so on. These lenders are considered to be lower grade lenders, may have less strict lending criteria or may offer a higher interest rate in return for your high risk application. Ensure to read the fine print and go over the entire mortgage agreement first.
- Become employed
Some people may search for an employment while being self employed. If being self employed is not in your long term goals, consider applying for a mortgage once your name is on payroll.
- Put down a higher downpayment
If none of the above options are for you, consider saving for a higher downpayment. Putting down a larger deposit will not only save you money in interest but will also decrease the monthly mortgage payment, make it easier to be approved, and will allow for a more flexible monthly budget.
- Apply for a smaller mortgage
Sometimes it is simply better to search for a property that is within your given means. This may result in a smaller house or condominium. If none of the above options work for you, and the income that is indicated in your annual tax returns will continue to stay as is, consider settling down for a small mortgage, which may mean a smaller property in the short run. The plus side is, you will still be investing in property and building equity. Once the property value increases, you may use the gain to invest into your dream home.