Many people today than ever work on contract. They usually are incorporated (especially if they want to work on government contracts), work through a recruiting firm for a client, invoice the recruiting firm for their hours, and pay themselves out of their corporation. Contractors are self-employed professionals, not employees. Unfortunately, contractor income isn’t as straightforward as an employee’s income, and so it can be difficult for contractors to get a mortgage, especially through a bank.
Fear not!
Declared Income (Personal vs. Business Income)
Consistency and Stability of Income
When qualifying income for a mortgage as a self-employed person, how you label or categorize your income can have a significant impact on how it’s assessed by lenders. Here’s how reporting your income in different ways can affect your mortgage application:
Declared Income (Personal vs. Business Income)
Personal Income: If you declare income as personal income on your tax returns, it is typically considered straightforward by lenders. This income will be reflected on your T1 General, Notice of Assessment (NOA), and possibly T4 slips if you draw a salary from your business. Lenders generally prefer to see a consistent and sufficient personal income over a few years.
Business Income: If the income is declared as business income, lenders may scrutinize it more closely, particularly if your business income fluctuates significantly. They might require detailed financial statements, including profit and loss statements, to determine the sustainability of this income.
Salary vs. Dividends
Salary: If you pay yourself a salary from your business, this is treated as personal income. Lenders often view a salary as more stable and predictable, which can be beneficial when qualifying for a mortgage.
Dividends: If you take income from your business in the form of dividends, lenders will still consider it as personal income. However, since dividends can vary from year to year, some lenders might average your income over two or three years to assess consistency. Dividends can also be grossed up (i.e., increased) for qualifying purposes because of the preferential tax treatment, which might help you qualify for a larger mortgage.
Gross Income vs. Net Income
Gross Business Income: If you focus on your business’s gross income before expenses, it might present a rosier picture of your financial situation. However, lenders are more interested in your net income (after expenses), as it reflects the actual earnings you have available to cover mortgage payments.
Net Income: This is the income remaining after all business expenses have been deducted. It’s critical for mortgage qualification because it represents the funds you have available to meet financial obligations. Lenders often base their decisions on net income, so if you reduce your taxable income significantly through deductions, it might lower your mortgage qualification amount.
Retained Earnings
Some self-employed individuals leave earnings in their business rather than withdrawing them as personal income. While this can be beneficial for business growth and tax deferral, it can be a challenge for mortgage qualification. Some lenders will allow you to use retained earnings as part of your income calculation, but you will need to provide detailed financial statements, and this approach may not be accepted by all lenders.
Stated Income Programs
Some lenders offer stated income programs for self-employed borrowers, where income is declared based on what the borrower states they earn, rather than what’s reported on tax returns. These programs often come with higher interest rates or require higher down payments, and the borrower may need to provide a reasoned explanation for discrepancies between stated and declared income.
Consistency and Stability of Income
Regardless of how income is labelled, lenders prefer to see consistency and stability in your earnings over a period of time (typically two to three years). Large fluctuations or significant year-over-year changes in how income is labelled might raise concerns for lenders about the reliability of your income.
To demonstrate your income to qualify for a mortgage as a contractor, you’ll need to provide additional financial information to support your mortgage application. Depending on how you report your income, how you pay yourself, and how best to represent you to a lender, be prepared to have the following:
Documentation
- Articles of Incorporation
- 2 years of business financials (see your accountant)
- 2 years T1 Income Tax Return
- 2 years T2 Corporate Tax return and related schedules
- 2 years Notice of Assessment (NOA)
- Statement of Account (SOA) – CRA statement showing the outstanding balance owed to the Canada Revenue Agency
For Stated Income Programs, you may only need:
- 6 to 12 months of business bank statements
- 1-year business financials (see your accountant)
- Statement of Account (SOA) – CRA statement showing the outstanding balance owed to the Canada Revenue Agency
Some lenders may also request your HST information return.
Other documents may be required depending on your unique financial situation.
Conclusion
In summary, how you label your income—whether as salary, dividends, or business income—can impact how much mortgage you qualify for, the interest rate you might receive, and the documentation required by lenders. It’s crucial to carefully manage and report your income to balance tax efficiency with mortgage qualification requirements.
