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What is a self-employed mortgage?

Homeownership is a pathway to financial and emotional freedom for many seeking to live the Canadian dream. For people with traditional employment, this means getting a mortgage that’s repaid over several decades.

But for the self-employed (as a growing number of Canadians are), it can be difficult to qualify for a conventional mortgage. That’s why self-employed mortgages were developed. In this guide, we’ll explore what these loans are, who they’re for, and exactly how they work.

Understanding the Basics: What’s a self-employed mortgage?

A conventional mortgage is simply a long-term loan. A lender (usually a bank) loans money to the prospective homebuyer allowing them to pay for the home outright. That loan is then paid overtime (often over an amortized period of 25 years). To ensure you are qualified for this loan and capable of repaying it, lenders will evaluate your financial situation. The most important metric the lender uses to evaluate your ability to pay back the loan is your income. The more money you make, the bigger the mortgage you can afford.

This is where self-employed people run into problems. Most self-employed people are diligent about deducting as many legitimate business expenses as possible. That includes transportation, office space, equipment, professional services, and so on. This allows small business owners to report a relatively low income, which keeps their income tax obligations small. But a low income, from a lender’s perspective, is a red flag. It means you can’t afford a major loan.

Self-employed mortgages are one solution to acquiring home purchase financing. They allow you to qualify for a mortgage by providing alternative documentation to prove your financial liquidity. This can include tax documents, customer invoices, bank deposit slips, and so on. The financial benchmarks you need to hit may be loose or stringent, depending on the type of self-employed mortgage you acquire. Generally speaking, you’ll need to provide more evidence of your earnings to obtain lower interest-rate mortgages.

Who is considered “self-employed” in Canada?

To be considered self-employed, you need to run your own business, either alone or with a partner. For example, sole proprietors or small companies, freelancers, commission sales workers, fishers, and farmers are all self-employed. If you find clients and generate sales directly, rather than receiving paychecks from a traditional employer, you are self-employed. While rules vary, many lenders require that you have been self-employed for at least two to three years to qualify for a self-employed mortgage.

The three major types of self-employed mortgage.

Self-employed mortgages are roughly grouped into three categories:

• ‘A Lender’ self-employed mortgages: These are issued by the “Big Six” major banks of Canada. They tend to have the lowest interest rates (which is good for you, the borrower) and the most stringent financial requirements. These are the most competitive mortgages and many applicants may be denied.

• ‘B Lender’ self-employed mortgages: These are issued by smaller regional banks and other lenders. They tend to have less strict financial requirements – but they also cost you more overtime, thanks to higher interest rates. B lenders face fewer regulations than the big banks and take more risks in the loans they issue. They may be willing to consider alternative types of documentation that A lenders would not allow.

• ‘Stated income’ self-employed mortgages: These are entirely unregulated mortgages. They are issued by very small lenders (known as “private lenders”) that are willing to take big risks. The documentation requirements are minimal: you simply need to state your income (hence the name) and the lender will take you at your word. The interest rates on stated income mortgages are extremely high, reflecting their unregulated nature. Private lenders can be corporations, groups, or even individuals who make loans on a one-to-one basis.

Requirements to get a self-employed mortgage.

The most important thing to understand about qualifying for a self-employed mortgage is that every lender is different. This means financial benchmarks and documentation vary considerably – especially between A lenders, B lenders, and private lenders. That said, there are some rough guidelines you can expect to encounter:

• Financial requirements: The lender will consider your income by reviewing line 150 on your income tax returns from the last few years. They will also need to see your Notice of Assessment (NOA) for recent years to confirm you have no tax arrears outstanding. Additionally, your mortgage lender will likely assess your Total Debt Service (TDS), which is a number that compares your total debt (including the mortgage and any other outstanding loans) to your total income. Finally, the lender will consider your credit report, generally looking for scores in the “good” to “excellent” range. (See the table below for more specifics.)

• Business requirements: You need to be self-employed and most lenders will want to see that your business has existed for a minimum of two to three years. You will probably need to provide your Articles of Incorporation as well as a business number or GST/HST account number.

• Down payment requirement: Conventional mortgages require you to make a down payment, and self-employed mortgages are no different. The down payment is simply a portion of your total home cost which you pay upfront, out of pocket. Different lenders have different requirements, but they generally range from five to 25%. In other words, if your new home costs $300K, you can expect to pay $15K to $75K upfront.

• Mortgage insurance requirement: In some cases, you’ll be required to get mortgage insurance (also known as “mortgage default insurance”). This is an insurance policy you pay for in addition to your monthly mortgage premium costs. It protects the lender financially in case you ultimately can’t make your payments and default on the loan. Paying for mortgage insurance may mean you’re allowed to make a lower down payment.

• Maximum mortgage size: Lenders cap the total size of your mortgage. This ceiling varies a great deal depending on the lender’s risk tolerance and the specifics of your financial situation. It may be just a few hundred thousand dollars or well over one million.

Should you get a self-employed mortgage? The pros & cons.

Getting a self-employed mortgage is a major life decision, with both drawbacks and advantages to consider. Let’s review some of these pros and cons:

• Cons of getting a self-employed mortgage:

  Buying a home is a powerful financial move that can pay off in the long run – but it also requires a huge initial buy-in. For many people, that down payment is a very unattractive (and perhaps impractical) part of the self-employed mortgage experience. If you’re not prepared to have tens of thousands of dollars tied up in a non-liquid investment, homeownership might not be the right financial move for you.

  Of course, homeownership also ties you up geographically. And for some small business owners, mobility is very important. If thriving financially means you need to periodically pick up and relocate, a self-employed mortgage may be more trouble than it’s worth. Finally, you should consider whether the rates available to you are advantageous. Some self-employed mortgages (especially stated income mortgages) come with extremely high interest rates. If that’s your situation, you may be better off renting.

• Pros of getting a self-employed mortgage:

  For most people, a mortgage (whether self-employed or conventional) is an unavoidable step on the path to homeownership. And with homeownership comes incredible financial and emotional benefits. There can also be perks that feed back into your business. If your new home provides a better workspace or more room to store inventory, it may pay for itself in sheer business growth.

  A self-employed mortgage can also be a tremendously effective way to invest your money. The Canadian housing market has grown by about 6% annually for the past 15 years. If it continues growing at that pace (which is, of course, not guaranteed), the cost of your mortgage could be hugely outweighed by the windfall you reap upon selling your home. In other words, real estate investment is a powerful way to leverage your capital for a brighter financial future.