Income can be a touchy subject when talking to both a perspective buyer and then taking that information to look at what is an actual provable number. There are specific criteria that a lender is always going to consider with income… Consistency, length of employment, industry experience, and can we prove it. The way you are paid will affect how your income is to be proven and what type of documentation will be required. Someone who is salaried is a much easier income to prove the criteria then someone who is self employed. I will take some time to explain what a lender looks for in a person’s income to help better understand what will be expected of a home buyer. Please note that gross income is used in qualifying a person for a mortgage and that this article is based on Prime lending business where you receive best rates and require only 5% down payment.
Salaried Income
Receiving a salary is typically the easiest income to prove on paper. You’re already meeting the criteria of consistency which is one of the biggest factors since your income is the same year-round! If you are not on a probationary period and preferably been employed at the same place for over 3 months, then your income should pose little to no problems for your mortgage application. If you have recently changed jobs but are in the same industry it is common that the 3 month probationary period requirement will be waived, but not always as it is at the lenders discretion as well as no two applicants are going to be under identical circumstances.
Things that commonly add additional paperwork to the process are additional income from bonuses and commissions. Since we are now outside the short-term scope of “is this going to be consistent or just one time?” we need to prove that it is sustainable. Was that commission the result of a one-time large sale or is this person frequently achieving this? In order to include this additional income, more documentation will be required to prove the consistency and longevity of it.
Okay Evan, so what do I need to have?
Documentation everyone will require:
· Current Paystub
· Letter of employment
Documentation that may be required in addition (depending on circumstances):
· Most recent 2 years T4s to show consistency of income beyond that of just your salary
o This will be taken at an average. Ex. 2019 T4 = $65,000 2018 T4 = $60,000 creates a 2 year avg of $62,500. Meaning the max income usable is either $62,500 for yourself or your base salary if that number is higher.
· Notice of Assessments can be used in place of T4s
Full Time Hourly
This type of pay is very common for people who work in trades and requires more documentation generally than someone who is salaried because of common variances in cheque to cheque. These variances are usually caused by things such as overtime, shift allowances, unpaid sick days, etc. These types of things tend to skew the “40-hour work week” even though lots of times things work out to be generally right around if not the same or more than your full-time hours. A common example I deal with is nurses who are on a rotation. Hours tend to vary a lot, but typically work out to a set expectation for a specific rotation. All this just means we must document things a little more meticulously when applying for a mortgage. It is recommended that you have been working in the industry for 2 years, as in many cases a 2-year average is going to be requested by lenders.
Documentation everyone will require:
· Current Paystub
· Letter of Employment
· Most recent T4 (in most cases, to show that your full-time income is in line with the previous years earnings)
Documentation that me be required in addition:
· Most recent 2 years T4s, in which income will be determined the same way as salaried employees with bonuses. This is typically the case to account for varying hours and to include overtime in income
· Notice of assessments can be used in place of T4s
The nature of your work and industry you partake in will play a role in how much additional documentation you will be required. To give an example, a construction worker will have times of the year that are busier than others generally where he or she may be working 120 hours every two week, BUT they may also have a slow time of year where they are laid off for 2 weeks until enough work comes about. Therefor a 2-year average is going to be required to get a reliable picture of the incomes consistency.
An example of something on the other end is a receptionist at your financial advisor’s office. They get paid full time hourly, same as the construction worker, but they have little to no variance in their hours. They work 40 hours a week consistently and the industry is considered more stable. This means the documentation and length of employment required will be reduced. Yes, the banks and lenders keep a record of which industries are more or less stable and will be biased as to what documentation is required based on your area of work and expectations of documentation will vary from person to person.
Part Time Hourly
This one is pretty simple, and the requirements are going to be the same every time, if you’re part time hourly you’re going to need 2 years T4s or notice of assessments and your average earnings over that time is always going to be used. Recent paystub will be used to show you are still currently employed.
Commissions
If all your income is commissions or a large majority expect to need a 2-year average for verification. Base guaranteed pay will be allowed without one, but commissions over and above that will need 2 years worth of T4s or notice of assessments to create average annual earnings so that consistency can be proven.
Self-Employed Income
Being self employed is great, but when it comes to proving income this is the most difficult as there is a lot of required documentation for anyone who is self employed and I will break this into sub sections to make it easier to traverse.
Documentation everyone will require:
· The most recent two years Notice of Assessments and full T1 Generals
· Proof of self employment for at least 2 years
· If incorporated, articles of incorporation will be required
· If incorporated, corporate financials prepared by an accountant will be required
Self Employed, sole proprietor
As a sole proprietor you gain a few benefits. The most notable being that your income will be grossed up 15% on your 2-year average to accommodate add backs of expenses. In some cases, a lender will allow to not use the 15% gross up but instead do addbacks on noncash expenses to a business such as business use of home and capital cost allowance. Everything you earn will be included in your income, but the biggest problem we sometimes encounter is good accounting. Sounds like a great problem to have right? In most cases it is, but we need to prove your income. When you’re writing down your 150k a year income to 40k lenders won’t accept using 150k. They will use the final reported amount of 40k plus gross ups and/or some addbacks. This tends to create problems of what you can get financing for vs what you can afford. Don’t fret! There are programs designed to help alleviate with this to get your approved.
There are two common programs used for self employed person’s if standard rules won’t work for getting you approved. The first of those programs is the stated income program. I won’t go into detail on the program, but what we are essentially doing is taking a number between your gross income and net income and stating it as your actual income. I’ll build off my previous example of 150k to 40k after write downs. Say you need to prove 80k income to qualify for your purchase. I work with the lender to create an argument based on your financials that this is reasonably what you take home and that the other 40k in tax reductions is just great accounting. The thing to remember most about this program - IS THIS REASONABLE. If after talking about it and going through the numbers and we can’t reasonably say your income is that high, then it will get rejected. Also, expectations shouldn’t be that you will get your gross income number, it will always fall less then that because of reasonability. Your minimum down payment is increased to 10% under this program and minimum 5% of that must be from your own savings.
The second program is relatively new and is targeted at people who are newly self employed, but in the same industry that they previously worked in. You are still required to have been self employed a minimum of 6 months and have 2 years of industry experience. Your income will be based off your previous 2 years income and your new self-employed income will be combed over and hopefully show your income as increasing since your new business venture. Contracts and guaranteed work can also help in this area. For example, you’re a hairdresser that always worked for someone else’s business. It’s been 3 years and you’ve decided you have a large enough client base that you’re ready to take that next step and open your own shop. Business has been good, you’re happy with your choice, and now you want to take another step and purchase a home. Prior to this program you would be unable to qualify your income, now we can take a two-year average using your previous employment partially and your new business income in part as well which makes this all possible. Down payment requirement is still the minimum 5%.
Self Employed, Incorporated
There are a few notable changes from an incorporated business and a sole proprietor, otherwise majority of the information remains unchanged. The first one is you will no longer be allowed the gross up to your income, whatever you pay yourself from the corporation, whether in the form of dividends or salary, will be considered the final amount in most standard cases. A 2-year average will also be applied to this and retained earnings in the corp. will not be included as income. You should also prepare for more documentation as corporate financials will also be required and will need to have been prepared by a certified accountant. Having all your documentation in order and organized will go a long way to getting you approved and making it a smooth process. Aside from that, confirmation and documentation will be the same as a sole proprietor.
Both programs previously mentioned are available to corporations as well. The most common program used though is the stated income program for corporations, especially for people who retain a lot of earnings in their corp. to reinvest in the company or even to hold as savings/rainy day fund. It is much easier to state income up on a corporation than a sole proprietor and retained earnings are the easiest to include as you technically could’ve paid yourself more if you wanted to, but didn’t need to for your lifestyle or business goals.
These programs are not available from every lender! I can’t stress this enough that a lot of lenders and banks don’t offer the additional business for self programs. You should always speak with your broker to consider the options available because just going to the bank could result in a no with no guidance other than the one size fits all approach.
Alternative lending for self employed individuals
I will be brief here, as alternative lending is available for all individuals, it is more commonly advisable for people who are self employed, and I will explain briefly why that is. I will write a full article explaining alternative lending options in the future, but this will just be pertaining to income for self employed persons.
Alternative lenders offer home financing that is far easier to obtain than prime lending, with less document requirements and much more lenient approval processes. First, documentation can be reduced to as little as 6 months business bank account statements to verify income and then a written testimonial from yourself. No lengthy tax returns needed, no accountant prepared financial statements, no fighting over reasonability. There are still some things to be aware of:
· Your interest rate is going to be higher. Higher risk = higher rate
· You still need to have good credit; these programs are offered for people with good credit but have income issues for prime lending options
· Minimum 20% down. Higher risk could lead to lenders requesting more down payment than this though
The most common use of this program is when we can’t use regular means or programs to improve your income to a high enough level to get your lending approved on the prime side. The most common question I get asked is “why do I have to take this higher rate when everything about my application is really solid and my income doesn’t show high enough on my taxes?” and in most cases you can either choose to increase how much income you report on your taxes and as a result pay thousands of extra dollars to the government, or pay a little extra interest and enjoy being able to write your income down as low as possible. Unfortunately, most of the time you can’t have both.
Closing Thoughts
Organization is going to be extremely important in any income situation. Keep your tax documents sorted and in good order, it can make or break approvals and ensures quick responses. Being able to prove your income up to this point and that it is stable will go a long way with making your purchase go smoothly. As a mortgage broker I review your income with you and go through what you will need as well as help get documents in order and provide insight as to the easiest way to verify your income and what programs would be of benefit to yourself
There are exceptions to documentation and some income requirements if applicants are very strong. With tighter regulation though over the years these exceptions are harder and harder to come by and I recommend trying to stick to regular confirmation whenever possible. I would also like to note tips and cash that is received and not claimed on your taxes will be disallowed on an application and there are no exceptions to this as there is no way to prove the income.
This isn’t a fully inclusive list; I have left some forms of income off as the rules vary a lot from person to person and lender to lender. Things such as rental income, universal childcare benefit, permanent disability, investment income, and retirement income are all other forms that can be used as well as some others depending on the situation.
If you are considering a new purchase soon, please reach out to me to have a discussion if you are worried about qualifying under your income. If you are considering a job change and a purchase in the new future it is also a good idea to speak with your broker to ensure the change won’t affect your ability to make a purchase.