As a result of sloppy mortgage lending practices starting in the mid-1990s and peaking in 2006, particularly in the USA and the subsequent global recession, the world's leading economies subsequently met and created a new set of standard mortgage lending guidelines for essentially the world. In Canada, the new rules called "OSFI B-20" took full effect in late 2012, and then in November 2014 round 2 or OSFI B-21 was finalized further aimed at enforcing consistency in mortgage underwriting and approvals.
These new rules create significant challenges for self-employed seeking mortgage financing who cannot easily confirm they make enough income to safely pay their mortgage and other debts. Let's take a closer look at how a self-employed borrower can prove their income:
In summary, the often-heard advice for business owners of minimizing your income by maximizing your expenses could BITE YOU HARD at mortgage time and could lead to either a "rejected" outcome, or added expense, headaches and restrictions.
The Good News:
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It's important to be current with your Income Tax, as it impacts your ability to qualify for a mortgage in Canada (or not).
SUPER-PRIORITY - ouch. What the heck is that and why should I care? If you want to get a mortgage and income tax isn't you favourite topic, time to learn.
It is very important to understand the term Super-priority Claim, which simply means Canada Revenue Agency can put a claim on all your assets if you don't pay your taxes, including seizing and selling your house! Mortgage lenders don't like that as it puts them second in line to get paid back and there might not be enough money left over for that. Notice neither the CRA nor the bank will care about you when this happens - they are just going to squabble over who gets the house and the CRA is going to win. So lenders will not lend you money if you cannot prove you are current with your income taxes! (This applies to all secured-loans, including vehicles.)
Your Notice of Assessment is an important document that you get back from the CRA after you file your taxes - it says the CRA agrees (or not) with your tax filing. While many of us tend to focus on the refund cheque (hopefully), mortgage lenders are focusing on if you owe money and will require you to prove your taxes have been paid before lending. When you get your NOA back, immediately file it with your other tax documents. If you don't have a filing system, you can get an accordion filing folder for as little as $7 at Wal-Mart.
If you have misplaced a NOA, call the CRA at 1.800.959.8281 and request a replacement or an "Income & Deduction Summary", which can be used as a substitute.
Also important for a borrower with non-guaranteed employment hours (or self-employed), you can use your NOAs (average of last 2) to prove what income you earn for mortgage qualifying. Even if you have guaranteed hours, you can get credit for overtime worked using the NOAs. So file them safely!
Self-employed, especially newly business-for-self (or "BFS" as we call you), please be very aware of income proof and income tax train-wrecks. Here's what happens: you start your business, the coin starts rolling in, but you don't set any aside for taxes because CRA does not yet require you to make monthly or quarterly tax payment installments. So the money disappears until at some point you try to get a loan and discover you can't prove via a current NOA that 1) you are current with your personal taxes, or 2) that you actually earn income (line 150)! Guess what? The Government wants you to pay taxes and they have it all figured out. So you finally do your taxes to discover not only do you have back-taxes owing, you also have future tax installment payments to start making, and your down payment savings and cash flow just dried up! So did the prospect of getting a mortgage any time soon. Don't go there - contact us if you need an accountant referral.
A final word on BFS. While your accountant might suggest that you maximize business expense deductions to minimize the taxes you owe, this can be a double-edged sword if you also want a mortgage any time soon. Low personal income (per Line 150 of your NOA) usually means you limit how much of a mortgage you can qualify for. I think a better BFS tax-reduction strategy is to contribute to an RRSP with after-tax dollars, then - if you are eligible - use the First Time Home Buyer Plan to take the money out for down payment tax-free.
Still have questions?