Historical article note: This article was originally published on 2018-10-11. Rates, policies, home prices, statistics, product names and qualification standards reflect the environment at that time and may have changed. This archive is for historical record and general education only. It is not mortgage approval, investment, legal or tax advice.
In July this year, CMHC released a news that it would introduce an "enhanced version" of the new self-employed loan policy, aiming to make it easier for self-employed people to apply for mortgage loans. After everyone has been waiting for it for a long time, CMHC revised the self-employed loan policy on its website on October 1 and added the "Enhancement for Recently Self-Employed" section. Because this change was made quietly and was not published in the CMHC news, the media rarely reported it and did not analyze it randomly, which is a good thing. It is better to let professionals analyze professional issues. It is difficult for self-employed people in Canada to get loans. It is not just a day or two. What is the difficulty? How helpful is the “enhanced version” of CMHC?
Compared with borrowers with salaried income, the difficulty of applying for a mortgage loan for self-employed people is reflected in the stability of their income. Borrowers with salary income need to provide pay stubs, employer letters or T4 to prove their income level. Current income proof is sufficient. Proof of continuous income in the past two years is not required. New graduates only need to have the above documents to prove that they are engaged in a full-time fixed job. Self-employed persons must not only prove their current income, but also prove that they have had income of the same nature for at least the past two consecutive years and that their income is stable. Self-employed people are divided into: salespeople with commission income; owners of individual companies, partnerships, limited companies, etc. The types of income that can be used to support mortgage loan applications include: 1. Self-employment income, which includes: business income, commission income, professional income, etc.; 2. Salary income or dividend income dividends of the owner of a limited company. Regardless of the type of income, you need to look at the net income for the past two consecutive years. For example, some people report the income of real estate agents as commission income. The gross income is reported in line 166 of the T1 tax return, and the net income is reported in line 139. When the bank approves the loan, the income of line 139 is used as the income to support the loan. If you apply for a loan in 2018, the bank requires the applicant to provide the T1 tax returns of 2017 and 2016 to verify the average income of line 139. There are also some real estate agents who regard commission income as business income. Gross income is reported on line 162 and net income is reported on line 135. Then the bank needs to look at the income of line 135 for the past two consecutive years. If the same real estate agent reported his income in line 135 in 2016 and in line 139 in 2017, the bank would consider the income to be discontinuous and the loan would not be approved. For self-employment income, the same is true for limited company owners. If the personal income in 2016 is salary income provided by the company, and it is changed to dividend income in 2017, it will also cause the income to be discontinuous for two consecutive years and cannot be used to support loan applications. Continuity, continuity, continuity, self-employed people, when filing taxes one year before applying for a loan, be sure to look at how you filed taxes the previous year. You must maintain continuity. If you want to apply for a loan in 2018 and file your taxes in 2017, you must refer to your 2016 tax returns to maintain continuity.
In order to prove that self-employed persons have continuous and stable income, almost all banks require 2 years of continuous income, but the "enhanced version" of CMHC attempts to break this situation. From a practical point of view, the most regrettable thing is those applicants who have just switched from salary income to self-employment income for less than 2 years. Because these applicants are not aware of this requirement of the bank, they may have just changed the nature of their income before buying a house. For example, I worked in a salaried IT job from 2014 to January 2018. I quit my job in February 2018, registered a company by myself, and signed a service agreement in the name of the company. My hourly income was higher than my original salary. However, when I applied for a loan, the bank considered that I did not have a stable income from self-employment for more than two years and rejected the loan. The "enhanced version" of CMHC provides a solution to this situation, that is, if you have been self-employed for less than 2 years, you can infer future income by referring to your previous work experience, income, education, and whether you acquired an existing company. This innovative idea can really help startup owners with their loan applications. Everyone needs to pay attention to three points: 1. This project does not include self-employed people with commission income, but only owners of individual companies, partnerships, and limited companies; 2. Since July this year, CMHC has actively discussed with various banks since it had this initiative, hoping to obtain recognition from commercial banks and join this project. As of the deadline of this article, it is not clear which commercial bank has joined this project. 3. CMHC’s help comes at a cost, and the cost is the premium for loan default insurance.
In addition to continuity, the way banks determine the income of a self-employed person is also a decisive factor in the success or failure of a loan. For borrowers with salary income, in addition to recognizing the base income shown on the current pay stub, banks can also use the average T4 income of the past two consecutive years. The latter is suitable for applicants whose basic income is not high, but whose total income after adding bonuses and overtime is relatively high. However, the average can only be used if the T4 income of the most recent year is higher than the income of the previous year. For example, if the basic salary in 2018 is 80,000, the total income on T4 in 2017 is 90,000, and the total income on T4 in 2016 is 82,000, the bank can use (9+8.2) divided by 2 equal to 86,000 to support the loan application; if it is reversed, the total income on T4 in 2017 82,000, and the total income on T4 in 2016 is 90,000. The bank will use the most recent total income of 82,000 in 2017 to support the loan application, instead of the average of the past two years. Of course, the employer must be the same from 2016 to 2018 to determine income in this way. For self-employed people, the same principle applies: if the income in the most recent year is higher than the previous year, you can use the average income, and vice versa, use the income in the most recent year. If it is self-employment income, some banks allow an increase of 15% on the basis of net income. For example, if the average income of line 139 in the past two years is 50,000, the bank can use 5X115% = 57,500 to support mortgage loan applications. The "enhanced version" of CMHC uses this method, but excludes commission income and only applies to the income of owners of individual companies or partnerships. In addition, some banks that do not use the 15% increase in net income may consider adding some self-employed expenses back to the net income. The specific items that can be added back depend on the bank's internal policy. Applicants need to provide a Statement of Business or Professional Activities listing all expenses for the bank to add back. For applicants who open a limited company, their income can only be salary income or dividends, so there is no way to increase the amount by 15% or add part of the expenses back to the income. No matter which method is used, the income used by all commercial banks and CMHC to support mortgage loans is "personal income", not corporate income; it is based on past tax filing records, not the current income when applying for a mortgage loan. Self-employed people who are preparing to buy a house, or who have already bought an off-the-plan property and are waiting to hand it over, must pay special attention to the above problems caused by their special status.
The crux mentioned above are all difficulties in getting a loan due to ignorance and can be easily solved. The really difficult problem to solve is the low “personal tax income” of the self-employed. Taking real estate agents and insurance agents as examples, what we see is that commission income is not low. For example, the total income of T4A is declared on line 162 or 166, which is gross income, but when it reaches line 139 or 135 of net income, which is the taxable income line, the income is very low. Many salespeople who earn commissions spread some of their income to their families due to the idea of tax avoidance. Of course, a large part of the low net income is caused by cost deductions such as business expenses or marketing expenses. In short, borrowers with commission income are afraid that the tax bureau will “tax” their hard-earned money, which makes it difficult for them to get loans. Owners of sole proprietorships and partnerships think the same way. The owners of a limited company can pay themselves salaries, and they can also pay dividends and forward the company's income to themselves. You can pay Canada Pension Plan (CPP) through salary payment, which can be used as an expense to offset the company's income, and there will also be an RRSP contribution limit; the main benefit of paying yourself income through dividends is that the tax rate is lower, but there are no advantages in CPP and RRSP. The owners of a limited company choose different ways to pay themselves income due to different personal plans. Whether it is salary or dividends, as long as it is continuous, it can support the mortgage loan application. Self-employed people are troubled by how to balance company income and personal income: the income paid to themselves is high, and the personal tax rate is higher than the corporate tax rate, so they pay more taxes and feel heartbroken; they keep all the income in the company and give themselves less income. When applying for a personal mortgage loan, they may not be able to apply for a loan because their income is too low. What we see is that a large number of people with self-employment income, about 70%, tend to keep their income in the company, or actively use expenses to offset their personal income to try to reduce their personal taxable income. In other words, reducing taxes has a higher priority. As for applying for a mortgage, we will wait until then, and some miracles may happen. A friend who is doing business in China registered a company after coming to Toronto and returned to his old business. However, he clearly felt that doing business in China requires hard work to earn excess profits, while in Canada it is hard work to barely maintain operations and make a living. Canada has a sparse population and it is difficult for small businesses to grow big, so they care 120% about tax avoidance. I understand very well that self-employed people have such thoughts, but I still want to borrow a passage from a book to give some advice to self-employed friends. Chapter 7 of the best-selling book “The Road to Financial Freedom” by German writer Bodo Schaefer, the subtitle “The Self-Employed Must Build Wealth” says this: “Perhaps you try to invest all your money in the company. This is the most common mistake of self-employed people. Outside of your company, you are not accumulating other wealth. In this way, you make your personal happiness all dependent on the success of the company, hoping that the company will sell for a good price at some point. If you really want to invest a lot of money in the company, you should use OPM wisely, other people’s Money, go get a loan. Take the money (you deserve) out of the company and invest it in your own name.”
According to CMHC, 15% of Canada’s employed population is self-employed, and this “enhanced version” can only help a small part. The solution to the difficulty of getting loans for self-employed people lies not in bank policies, but in the income and financial intelligence of self-employed people. It is undeniable that some people who cannot find a place in the workplace are engaged in self-employment, so their income cannot be high. No matter how the loan policy is changed, it will not help. Another group of self-employed people started their own businesses because their abilities were underestimated in the workplace. As long as their financial intelligence improves, it shouldn't be difficult to apply for a mortgage loan. For taxpayers with an annual income of 93,200 to 144,000, the personal income tax bracket in Ontario is 43.41%. For every additional 10,000 yuan of personal income declared by people in this income range, they will pay 4,341 more taxes, and their borrowing capacity can increase by 50,000. Taxes: Borrowing capacity = 1:10. For self-employed people with commission income, there is no problem of business inheritance and sale. Since personal income is reduced, they are unable to get loans to buy houses and invest, which is really more loss than gain. Some banks provide special projects/programs for self-employed people, but they all require a down payment of more than 35%. Taking the average house price in Toronto of 800,000 as an example, a 35% down payment is 120,000 more than a 20% down payment. For self-employed people, if they report an overstated income of 24,000, how about buying a house with a 20% down payment as soon as possible? Or should I underreport my income by 24,000 and save an extra 120,000 for a down payment? This account is not difficult to calculate. Salespeople with T4A income do not have corporate annuities. After retirement, they rely on social security of 15,000 yuan a year. This is not a problem of living like a year, but a problem of being miserable. For small business owners, in the information age, time has become fragmented and even dusty; due to overcapacity, the real economy can no longer find rare commodities to produce, and nothing can be sold without advertising. Products are transforming from solid to gas. Only gas-based products such as online game equipment and cloud services have high gross profits. The industrial age concept of small business owners wanting to sell their business for a sum of money and use it for retirement is difficult to realize in the information age because changes are too fast and the company's survival time is too short.
Be kind to yourself, pay yourself more, make good use of financial leverage, accumulate personal wealth, and replace active income with passive income as soon as possible. You have to solve your own problems by yourself, so take action.