Being self-employed comes with plenty of perks; a flexible work schedule, no boss but yourself and the ability to take your career in any direction you want. But, it’s not all a bed of roses; self-employed people have a harder time of getting approved for mortgages compared to everyone else. Fortunately, as the number of self-employed people in the country now exceeds 15%, things are slowly changing for the better.
Having said that, if you’re self-employed and have buying a Waterloo Region home in your sights, it’s important to know what to expect along the way. With that in mind, let’s take a look at some things self-employed people need to know about buying a home.
It May Be More Expensive
To a lender, self-employed people are typically viewed as higher risk customers. As such, they tend to protect their investment by tightening the rules and may charge higher interest rates or insist on a larger minimum down payment.
With that in mind, it can pay to save for a larger down payment, with some lenders offering special mortgages for business owners and self-employed people with a down payment of 30% or more.
You’ll Need to Provide 2 Years of Documentation. Maybe
For most people, getting a pre-approved mortgage is relatively simple. And for the self-employed, the initial steps are much the same. You’ll need to fill out an application form, supply supporting documents, and sign the paperwork. Even the criteria for down payments, credit scores, and debt to income ratios are typically the same.
However, when it comes to providing proof of income documents, things get trickier. Most people simply hand over their pay stubs and T4 tax slips, but for the self-employed, you’ll need to get a certified accountant to supply financial statements, notices of assessment, and 2 years worth of tax returns. This means that accurate, meticulous record keeping is a must.
When applying for a mortgage as a self-employed person, there is another option open to you, that removes the arduous task of proving your income. You can simply tell the lender how much your income is, rather than providing documentation and tax returns from the past 2 years. Not everyone qualifies for this option, however.
Generally, you need to be able to prove that you worked in the same profession for the 2-years before you became self-employed. Lenders then take an average income figure for that profession. Stated income products are a little more complicated, and not every lender will agree to the practice.
It Pays to Plan Ahead
As we said, most lenders require at least 2 years worth of documentation as proof of income before they will consider your request. If you plan for this however, you can tilt the balance in your favor. During this 2-year period, it might be in your best interest to keep your deductions as low as possible, thus increasing your income, which will help when you apply for a mortgage. It’s a double-edged sword however, as this will increase your income tax.
The best advice is to speak to a mortgage professional long before you plan to make the move. In this way, you can see exactly what products are out there, and which option is the best for you. With this information, you can better plan how you manage your income.
Income Tax vs Interest Rates
Most self-employed people declare many expenses to reduce their net income in order to lower their income tax rate. However, this may not be the best course of action when applying for a loan, as lenders will want to calculate your income-to-debt ratio — i.e., how much of your income will go towards paying off debt. Ideally, this figure should be around 35-44%, but if you’re deducting a lot of expenses in a bid to reduce your income tax, your ratio may appear higher.
Weigh up how much you’d be paying in interest rates on a lower net income, compared to how much extra you’d pay in income tax if you weren’t to deduct as many expenses. You might find that it actually pays off to pay the marginally smaller interest rates, compared to the extra income tax.
Keeping Your Credit Score Up is Essential
As a self-employed person, it’s even more important than ever to ensure you have a healthy credit rating. Keep on top of payments and debt management, and aim for as high a credit rating as possible. Doing so can help reduce the higher interest rates you’ll be expected to pay as a self-employed borrower. The more you can prove you’re not a risk to the lender, the more generous they will be with their rates, and the more likely you are to qualify for better products.