Mortgages and loans – harder for the self-employed?

Self-employed borrowers tend to get a more thorough look, says Rick Arnds, senior manager, emerging markets at Meridian Credit Union in St. Catharines, Ont. ‘Two years of financials tell us the strength of the business . . .’
(Rosa Park for The Globe and Mail)

As a self-employed website developer who had recently restructured his business, Greg Schmidt knew that refinancing his mortgage wasn’t going to be a piece of cake.

“I had a little bit of a line of credit built up from shifting the focus of the business and my car lease had come up for being bought out, so I needed money to take care of that,” said Mr. Schmidt, a single 42-year-old who owns a home in Toronto that includes an apartment for income. “It turned out the best way to go was to do a new mortgage, increase the amount of the old one and take care of those costs.”

However, when he approached his bank, he was told “the numbers didn’t work for them.”

For salaried workers, “the numbers” would simply be printed out in black and white on a recent pay stub or a T4 slip, proving their income. But for someone like Mr. Schmidt, who has various clients and no guaranteed paycheque from week to week, the requirements are more complex.

When lenders work with self-employed people, they have to rely on what’s called stated income, rather than verified income. Stated income is the amount of income the borrower attests to having, and which can be supported with documents such as tax returns, notices of assessment, contracts and financial statements.

Meridian Credit Union, for example, requires that business owners applying for a mortgage provide two years of financial statements and their most recent notice of assessment.

“The two years of financials tell us the strength of the business and the ability of the business to pay the business owner a reasonable salary for that business owner to have cash flow to repay debt,” said Rick Arnds, senior manager, emerging markets at Meridian in St. Catharines, Ont. “The [notice of assessment] tells us how much this person is actually reporting out back to the government as their income. There’s a balance between those two.”

That’s because business owners often report relatively small income after they have accounted for all of their expenses. They’re usually not subject to the normal gross debt service and total debt service ratio formulas, but lenders do look for a reasonable reported income, according to Mr. Arnds. For example, he said, a notice of assessment indicating annual income of $5,000 and a request to borrow $60,000 would raise a red flag.

Lenders will also assess the borrower’s assets. If someone is applying for a $400,000 mortgage and his notice of assessment doesn’t show income that would normally support that but his business owns vehicles and expensive equipment, the credit union will have a closer look.

“We would look at the situation and say, this is a strong business, it has strong assets that have been accumulated over the years, there’s a solid credit report with good repayment history and there’s cash flow within the business to repay the $400,000 principal residence loan,” Mr. Arnds said. “So we would probably give them the mortgage.”

Essentially, the lender needs to understand the borrower’s ability to service the debt they’re asking to take on. And the best way to do that, according to Richard Goyder, vice-president of personal lending at Royal Bank of Canada in Toronto, is for the lender to get to know the business and the business owner as well as possible.

“The best advice that I can give to self-employed people looking to take out a loan is to make sure that you have a relationship with your bank,” Mr. Goyder said. “When the bank is making decisions around whether to lend them money, those decisions are all around: How well do we understand this person’s business? How well do we understand their finances? And how well do we understand their ability to pay back this loan?”

Even if a business owner has a long-standing relationship with a lender, she might be denied the loan or mortgage she has asked for. In that case, Mr. Goyder said, the lender’s credit adjudicators will come back to the account manager or mortgage specialist and ask for additional supporting information or suggest a different way of structuring the loan. Or the loan might be offered at a higher interest rate.

“There may be an increase in the rate if you are high risk but, obviously, part of the point in the process of establishing income is to try to demonstrate that you do not represent a higher risk than somebody who’s on salary,” Mr. Goyder said.

In the end, Mr. Schmidt went to a mortgage broker, who secured a new mortgage for him with Merix Financial. The weeks leading up to the approval were stressful, he said, but it’s a stress he’s willing to take on if it gives him the freedom of running his own business.

“This happens once every couple of years, and all the benefits easily outweigh the reduced level of stress I have the other 59 months of the five-year term,” Mr. Schmidt said.

What you’ll need:

As a self-employed person, here are some of the documents you will need to apply for a mortgage or loan:

1) Tax returns and notices of assessment for the past two or three years

2) Financial statements

3) Confirmation that HST/GST payments are up to date

4) Contracts showing ongoing expected revenue

5) Personal credit score

6) Business credit score

If the lender is reluctant, you can bolster your case with these:

1) Co-signer

2) Bigger down payment

3) Proof of assets, such as business equipment, vehicles, property

4) Proof of skills, in case you were required to find a salaried position