Breaking down self-employment, the aftermath of the global recession, and what it all means at the mortgage table.
Did you know that one in six (16%) of working Canadians are self-employed? If this is or will be you or someone you know, and you are thinking about buying a home, please take a moment to understands how the new self-employed income documentation rules affect mortgage qualifying.
First of all, to get a mortgage in Canada you need a reliable income, and how you document or show that income is critical to preserving your mortgage options.
Documentation requirements have tightened considerably in recent years predominantly due to sloppy mortgage lending practices in the USA that began in the mid-1990s and peaked in 2006 as western economies tumbled into a world-wide financial crisis and a lingering global recession.
In the after-math of this debacle, the world's leading economies, the G-20, vowed to never allow the mortgage-rot that prevailed in the US financial system to happen again. The G-20 met and created a new set of standard mortgage lending guidelines for consistent world-wide use. In Canada, the new rules were called "OSFI B-20" and took full effect in late 2012. These new B-20 rules created significant challenges for those who were self-employed where the applicant no longer met the income documentation rules that historically had worked when seeking mortgage financing.
To better understand this new internationally-consistent process of income confirmation, here are a few key definitions:
Traditional Income Confirmation: This is known as the norm for employees of a company. This means that you meet a set of criteria:
- You make money.
- Your income can support the mortgage payment and your other debts.
- You consistently report your income on your personal tax returns.
If you meet this set of criteria, you can get a mortgage with as little as 5% down payment.
Non-Traditional Income Confirmation: This means that you meet this set of criteria instead of traditional confirmation:
- You make money.
- You can prove you make enough money with a combination of banking statements, business financial statements, business tax returns, etc.
- Although you can prove the earnings, the income does not show up on your personal tax returns.
If you meet this set of criteria, your minimum down payment will be 10% and your interest rate will also be a touch higher. Additionally, an insurance risk premium (~2.75% of the property value) is added to your mortgage balance, and the types of property you can own is also restricted. (Yikes!)
Stated Income: This means you aren’t traditional or non-traditional and you are simply unable to confirm your income. Because of this lack of confirmation, the federally-regulated banks must tag your mortgage as "non-conforming," which means your down payment will be about 35%. Lending options get less, interest rates are higher, and further restrictions on the type and location of the property you can finance are restricted as well. You may also find that you have turn to private or alternate lending sources as federally-regulated banks have now bowed out.
In summary, the often-quoted advice for business owners to minimize income by maximizing expenses could backfire at mortgage time. This could lead to a rejected outcome, added expenses, headaches and restrictions.
There is some good news though; a competent Mortgage Planner and your Tax Accountant can help you manage these B20 rules. For a complimentary situation assessment, please contact us.
Follow the OSFI B-20 link for more information on the latest implementation of the mortgage qualifying rules or continue reading below.
More Background on B-20 and the Impact on Mortgages
- In late 2008, the world became painfully aware that it was being rocked by a global financial crisis and the start of what later has been called the "Great Recession." The crisis has been blamed on sloppy mortgage lending practices, particularly in the USA, that caused real estate prices to unrealistically escalate during the decade, then plummet (a.k.a. "the bubble burst"). Globally, financial Institutions that lent the mortgage money or who otherwise owned sophisticated financial investments tied to the value of US real estate were significantly damaged, as were countless families that lost their homes or their retirement savings. (Check out the 2015 film, The Big Short for a mind boggling explanation of this complex topic.)
- The damage spread like wildfire and entire countries beyond the USA, like Ireland, Iceland, Portugal, Italy, Spain, and Greece (to name a few) were caught in the mess compounded by their own problems. Thankfully, Canada emerged as a global leader in (more) prudent mortgage lending practices and the impact was far less here.
- The "NINJA Mortgage" was thrust into the spotlight as a category of particularly risky lending seen by many as a root cause of the problem. NINJA stood for No Income No Job or Assets and was a popular mortgage solution for the self-employed (even in Canada), where the mortgage applicant stated how much income he or she made, and the burden of proof was very low. The global rule book has now changed!
- In the aftermath of the crisis, finance representatives of the world's 20 most important countries/economies (the "G-20") met and - among other things - created a set of rules to ensure the world economies would never again be so damaged by such sloppy mortgage lending and investment practices.
- Part of the process was the creation of an international standard for lending. In Canada, the mortgage rules have manifest as the B20 Underwriting Guidelines for Residential Mortgages, fully effective as of December 31, 2012.
- These rules significantly create challenges for self-employed (business-for-self or BFS) clients, particularly those who do not have traditional income confirmation documents (personal income tax filings, Notice of Assessments, etc.)
- To learn more click OSFI B-20.