In earlier posts in this series on How the banks look at you for a mortgage, we looked at what your credit score and report needs to show in order to convince the banks of your responsibility in handling debt. We looked at how much of a mortgage payment you can qualify for to avoid becoming over-extended, as viewed by the banks.
Now we turn to what it takes to convince the banks that you will be able to sustain that payment over the length of the mortgage. Obviously, they want to be assured that you will not only be able to afford it today, but over the term of the deal. They will need to be convinced of the ongoing security of your income.
First, let’s talk about the mortgage “term.” In Canada (unlike in the U.S.), mortgages are not given out for the full length of amortization (pay off) period. Typically, mortgages are only given out over 3- to 5-year terms, but they can be for as little as one year or as high as seven years. At the end of the term, you have to re-qualify.
The mortgage may be given at a “Fixed” rate, meaning the initial rate is “locked-in” for the term of the deal, or a “Variable” rate, meaning it rises and falls with the changing interest rate environment. Often it is at the borrower’s option, where they need to weigh the importance of a security against the prospects of saving money.
Regardless, because of the banks’ need to assure you can sustain your payment over the term, they will restrict the kinds of income that count towards reaching your Gross Debt Service levels (defined in the previous post.) They will accept only income that is very secure, in calculating your GDS ratio.
The most secure income, in the eyes of the lenders, is fixed, salaried income. Union and government jobs are very secure. But any income that is salaried or wage-based with fixed hours, is acceptable, provided it has enough history to show that. Traditionally, you simply had to be beyond any probationary period in a new job. In the past year, though, because of the jolt that the covid pandemic introduced into job security, the lenders have become tougher, sometimes requiring longer work histories.
Other acceptable income is fixed disability or pension income, provided it is permanent. Contracts with government agencies, such as community living homeshare contracts, are accepted by some lenders but not others.
Also acceptable are child tax benefits, provided they are not on the verge of expiring. Lenders will probably accept the child tax benefits for children under about age 15, so that there are at least three years remaining on those payments. (For rent 2 own, we have to reduce the age further by the number of years of the rent 2 own program, so we often use age 12 as the cut-off.)
What if you’re self-employed? This is a problem for the banks because the income is normally quite variable and uncertain. The only way they can assess this is to look at the pattern established over several years. They will typically check your income tax records for the last two years and take the average of the two as your accepted income. But, if it is declining (not a good sign), they may only use the last year’s amount in their calculation.
There is another complication for the self-employed: what do you count as income? There is often a big difference between total (gross) business income and the amount that ultimately gets claimed as personal (net) income, after deducting business expenses. It is the net income (line 150 of your Income Tax Return) that is used in the calculation (though some lenders have been known to “gross up” the net income by a modest amount, perhaps 15%). This is when self-employment can really hurt you. One benefit of self-employment is the ability to “write off” a lot of expenses, leaving you a low net income and thus saving you a lot of taxes. But you can’t have it both ways.
So, if you are self-employed, you may need to forego some of your otherwise eligible business deductions for several years in order to show a larger income to the mortgage lenders. This is where a rent-2-own program can be a good fit, establishing that income history while you are already in the home you will own.
Several other types of income are treated similarly to self-employed income. Commission income is also variable, and will likely require two years of income tax statements to demonstrate consistency. It’s the same for jobs that may have a base income rate but for which you accumulate a lot of overtime or bonus payments. Only the base rate will be taken into consideration as secure income unless you have several years of history to show consistency in the surplus earnings.
Income sources that do not count are: unemployment income (EI), social security income, most alimony and child support payments (unless they can be proven secure over the long term), CERB payments and other short-term support programs, and tips, unless they are reported on your Income Tax Return (in which case, they may require the same 2-year history as other surplus income).
The above should be considered general guidelines. There are variations between institutions, and the lending landscape is a shifting tectonic, so it’s always best to consult a mortgage broker. They will know the current mortgage climate and the variations between lenders.