A good read for self employed, and/or Real Estate Investors, and/or Accountants.
The bulk of this content is aimed at self employed clients, however much of it spills over to Real Estate investors with multiple properties as they too are subject to greater documents disclosure and inspection than ever before.
However with the current trends much of what is set out below may soon apply to even the most basic of transaction with the most simplistic of scenarios.
I am often asked what is the biggest challenge prospective borrowers face these days. The answer to that question is ‘knowing what is required’.
I do not simply mean knowing which documents to have ready for your broker during that first meeting, instead it runs much deeper than that in particular for clients with investment properties or in particular those that are running their own business’. There are key steps that a self employed applicant needs to be taking today to ensure a smooth purchase or refinance transaction as far out as three years from now. Steps with regard to business license documentation, consideration of Dividend income, utilizing an accredited accountant to prepare not only business financials, but also their personal T1 General tax returns.
If you start a discussion with a broker or a banker about the changes to the lending guidelines over the past year you will likely be met with an eye roll and a heavy sigh, maybe even sagging shoulders. Frankly it has been extremely difficult for full time active brokers to keep up with the changes in the lending landscape – it has been just shy of impossible for the client themselves to have a clue how things have changed.
Many of these changes were not ones trumpeted in the news, such as the recent reduction in amortization for insured mortgages, rather they were quietly announced policy changes within the underwriting offices of Chartered Banks, Credit Unions, MBS (mortgage backed security) lenders, and even private lenders. All have tightened things up to some degree, most to an extreme degree.
The first sign to a client as to how things have changed is the significant increase in documentation requested for all mortgage files. The list for income confirmation for instance has grown from one or two pages, to several dozen.
Without exception we are being asked for T1 General tax returns, and in the case of a self employed applicant said T1’s MUST be accountant prepared. No two ways about it.
Furthermore, these T1’s are being combed over for clarity on sources of income. Have their been RRSP meltodowns, one time share sales, and are any rental properties in the mortgage application (and all properties in your personal name had best be on the application) that are not listed on the ‘Statement of Real Estate Rentals’ within your T1 General?
A rental with unreported income will not be allowed to have its income used for debt servicing. Thus your personal income needs to be that much strong to debt service the file in such an instance. Not a scenario that plays out well for most clients.
Where we were with (owner occupied) mortgages for self employed applicants;
Strong personal credit score and 35% down payment from your own resources?
One document;
- Please supply the most recent years Notice of Assessment to confirm no income taxes owing. Your line 150 personal income…not relevant.
- In many cases with one or two extra documents (2 years business licenses for instance) we could reduce the down payment to 25%
That was it.**Maximum Mortgage as high as 2.0M in my own experience.
Where we are today with (owner occupied) mortgages for self employed applicants;
1) Chartered Banks (Following changes primarily driven by the new B20 guidelines from the OFSI – http://www.osfi-bsif.gc.ca/app/DocRepository/1/eng/guidelines/sound/guidelines/b20_e.pdf )
Strong(er) personal credit score and minimum 35% down payment from your own resources?
Mandatory Documents;
- Two most recent years Notice of Assessment to confirm no income taxes owing ***and also to test reasonability of income exception being requested. (in most cases an income having to be ‘stated’ at over 100K will not be approved, nor will an income having to be stated at more than double the actual line 150 (from your NOA) reported income.
- Two most recent years (accountant prepared) T1 general Tax returns to confirm source(s) of income
Additional Documents that may be requested (in most cases much of this is typically requested)
- Two years Business license’
- Notice of articles to confirm shareholder status
- Two years ACCOUNTANT PREPARED business financial statements
- 6 – 12 months Corporate bank statements to demonstrate current cashflow
Maximum Mortgage now effectively 1M with most Chartered Banks
2) Credit Unions (not regulated by the OFSI
Strong(er) personal credit score and minimum 35% down payment from your own resources?
Mandatory Documents;
- Two most recent year Notice of Assessment to confirm no income taxes owing and also to test reasonability of income exception being requested.
Additional Documents that may be requested (in most cases much of this is requested)
- Two most recent years T1 general Tax returns to confirm source(s) of income
- Two years Business license’
- Notice of articles to confirm shareholder status
- Two years ACCOUNTANT PREPARED business financial statements
- 6 – 12 months Corporate bank statements to demonstrate current cashflow
Due to increased demand since the Banks tightening the Maximum Mortgage is now effectively 500K with most Credit Unions
3) MBS (non-bank) Lenders i.e. First National, Merix Financial, etc.
Strong(er) personal credit score and minimum 35% down payment from your own resources?
Mandatory Documents;
- Two most recent year Notice of Assessment to confirm no income taxes owing and also to test reasonability of income exception being requested.
- Two most recent years T1 general Tax returns to confirm source(s) of income
- Two years Business license’
Additional Documents that may be requested (in most cases much of this is requested)
- Notice of articles to confirm shareholder status
- Two years ACCOUNTANT PREPARED business financial statements
- 6 – 12 months Corporate bank statements to demonstrate current cashflow
Due to increased demand since the Banks tightening the Maximum Mortgage is now effectively 500K with most Credit Unions.
4) Insured Business – Applications put through under CMHC, Genworth, or Canada Guarantee insured programs
Strong(er) personal credit score and minimum 10% down payment from your own resources?
Mandatory Documents;
- 5% of down payment must be from personal resources, 5% can be gifted.
- Two most recent years Notice of Assessment to confirm no income taxes owing ***and also to test reasonability of income exception being requested. (in most cases an income having to be ‘stated’ at over 100K will not be approved, nor will an income having to be stated at more than double the actual line 150 (from your NOA) reported income.
- Two most recent years (accountant prepared) T1 general Tax returns to confirm source(s) of income
- Two years Business license’
- Notice of articles to confirm shareholder status
- Two years ACCOUNTANT PREPARED business financial statements
- 6 – 12 months Corporate bank statements to demonstrate current cashflow
In most instance sthe maximum property value cannot exceed 1M, and thus the maximum mortgage approval is 900K
A final footnote re Dividend Income. Most lenders treat dividend income as one time ‘bonus’ income and will not account for a scenario whereby you reduce your annual salary by 50% one year and replace it with the equivalent in dividend income, instead the lender sees only that your income has fallen by 50%. If Dividend income has been claimed for three tax years consistently then we can request an exception to have it allowed – however it is still an exception.
Bottom line, this is not the year to take your first dividend. Great idea tax wise, Disastrous idea Mortgage approval wise.
Being the owner of my own personal Corporation I certainly concur with my clients and their Accountants alike that this lacks logic. Arguing the point has proven fruitless, it is not something that is likely to change anytime soon and so we must work with it.
Assets – Why have I not touched on this topic? Aside from having 50K in liquid assets for each rental property in your portfolio (a condition a limited number of lenders apply) there is no significant weight put on assets.
It is not about how much you are worth, how much you own, how great your credit is, the huge retained earnings in your Corporation, the massive equity position in your properties, or how your family has never missed a payment in ten generations…it is all about Documented Line 150 personal income. That one thing is where the focus is.
Documented line 150 personal income.
Action Items
– Choose to pay more personal income tax this year, push the line 150 income up to account for any mortgage transactions you hope to make.
-Do not start a dividend income program this year.
-Make sure you have a 2012 Business license. The #1 reason I hear for not getting one from various trades ‘I work all over town’. Uh-huh, get one from the municipality in which you reside.
– Make sure you have an accredited accountant filing your taxes and/or preparing your business financials.
-connect your mortgage broker with your accountant at tax time and make sure the two are speaking with each other and that both are aware of your plans as per Real Estate moving forward.
-take a look at incorporating. Aside from liability advantages and tax advantages, moving forward sole Proprietors are going to have it more difficult that owners of limited corporations when it comes to financing. (I have been INC since I was 21 years old doing 18K in annual revenue.)
-Report all rental income on your T1 General, or via Hold CO Financials. Make sure those financials are up to date and filed.
-Keep impeccable records.
Thank you for your time.