The Self-Employed Dilemma
Michael Hallett • July 7, 2015
You're likely asking yourself, what is the dilemma that self-employed workers face? Well, with more and more Canadians joining the ranks of the self-employment every year one has to ask themselves how they are going to tackle the age old question, how much does one write off vs how much income does one claimed on their taxes. We all want to earn as much money as possible and pay as little income tax as required.
This was my train of thought until the topic of 'paying taxes' was brought to my attention by a friend that's an accountant. As he said, paying income tax isn't such a horrible thing, in fact it's a necessity which provides for our infrastructure and without it the 'world' we know would be drastically different. Here was the response from him after I re-posted a reference to INCOME TAX RELIEF DAY that I saw on social media.
"I would actually look at it more positively and say that I/we spent this money to live in a great country, province and municipality and its worth every penny in taxes spent. I will guarantee you there are billions of people on this planet that would switch positions with us in a second and remember this so called date (INCOME TAX RELIEF DAY) is based on the average Canadian family income of $45,000 and is based on all taxes including not just income taxes, but property tax, sales taxes, health taxes, fuel taxes and much more. So technically not all of it is going to Canada Revenue Agency (CRA). Some of it is going to municipal and Metro Vancouver. For more information go to the Fraser Institute website https://www.fraserinstitute.org/research-news/display.aspx?id=22954."
After reading over this message, it got me thinking about how some self-employed people report their taxes and the effect that it has on their chances of qualifying for a mortgage. Besides the duty to provide to our country, we all have a personal desire to provide as much as possible for our family. It's a so-called 'tug-of-war' of who gets your money and how much of it. Here's where the dilemma get's complicated if you want to borrow money from a lender to purchase residential real estate.
The federal Government of Canada regulates the CRA as well as the lending criteria and policies followed by ALL the 'A' lenders. 'A' lenders are our chartered banks and non-bank or monoline/investment lender. We also have credit unions that are provincially regulated but follow the CMHC lending criteria, which is federal. Having more 'cash' in your pocket actually allows you to borrow less. Showing more income claimed which requires you to pay more tax allows you to borrow more money if desired. 'A' Lenders assess their risk management for lending money to borrowers on historical earning and in this case if one is self-employed then they require a 2 year average based on T1 Generals or in some cases Notice of Assessments (NOA).
It's a CATCH 22 and you (and your qualified accountant) need to decide which path you're going to follow; write off maximum expenses and claim 'little' income or claim a 'healthy' income and pay more income. Neither is right or wrong.
Upon getting the urge to buy residential real estate a detailed conversation on how 'your' is structured should be had with their Mortgage Expert and Certified General Accountant. Once you have chosen which style of accounting your business will adopt, you just have to be prepared to follow the lending guidelines. And plus, it's really not that bad either way.
Let's face it, everyone wants the lowest rate possible when it comes to their mortgage. As a Mortgage Expert, it's something that I seek for every client. But not all clients are eligible for the lowest rate for a number of different reasons, 2 main reason are because of credit blemishes and of course lack of income reported.
Business Case
The following is a fictitious scenario that represents a self-employed person that writes down ones expenses in order to minimize CRA income tax.
Jane is a business owner in Vancouver. She has a modest business that is experiencing growth year after year. Jane enjoys the many perks of being a business owner, especially the tax breaks that come along with it! Since Jane is able to work with her certified accountant, and considerably write down her income, she often saves thousands of dollars a year on taxes.
Jane would like to purchase a new home. She has a 20% down payment to place on a home, and knows that she grosses more than $100,000 per year in her business. However, since she currently writes down her income to $20,000 per year, her Mortgage Expert has just informed her that she will need to state her income with a 'Non-Prime' or 'B' lender for approval.
Now if Jane claimed $100,000 per year for the last 2 years, she may qualify for the best rate out there from an 'A' lender. However, let's look at what that really means:
Income claimed $100,000/year $20,000/year
Taxes paid $ 25,060/year $1,761/Year
Jane has saved $23,299 per year because of the tax laws the government has legislated for self-employed business owners. Now let's compare the interest on a 'typical' verified-income loan, and a 'non-prime' stated-income loan.
Loan Type 'A' 'B'
Mortgage $200,000 $200,000
Rate 2.69% 4.50%
Term 1 year 1 year
Interest per Term $5,281 $8,826
** For ease of comparison to BC yearly tax rate-- 1 year term has been used. Rates are approximations for example purposes.**
Jane is paying $3,545 more in interest per year, but with her income tax savings is $23,299 per year. She is actually saving $19,754 per year more than the typical 'verified-income' Employee that was able to receive a mortgage interest rate of 2.69%.
With all entrepreneurs there is one thing in common they are all savvy and driven to succeed, or fail, on their own terms.
It takes an extreme amount of hard work to get a business from the infancy stage to a self sufficient entity that produces a constant and steady flow of revenue. Business owners all want to save money while at the same time earning and establishing a presences in their chosen space. Business financials are all structured differently and depending on how one chooses to operate will dictate how they can proceed once it's time to seek residential real estate financing.
If you are self-employed, make sure to consult with your Mortgage Expert to find out how your mortgage can tailored. Every mortgage scenario is completely different from the next, so make sure your fits correctly and you are informed before you start the financing process.
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Thinking of Buying a Home? Here’s Why Getting Pre-Approved Is Key If you’re ready to buy a home but aren’t sure where to begin, the answer is simple: start with a pre-approval. It’s one of the most important first steps in your home-buying journey—and here's why. Why a Pre-Approval is Crucial Imagine walking into a restaurant, hungry and excited to order, but unsure if your credit card will cover the bill. It’s the same situation with buying a home. You can browse listings online all day, but until you know how much you can afford, you’re just window shopping. Getting pre-approved for a mortgage is like finding out the price range you can comfortably shop within before you start looking at homes with a real estate agent. It sets you up for success and saves you from wasting time on properties that might be out of reach. What Exactly is a Pre-Approval? A pre-approval isn’t a guarantee. It’s not a promise that a lender will give you a mortgage no matter what happens with your finances. It’s more like a preview of your financial health, giving you a clear idea of how much you can borrow, based on the information you provide at the time. Think of it as a roadmap. After going through the pre-approval process, you’ll have a much clearer picture of what you can afford and what you need to do to make the final approval process smoother. What Happens During the Pre-Approval Process? When you apply for a pre-approval, lenders will look at a few key areas: Your income Your credit history Your assets and liabilities The property you’re interested in This comprehensive review will uncover any potential hurdles that could prevent you from securing financing later on. The earlier you identify these challenges, the better. Potential Issues a Pre-Approval Can Reveal Even if you feel confident that your finances are in good shape, a pre-approval might uncover issues you didn’t expect: Recent job changes or probation periods An income that’s heavily commission-based or reliant on extra shifts Errors or collections on your credit report Lack of a well-established credit history Insufficient funds saved for a down payment Existing debt reducing your qualification amount Any other financial blind spots you might not be aware of By addressing these issues early, you give yourself the best chance of securing the mortgage you need. A pre-approval makes sure there are no surprises along the way. Pre-Approval vs. Pre-Qualification: What’s the Difference? It’s important to understand that a pre-approval is more than just a quick online estimate. Unlike pre-qualification—which can sometimes be based on limited information and calculations—a pre-approval involves a thorough review of your finances. This includes looking at your credit report, providing detailed documents, and having a conversation with a mortgage professional about your options. Why Get Pre-Approved Now? The best time to secure a pre-approval is as soon as possible. The process is free and carries no risk—it just gives you a clear path forward. It’s never too early to start, and by doing so, you’ll be in a much stronger position when you're ready to make an offer on your dream home. Let’s Make Your Home Buying Journey Smooth A well-planned mortgage process can make all the difference in securing your home. If you’re ready to get pre-approved or just want to chat about your options, I’d love to help. Let’s make your home-buying experience a smooth and successful one!
If you’re looking to purchase a property, although you might not think it matters too much, the source of your downpayment means a great deal to the lender. Let’s discuss the lender requirements, what your downpayment tells the lender about your financial situation, a how downpayment helps establish the mortgage loan to value. Anti-money laundering Lenders care about your downpayment source because, legally, they have to. To prevent money laundering, lenders have to document the source of the downpayment on every home purchase. Acceptable forms of downpayment are money from your resources, borrowed funds through an insured program called the FlexDown, or money you receive as a gift from an immediate family member. To prove the funds are from your resources and not laundered money from the proceeds of crime, you’ll be required to provide bank statements showing the money has been in your account for at least 90 days or that you’ve accumulated the funds through payroll deposits or other acceptable means. Now, if you’re borrowing all or part of your downpayment, you’ll need to include the costs of carrying the payments on the borrowed downpayment in your debt service ratios. If you’re the recipient of a gift from a direct family member, you’ll need to provide a signed gift letter indicating that the funds are a true gift and have no schedule for repayment. From there, you’ll need to show the money deposit into your account. Financial suitability Lenders care about the source of the downpayment because it is an indicator that you are financially able to purchase the property. Showing the lender that your downpayment is coming from your resources is the best. This demonstrates that you have positive cash flow and that you’re able to save money and manage your finances in a way that indicates you’ll most likely make your mortgage payments on time. If your downpayment is borrowed or from a gift, there’s a chance that they’ll want to scrutinize the rest of your application more closely. The bigger your downpayment, the better, well, as far as the lender is concerned. The way they see it, there is a direct correlation between how much money you have as equity to the likelihood you will or won’t default on their mortgage. Essentially, the more equity you have, the less likely you will walk away from the mortgage, which lessens their risk. Downpayment establishes the loan to value (LTV) Thirdly, your downpayment establishes the loan to value ratio. The loan to value ratio or LTV is the percentage of the property’s value compared to the mortgage amount. In Canada, a lender cannot lend more than 95% of a property’s value. So, if you’re buying a home for $400k, the lender can lend $380k, and you’re responsible for coming up with 5%, $ 20k in this situation. But you might be asking yourself, how does the source of the downpayment impact LTV? Great question, and to answer this, we have to look at how to establish property value. Simply put, something is worth what someone is willing to pay for it and what someone is willing to sell it for. Of course, within reason, having no external factors coming into play. When dealing with real estate, an appraisal of the property will include comparisons of what other people have agreed to pay for similar properties in the past. You’ll often hear of situations where buyers and sellers try to inflate the sale price to help finalize the transaction artificially. Any scenario where the buyer isn’t coming up with all of the money for the downpayment, independent of the seller, impacts the LTV. All details of a real estate transaction purchase and sale have to be disclosed to the lender. If there’s any money transferring behind the scenes, this impacts the LTV, and the lender won’t proceed with financing. Non-disclosure to the lender is mortgage fraud. So there you have it; hopefully, this provides context to why lenders ask for documents to prove the source of your downpayment. If you’d like to talk about mortgage financing, please connect anytime; it would be a pleasure to work with you.
