It’s a proud moment for any fledgling entrepreneur. They start a new business and manage to make it a going concern. Perhaps they’re even taking a salary—a relative luxury for many business owners in the start-up phase—and can finally think about spending on themselves.
Maybe a new home is at the top of that expenditure priority list.
But when they approach their lender in search of a mortgage, many entrepreneurs hit the self-employed ceiling. That is, the bank or credit union with whom they’re dealing deems them a financial risk, refuses to recognize their business-related income, deems that declared income to be too low to qualify for a mortgage, or finds another reason to reject their application. This scenario is common and is a cause of concern across the entrepreneurial community, particularly among younger business owners or those who are starting businesses later in life, but aren’t yet living mortgage-free.
A recent announcement by the Canada Mortgage and Housing Corporation could help ease their angst, while demonstrating Ottawa’s willingness to at least begin tackling a longstanding problem.
Beginning October 1, the CMHC will adjust its qualification criteria to make it easier for self-employed borrowers who own their own business, or who have been employed in the same position for less than two years, to obtain financing for insured mortgages. Currently, these individuals can obtain mortgages, but only at the lender’s discretion based on strict CMHC criteria. Financial institutions now have far greater leeway when formulating a case for approval.
“Factors that could be used to support the lender’s decision will include acquiring an established business, having sufficient cash reserves, predictable earnings, previous training and education, and looking at borrowers’ demonstrated history of managing credit,” said Monica Guido, CMHC’s manager of client relations, as reported by various media outlets.
Newly self-employed mortgage applicants will now be eligible to use recent account statements, business contracts and other business-related documentation pertaining to various types of income to enhance their chances of qualification. To date, audited financial statements signed by an accountant are still one of the gold standards to demonstrate income, but this has created hurdles for owners of unincorporated businesses.
“CMHC recognizes that unincorporated business owners may not typically have that documentation,” Guido told media. “The following documentation will be added: A Statement of Business or Professional Activities report, and use of Notice of Assessments to support income from the self-employed. The NOA should be accompanied by the T-1 General. This is new.
“The second new component … is the use of Proof of Income statements,” she continued, “which isn’t applicable in our current guideline, but in our enhancement, in response to lender inquiries, the POI statement will be added to the guideline as an example of documentation to support that qualifying income, and to ensure that personal income taxes are up to date. So, the POI statement can be used as an alternative to the NOA and T1 General.”
The changes are a welcome relief for self-employed individuals whose income streams are often deemed precarious by financial institutions. This is unfortunate, and outdated, thinking.
The reality, from our perspective, is that entrepreneurs tend to have far greater control over their employment than many employees. Why? While businesses can—and sometimes do—go bust, business owners can often adjust their business or lifestyle expenses to keep their companies in operation and cash-flow positive until they can find new clients, deliver new products or make operational changes to improve bottom-line performance.
While an employee’s earnings are generally consistent, they have no say in their potential lay off or termination, creating significant financial uncertainty. If that’s the case, then why are some lenders still reluctant to work with self-employed individuals?
It’s no secret that, statistically, most businesses will run into major challenges at some point on the road to success. The severity of those challenges will vary greatly. This makes certainty-loving banks nervous. Business owners’ income can also fluctuate unpredictably from year to year—lenders know this and see it as a greater risk of default.
But much of that legacy attitude when dealing with entrepreneurs stems from a long-standing, conservative approach to business—one that generally serves financial institutions well in times of crisis such as the Great Recession of 2008-09, when many U.S. and international lenders were forced to shut down or scale back operations due to crippling risk exposures. On the other hand, it hampers these lenders’ ability to innovate and address new trends such as the rapid rise in recent years of self-employment with the emergence of the sharing and gig economies. As Organization for Economic Co-operation and Development (https://data.oecd.org/emp/self-employment-rate.htm) figures show, fully 8.3 per cent of Canadians reported being self-employed in 2017. That’s a sizeable market for financial institutions on the constant lookout for new customers.
While there’s still work to be done, we’re glad to see the CMHC taking meaningful first steps to help entrepreneurs obtain mortgages more easily and, in turn, allow them to focus on what they do best: growing their businesses.
Adriano Romeo, Partner