Self-employed mortgages as we know it is fast becoming a dinosaur. Stated income mortgages are a thing of the past and more and more self-employed clients are having difficulties either qualifying to buy a house or qualifying to refinance the property they currently own. Almost all the mortgage agents I know of have clients who fall in this category. Like me they have been advising their clients for years that they need to declare more of their income in order to qualify for a mortgage.
What is a stated income mortgage? Previously lenders would accept the income declared by a self-employed individual as long as
- They could prove that they were in business for at least two years
- Provide their business registration to prove business existence
- Prove that they have filed their tax return in the last two years
- Have no income tax owing have a beacon score of 680 or more
Self-employed clients are savvy in avoiding income taxes so they reduce their income as much as they can. Those who collect cash don’t usually let that income pass through their accounts and thus lay the dilemma. New regulations require that the borrower provide proof to the lender that he/she is making enough to afford the mortgage payments (principal and interest payments plus property taxes) and all other outstanding debts on the credit bureau at the time of closing the mortgage. There are five criteria of getting a mortgage which will be discussed later but a borrowers capacity to pay the mortgage has been the main reason why many self-employed borrowers get declined with their mortgage application
Assuming your mortgage principal, interest and tax payment is $1,751.07 and the total payment of the other debts (car loans, credit card payments etc.) is 739.38, your total monthly obligation for mortgage qualification is $2,490.45. The lenders use a ratio to qualify a borrower and depending on your credit score there are different ratios. For this scenario I am going to use a Gross Debt Service GDS of 35% and a Total Debt Service (TDS) of 42%.
So what is your GDS? Your GDS is the amount of your income that a lender allocates for your mortgage payment (mortgage principal and interest plus tax payment plus 50% of a condo fee if you are buying a condo). In this scenario we are using 35% of your reported monthly income. So in our example if your mortgage payment is $1,751.07 then your monthly income before taxes should be $5,003.00. Your TDS (mortgage principal and interest plus taxes plus 50% condo fees and all other debts) which in this instance is $2.490.45. Now to qualify for a mortgage the monthly income should be $5,929.64 or $71,155.68 annually.
If you cannot satisfy those requirements then you are likely going to have difficulties getting the mortgage approved and from what I am seeing changing the culture of self-employed borrowers is a slow process. They are existing in two different worlds. For four years they try to minimize taxes as much as possible and in year five when their mortgage matures (or any other time when they want a refinance) there is disappointment that the income isn’t enough to get them a bigger mortgage.
It’s especially harder to refinance as when some of these current crop of owners bought their houses there was no income verification, stated income, no money down and so many other features to put people in a home. Now the criteria’s are close to similar to those of a salaried borrower and most self-employed refinancers aren’t prepared as the lenders will sometimes require as many as 12 months bank statements to prove that the annual income is similar to what is stated on the application.
These days in addition to the borrowers Notice of Assessment, lenders will require audited financial statements or a review engagement financial statement prepared by a practicing accountant. The income for the last two years will be average to determine the income and if the income has fallen by more than 10% the most recent year they will use the lower income. Conversely if the income has increased year over a year over the last 4 years they will use the most recent year’s income.
There are five things that a lender looks at when approving a mortgage, Credit – What’s on your credit report or how you use your credit. Character – are you believable or do you do the right thing like making your payment on time, are there any judgment, collection etc. Collateral – when they lend you money they are also owners of the property. So they ask themselves if they would like to own that property. Lenders are only interested in collecting interest so their only concern is how quickly they can sell should a borrower default. Capital – How much are you investing in the property and all these proponents are inter related as if they love your character, credit and character then your down payment is lower, but if they think you are a high risk then your rate is higher and your capital requirement will be more. Finally Capacity – This is your income, more and more lenders are looking at peoples capacity to make the payments and so they are asking for more information on income to make sure that unless something unforeseen happens there is the belief when the mortgage is approved that you will be able to make the payments for the term of the mortgage.
Increasingly lenders have been looking at credit and capacity. Currently you have to have a down payment to buy and when you refinance you have to have 20% equity (15% if you get a second mortgage) (your collateral) and your character determines your credit. So if you don’t have adequate credit you won’t be financed (unless you go to a B lender and they have their cut off criteria as well). And you definitely will not be approved if you don’t have the capacity or thin income showing going through your bank account(s) satisfying both the GDS and the TDS.
I advise my clients to talk to an accountant who has a relationship with a mortgage agent or agents who can interpret the need of a self-employed individual to reduce taxes but also understand what needs to be done (add backs etc.) to have their clients qualify for a mortgage either to purchase or refinance when that time comes.
I do a lot of work in the self employed market and with creative financing there are countless solutions and with numerous lenders having their niche getting an approval is not as daunting as it seems. Due to these issues I have temed up with lenders who have an appitite for these mortgage and we have had a lot of very satisfied and happy clients.