Imagine a man and a woman want to get a mortgage to buy a house. The man has a dry wall business where he doesn’t pay himself much to keep his income taxes down, and the woman is a full-time permanent dental hygienist. Should they apply for a mortgage under a prime lender like a chartered bank or monoline lender, or do they have to get their mortgage through a B lender because the man is self employed?
What’s the difference Between Prime and Alternative Lenders
Third Scenario: Increase Salary
Fourth Scenario: Bigger Downpayment
What’s the difference Between Prime and Alternative Lenders
Before we answer the above question, we need to know the difference between prime and alternative lenders
Prime Lenders
In Canada, a prime lender (also known as an A lender) refers to traditional lending institutions that cater to borrowers with strong credit profiles, stable income, and low debt-to-income ratios. These lenders typically include federally regulated banks, provincially regulated credit unions, and other major financial institutions. Prime lenders offer the best interest rates and terms because they focus on borrowers with the lowest risk profiles. To qualify for a mortgage from a prime lender, borrowers must meet strict criteria, including passing a mortgage stress test and having a good credit score, often above 680 FICO
Alternative Lenders
In Canada, an alternative lender (often referred to as an alt lender or B lender) is a financial institution that provides mortgage financing options outside of the traditional banking system. These lenders cater to borrowers who may not qualify for mortgages from prime lenders due to factors such as lower credit scores, variable income, or shorter employment histories.
What’s the Rate Difference?
The interest rate difference between prime lenders and B lenders can vary significantly. Prime lenders typically offer rates that are closely tied to the prime rate, which is currently around 4.3 to 5%. B lenders, on the other hand, charge higher rates due to the increased risk associated with borrowers who may have lower credit scores or less stable income.
B lender mortgage rates can range from similar to those of big banks to about 2.5% higher, depending on the specific circumstances of the borrower and the lender
Thus, the interest rate difference between prime and B lenders can be anywhere from 0.5% to over 2.5%, depending on the specific terms and conditions of the mortgage.
Example of Rate Differences:
- Prime Lender Rate: Assume a variable rate tied closely to the prime rate of 5.20% or a fixed rate slightly below this.
- B Lender Rate: Could be as high as 7.19% for a 1-year fixed term, resulting in a difference of approximately 1.99% compared to the prime rate.
This difference reflects the higher risk that B lenders take on by lending to borrowers who may not qualify for prime lender mortgages.
Scenario Assumptions
Assume the following:
- Man’s Income: $20,000
- Woman’s Income: $90,000
- Home Price: $900,000
- Down payment: $160,000 (LTV: 82%)
First Scenario
Based on calculations, GDS/TDS is 59% with an estimated monthly mortgage payment of $4768.
Prime vs B Lender
A Lender Guidelines:
- Maximum GDS: 39% (or 44% TDS with strong credit and income)
- Their GDS and TDS are 59.01%, which is far above prime lender limits.
- They would not qualify with a prime lender.
B Lender Guidelines:
- B lenders allow GDS/TDS ratios up to 50-55%, sometimes higher with strong compensating factors.
- Given that their TDS is 59%, some B lenders might still approve them, but it would depend on:
- A larger down payment to lower the loan amount.
- A co-signer or higher stated income for the self-employed applicant (if using bank statements).
- A lower-priced home.
Conclusion
Prime lenders will not approve this mortgage due to the high GDS/TDS.
B lenders may approve it, but they may require a larger down payment, alternative income verification, or a co-signer.
Alternative options:
- Increase down payment to reduce the loan amount.
- Consider a less expensive home.
- Explore stated income programs with a B lender.
Second Scenario: Add Back
Make the following adjustment to the first scenario by assuming the man’s business can show revenue of $100,000 per year for 2 or more years.
Assume the following:
- Man’s business revenue: $100,000 per year
- Man’s Income: $20,000
- Woman’s Income: $90,000
- Home Price: $900,000
- Down payment: $160,000 (LTV: 82%)
Updated Debt Service Ratios with Business Income Add-Back
With the man’s business generating $100,000 in revenue but paying himself only $20,000, and assuming a 50% add-back on business revenue, the revised calculations are:
- Total Adjusted Household Income: $150,000
- Gross Debt Service (GDS) Ratio: 43.28%
- Total Debt Service (TDS) Ratio: 43.28%
Prime (A) Lender vs. B Lender Approval
A Lender (Prime) Consideration:
- Maximum GDS allowed: 39% (or up to 44% for strong applicants).
- Maximum TDS allowed: 44%.
- At 43.28% GDS/TDS, they are just within the upper limit for some prime lenders, but approval would depend on:
- Strong credit scores (700+ recommended).
- Reliable proof of business income (NOAs, bank statements).
- The lender’s willingness to use the income add-back calculation.
- They may qualify with a prime lender, but it could be a tight approval.
B Lender Consideration:
- B lenders allow GDS/TDS up to 50-55%, making them more flexible.
- Given the 43.28% ratios, they would easily qualify with a B lender if a prime lender declines them.
Conclusion & Next Steps
They are in a borderline position for a prime lender.
- If they have strong credit, they may still qualify with a prime lender.
- If the A lender is conservative with self-employed income, they may need a B lender.
If they want a safer approval with better rates, they could:
- Increase the man’s declared income further by adjusting how much he pays himself.
- Increase the down payment to reduce the mortgage amount.
- Look for a slightly lower-priced home to improve ratios.
Third Scenario: Increase Salary
Make the following adjustment to the second scenario by assuming the man’s business can show revenue of $100,000 per year for 2 or more years and he has been paying himself $60,000 per year out of his company’s revenue.
Assume the following:
- Man’s business revenue: $100,000 per year
- Man’s Income: $60,000
- Woman’s Income: $90,000
- Home Price: $900,000
- Down payment: $160,000 (LTV: 82%)
Updated Debt Service Ratios with Business Income Add-Back
The GDS and TDS ratios remain the same at 43.28%, even with the man paying himself $60,000 instead of relying on an income add-back.
Why?
- Previously, the 50% add-back method estimated an adjusted income of $50,000 for the man ($20,000 declared + $30,000 from add-back).
- Now, since he directly declares $60,000 in salary, the total household income remains $150,000.
- Since GDS and TDS depend on total income, and that number remains the same, the ratios don’t change.
Approval Outlook
Prime (A) Lender: Now very likely to approve
- GDS/TDS limits (39%/44%) → They are within range at 43.28%.
- Stronger declared income makes underwriting easier than relying on add-backs.
B Lender: Not needed anymore.
Recommendation
- They should apply with a prime lender.
- Declaring $60,000 directly makes the file stronger than using an add-back calculation.
- If the lender is conservative, increasing the down payment or choosing a slightly lower home price would provide additional security.
Fourth Scenario: Bigger Downpayment
To enable the couple to afford the house, they receive a gift from the woman’s father so that they now have a 30% down payment.
Assume the following:
- Man’s business revenue: $100,000 per year
- Man’s Income: $60,000
- Woman’s Income: $90,000
- Home Price: $900,000
- Down payment: $270,000 (LTV: 70%)
Updated Debt Service Ratios
By increasing the down payment to 30% ($270,000), the new mortgage amount is $630,000. Here’s how this affects their qualification:
- New Monthly Mortgage Payment: $4,059
- New Gross Debt Service (GDS) Ratio: 37.61%
- New Total Debt Service (TDS) Ratio: 37.61%
Prime (A) Lender Approval
They now qualify for a prime (A) lender!
- GDS is now below the 39% limit.
- TDS is well below the 44% limit.
- No need for a high-ratio mortgage (CMHC/Sagen/Canada Guaranty not required).
Key Benefits of 30% Down Payment
Lower Mortgage Amount = Lower Payments
Monthly mortgage payment drops to $4,059 (vs. $4,768 at 20% down).
Better Interest Rates & More Lender Options
Conventional (uninsured) mortgages qualify for lower rates than high-ratio insured mortgages.
No CMHC insurance premium (saves thousands in fees).
Easier Prime Lender Approval
With a GDS of 37.61%, they now comfortably qualify for an A lender mortgage.
No need for a B lender or alternative lending solutions.
Recommendation
Since they now meet prime lender guidelines, they should:
- Apply with an A lender for the best rates.
- Ensure they have strong credit (680+ recommended).
- Lock in their rate early (since mortgage rates may fluctuate).
Analysis
Many self-employed people attempt to reduce the amount the pay in income taxes by paying themselves as little as possible. While this does save them income taxes, it makes it more difficult to qualify for a mortgage because they have to demonstrate sufficient income for at least 2 years. This pushes most self employed people towards B lenders and higher mortgage rates.
Also, because they must demonstrate this income for at least 2 years, they must wait to get a mortgage or get a shorter term mortgage (usually a 3 year fixed) with a B lender and pay higher rates until they can move over to a prime lender.
Whether the man and woman should apply with a prime (A) lender or a B lender depends on the overall strength of their application, particularly the woman’s income, the man’s declared income, and their credit scores.
They could still qualify under a prime lender if:
- The woman’s salary as a full-time permanent dental hygienist is high enough to support the mortgage qualification on its own (or with limited additional income from the man).
- The man declares a reasonable income on his tax returns and provides two years of Notice of Assessments (NOAs) and T1 Generals.
- They have strong credit scores (usually 680+ per applicant) and manageable debt service ratios (TDS/GDS within guidelines).
- They have a 20%+ down payment (if not insured) or qualify for CMHC/Sagen/Canada Guaranty if going with an insured mortgage (less than 20% down).
If the man doesn’t report much income on his taxes, the woman’s income might have to carry the application, which limits the mortgage amount they can qualify for.
