When applying for a mortgage, it is important to show as much income as possible to demonstrate to a lender that the applicant can service the mortgage. For some clients, applying with disability income is an important part of proving they qualify for a mortgage.
Disability income comes in two forms, taxable and non-taxable. The difference between taxable and non-taxable disability income in Canada primarily lies in how the income is treated for tax purposes and the implications for the recipient.
Mortgage Application: Gross-up
How to Gross-up Disability Income
Applying with Disability Income: Required Documents
Taxable Disability Income
Taxable disability income is any disability-related payment that must be reported as income on the recipient’s tax return. This income is subject to federal and provincial/territorial income taxes.
- The income received is included in the recipient’s total income for the year and is subject to taxation based on their overall income level.
- The recipient might owe additional taxes or may receive a smaller tax refund depending on their tax bracket.
- The recipient must ensure that sufficient taxes are withheld or paid to avoid a tax liability at year-end.
Examples
Examples of taxable disability income include:
- Canada Pension Plan (CPP) Disability Benefits
CPP Disability benefits are considered taxable income. Recipients will receive a T4A(P) slip showing the amount of CPP disability income they received, which must be reported on their tax return. - Employer-paid long-term disability insurance
If the long-term disability insurance premiums were paid by the employer, any benefits received are taxable. The recipient will receive a T4A slip for the taxable benefits. - Employer provided short-term disability benefits
If the employer provides short-term disability benefits and pays the premiums, the benefits are taxable to the recipient.
Non-Taxable Disability Income
Non-taxable disability income is not subject to income tax and does not need to be reported on the recipient’s tax return as taxable income.
- The recipient does not need to pay income tax on this income, which means they keep the full amount received.
- Non-taxable income does not increase the recipient’s taxable income, which can be beneficial in terms of overall tax liability.
- While this income is not taxed, it still needs to be reported in certain situations, such as when applying for loans or mortgages, to demonstrate financial capacity.
Examples
Examples of non-taxable disability income include:
- Long-Term Disability Insurance
If the individual paid the premiums themselves (without employer contributions), the benefits received are generally non-taxable. - Workers’ Compensation (WSIB in Ontario)
Workers’ compensation benefits for work-related injuries or illnesses, such as those from the Workplace Safety and Insurance Board (WSIB) in Ontario, are non-taxable. - Veterans Affairs Disability Pension
Disability pensions provided by Veterans Affairs Canada are non-taxable.
- Disability Support Programs (ODSP in Ontario)
Disability support program (such as ODSP) payments are non-taxable, as they are considered social assistance.
Mortgage Application
When applying with disability income for a mortgage in Canada, non-taxable disability income can often be “grossed up” to account for the fact that it is not subject to income tax. This gross-up process makes non-taxable income more comparable to taxable income when lenders assess an applicant’s ability to service the mortgage.
Grossing Up Non-Taxable Disability Income
Grossing up refers to increasing the non-taxable income by a certain percentage to reflect its tax-free status. This adjustment helps equate non-taxable income with taxable income in terms of purchasing power.
Since non-taxable income is not subject to income tax, the borrower effectively has more disposable income than someone with the same amount of taxable income. For example, if someone receives $30,000 in non-taxable income, they keep the entire $30,000, whereas someone with $30,000 in taxable income might only keep a portion after taxes.
Grossing up non-taxable income makes it comparable to taxable income, allowing lenders to better assess the borrower’s financial capacity. By recognizing that non-taxable income stretches further, lenders can more accurately evaluate the borrower’s ability to afford the mortgage payments.
How to Gross-up Non-Taxable Disability Income
The gross-up percentage can vary by lender, but it is typically between 15% and 35%. This percentage represents an estimate of the taxes the borrower would have paid if the income were taxable.
For example, some lenders will allow a gross-up of non-taxable disability (NTD) income of 15% when NTD income is less than $25,000 and a gross-up of 35% when NTD income is more than $25,000. Others only apply the 35% gross up when income is greater than $30,000.
Example: Gross-up Calculation
Assume an applicant has $30,000 in non-taxable disability income and the lender applies a 25% gross up:
Grossed-up Income = $30,000 x 1.25 = $37,500
In this case, the lender would consider the applicant’s income to be $37,500 when calculating the applicant’s debt service ratios (GDS, TDS).
Without grossing up (grossing up is not available to taxable disability income), only $30,000 can be claimed as income, which could disqualify an applicant from some mortgage products, lower the mortgage they qualify for, or require them to pay higher interest rates on a more limited range of products available to them.
Applying with Disability Income: Required Documents
Lenders evaluate sources of disability income based on their consistency, duration, and the likelihood of continuation for the term of the mortgage. It’s important for applicants to provide comprehensive documentation to demonstrate the stability and permanence of the disability income.
When applying with disability income, expect lenders to request:
- A letter from the disability income provider stating that the disability income is provided to age 65 or death (in the case of pension.
- 3 months of bank statements (demonstrating deposit of disability income)
- T4A issued by the payer of disability benefits showing the total amount of disability income received by the individual during the tax year.
Mortgage Application Impact
The grossed-up income increases the applicant’s total income in the eyes of the lender, potentially improving their debt service ratios and allowing them to qualify for a larger mortgage or better terms.
Remember, not all lenders gross up non-taxable income, and those that do may apply different gross-up rates. It’s important for borrowers to work with Allen Ehlert to understand how their non-taxable income will be treated by lenders, and to select the most suitable lender for them.
