As the job landscape continues to change – from traditional 9-5 employment to a mounting percentage of the workforce taking on freelance gigs, side-hustles, contractual work or entrepreneurial ventures, finding a permanent base operations – an HQ – a home still resonates. While the definition of employment has shifted, home ownership is still a huge goal for many – which means you first have to get approved for a mortgage.
Generally speaking, lenders prefer highly stable incomes and job histories, people are who predictable and dependable in a traditional sense of the word – they want to know you’re good for it, and they are also disinclined to risk hundreds of thousands on someone with inconsistent revenue streams. Good credit, consistent pay periods, permanent jobs or dwellings are the qualities lenders look for in borrowers.
For self-employed people, writing-off as much expenses as possible is a benefit of this career path thereby lowering your tax bracket, and saving you a ton of cash at the end of the year. On the flip-side, this also means your returns will indicate low earnings, and so may disqualify you from the mortgage you’re after. Knowing this is a dilemma for a number of people we talk to, today we’re going to discuss the key areas you need to submit on a loan application to get qualified.
It’s all about paperwork. Some people liken the process to a job interview, which might not be the best analogy, and you want to make a great impression by selling your features-and-benefits if you will. The more you provide, the better defined your profile, the easier it is for the bank to make a decision. You can expect your lender to ask for:
- 2 years of Tax Returns
- A year or more of Pay Stubs
- Proof of employment
- Bank statements to review your assets
- Credit History and Credit Reports
Provide these and you’re good to go. You might be working contracts and odd-jobs, but if you can indicate that you’re consistently earning and paying debts and have been for some time, then you’re the kind of person the bank wants to lend too.
You may have noticed we said at least 2 years in tax returns earlier. Well, the bank will likely ask for pay stubs, proof of employment, anything to indicate that you have been working and making enough money for some time – you may have been in a job for a year but a mortgage is for 25 years, give or take 5 or 10. So 2 years or further back for employment history is not that far fetched. If you’re self employed, you need to start filing your taxes to reflect your real income as far in advance of buying the home as you can. If you’re a contractor or freelance, you’ll need to make sure your paperwork is in order and your tax returns are available as well. Ideally this starts well in advance of your home search, so if you’re considering buying, and you’re in a non-traditional job, start now.
What if you have the paperwork, and things are looking good, but your credit score isn’t perfect? Well it’s good we decided to start early, because the most important step is paying off debts. Your credit will be a giant factor in your application, if not the largest, because this is the only hard and fast proof that you pay your debts. If you have outstanding loans, debts, bills, taxes or anything else of the sort, the banks are going to be paying very close attention. Use these two or so years of planning to clean up the books. If you can repay a debt, repay it, if you can pay down your credit cards, do so, and if you can’t clear an entire debt, at least show you consistently pay it. Missed payments, big balances on multiple credit cards – even phone bills you forgot about from years ago – they’re looking at all these, and they’re not going to ignore them. A few hundred outstanding from a lifetime ago might not seem like a big deal compared to $500,000 or more, but that’s exactly it – they don’t want to lend to anyone who doesn’t take their credit seriously. But this can be remediated, and once you have, the final step comes in.
The Mortgage Stress Test
Since 2018, it’s required that every mortgage applicant undergo a stress test. This stress test is for determining if you can make your monthly payments in the case that interest rates rise. For some people, an increase of 2% might not sound like much, but for others it’ll be the difference between the house you wanted and the budget you can afford. This is how it works:
If your down payment is above 20% the stress test will use the minimum qualifying rate based on the Bank of Canada’s five-year benchmark or what your lender offered you plus 2%, whichever is higher. Right now, Bank of Canada’s rate is 5.14%. If your down payment was below 20% you must qualify using that same rate or what your lender offered you. You don’t add the 2% but you’re still qualifying with the higher rate.
So if your lender offers a rate of 2.99%, you’ll have to use the 5.14% benchmark rate in your stress test. If you make a 20% down payment and your lender offers a rate of 3.49%, you’ll have to qualify using a rate of 5.49%.
Although the new mortgage rules are supposed to protect the Canadian housing industry (and make sure that Canadians are spending within their means), the changes also mean that you might have to settle for a lower budget.
For example: Let’s say you have a household income of $87,000 and made a down payment of 20%. Before the new rules, you may have been able to afford a maximum purchase price of $508,069 (based on a 2.99% rate). Now, because of the 2018 mortgage rules, you’ll have to qualify for a rate of 5.14%. This means you may only be able to afford a maximum purchase price of $393,716, which is 22.5% less than under the previous rules.
Get to Work
To make a long story short, catch up. The bank is going to want to see as much of your financial data as it can to make a good profile for you and justify lending you however much you’re asking. That means clearing outstanding debts or bills, filing your taxes, collect your pay stubs, get your paperwork in order, and well in advance. The bank is going to go well into your past, and even into your future with the Mortgage Stress Test to see how well you’ll fair in worse conditions.
That two percent difference between what the bank is offering and what the Mortgage Stress Test is qualifying you with means $100,000 or more of your budget is gone when applying. This is a big difference, obviously, so you have to do everything you can to prove you can afford what you’re asking for. Go through this article, ask for help, stick to the steps and you’ll be on track to getting that home you always dreamed of.
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