Buying a Home When You’re Self-Employed

Are you your own boss?

During the coronavirus pandemic, self-employed Canadians accounted for nearly one-fifth of all workers. But times have ostensibly changed in just the last year alone as growth in the number of self-employed Canadians has flatlined. In fact, it is down from the crisis-era peak by about five percent, according to data provided by Statistics Canada.

Still, despite the downward trend in self-employment, many Canadians continue to work for themselves, which comes with its advantages and disadvantages. If you are in the market to acquire a residential property in today’s Canadian real estate market, you might come across some unique challenges compared to prospective homebuyers who are traditionally employed.

So, what should you do when you are self-employed and purchasing a home? Here is what you need to know about buying a detached house, townhome, or condominium.

Buying a Home When You’re Self-Employed

1. Stated Income

Self-employed Canadians will possess variable income, so showing that you generate consistent earnings can be tough when seeking approval for your mortgage applications. Indeed, self-employed people do not have traditional pay stubs, and their tax returns might not accurately reflect current income as some deductions and variables differ for self-employed people.

Solution: Keep thorough and accurate financial records for the business and ensure these records can be verified through other documentation.

2. Proof of Income and Business Stability

Third-party mortgage brokers and banks require proof of income for approval.

For self-employed people, this usually means tax returns, detailed financial statements, numerous invoices, and other paperwork that would provide proof of income. Some lenders might even require multiple years of tax returns to establish a reliable income history, and even then, financial institutions might remain unconvinced of the exact annual income of a self-employed worker.

Solution: Be sure to have a tax accountant to ensure tax returns are filed on time and accurately reflect self-employed income.

3. Seasonal Income

If a self-employed business has seasonal income fluctuations, lenders may not be comfortable approving a high mortgage as they are unsure of the individual’s ability to make consistent mortgage payments.

Solution: Build a credit history and maintain a good credit score to improve your chances of approval.

4. Initial Down payment

All homebuyers need a down payment, typically between five percent and 20 percent of the purchasing prices. But it all depends on how much the home costs, so you might be required to have a minimum down payment of 20 percent. Moreover, self-employed individuals are often asked to put down a larger down payment. This is because lenders want to mitigate the risk associated with self-employed income as they consider it highly variable, and, as a result, they are considered high-risk borrowers.

Solution: Save enough for a substantial down payment, as this can significantly improve the chances of mortgage approval.

5. Passing the Stress Test

Mortgage lenders use a stress test to ensure borrowers can handle interest rate variations. Passing this test is often more difficult for self-employed individuals, who are evaluated against more stringent standards. This is because it is often difficult to determine a self-employed person’s ability to handle payment increases, and they are evaluated more strictly than those who are traditionally employed. When you factor in today’s rising-rate climate, it becomes even more challenging to pass a stress test with flying colours.

Solution: Know how much you can afford with a mortgage stress test above seven percent.

6. Higher Mortgage Rate

Since self-employed individuals often struggle to go through the regular lender, borrowers may have no choice but to turn towards specialized mortgage options that usually come with slightly higher interest rates or stricter qualification criteria.

Solution: Find a mortgage broker who specializes in working with self-employed individuals, as they can help you find lenders that are more open to approving mortgages for self-employed people.

7. Debt-to-Income Ratio

Most lenders assess an individual’s debt-to-income ratio to determine their ability to handle mortgage payments. Self-employed individuals can possess high business expenses, hampering the ability to meet the lender’s debt-to-income requirements.

Solution: Pay off your debts, such as automobile loans, credit cards, and personal lines of credit, before you apply for a mortgage. In addition, try to minimize all of your business-related debts.

An Important Reminder

Of course, no matter how prepared you are, it is crucial to remember that all lenders maintain their own criteria. Indeed, mortgage lenders’ criteria for self-employed people will differ from those traditionally employed. Ultimately, it is imperative to evaluate your options, understand the strengths and weaknesses of your business, acclimate to market conditions, and make an effort to locate lenders who understand your business and your needs.