This is Part 2 in my series that aims to “Understand the Mind of a Lender“. There are 4 key areas that come under scrutiny; income, credit, downpayment and the property. The following is an in depth look at how your income is viewed by a lender.
Obviously the more money you make the more money you will qualify to borrow… but that’s not what we’re here to look at. Sometimes, regardless of “how much you make” if your income can’t be substantiated (by their guidelines), you might not qualify for a mortgage at all.
The key here is to try and see it from the lender’s point of view. If someone (not you) with your exact financial situation wanted to borrow (insert amount you want for a mortgage here), would you feel comfortable lending it to them? What steps would you take to verify they have the means (through proven income) to pay you back?
So with that perspective in mind, let’s take a look at the normal documentation required to prove income, and how your employment type, status, and tenure factor into qualifying for a mortgage. For the lender, its all about limiting their risks and making sure you are able to make your payments (despite how good of a person you are).
In order to prove your income to a lender, you will typically be required to provide the following:
Employment Letter. An employment letter should be on company letterhead, state your name, when you were hired, your annual income, your employment type (full time, part time or seasonal), your employment status (permanent or on probation), if you receive bonus or overtime income, and should be signed by an authorized representative of the company. The lender will then contact the company to confirm the details on the letter.
Paystub. A current paystub that confirms the income provided on the employment letter and also has the amount you have made year to date.
Latest 2 years Notice of Assessments (NOA’s) or T4’s. These might be required to substantiate bonus, overtime, or self-employment income.
Articles of Incorporation or T1 Generals. These documents are required to prove self-employment.
These are the most common documents required, however depending on your specific situation, and after reviewing some documents, the lender always reserves the right to ask for more (and oftentimes does).
Your employment status is probably the most important consideration to the lender when looking at your income because your status is a strong indicator of your employer’s commitment to your continued employment.
Permanent Employment. This is the gold star, if your employer has made you a permanent employee, it means that your position is as secure as any position can be. When a lender see’s permanent status (passed probation), it gives them the confidence that you are valuable to the company and that your income can be relied on.
Probationary Period. If you have only been employed with a company for a short period of time (typically 3-6 months), the lender is going to want to see that you have passed any probationary period. This is because an employer can terminate your employment without any cause while you are under probation. There isn’t a lot of confidence for the lender if you haven’t made it through your initial evaluation.
Now, it’s not really the length of time with the lender that is being scrutinized here, its the status of your probation. So if you have only been with a company for 1 month, but you have been working with them as a contractor for a few years, and they are willing to waive the probationary period based on a previous relationship, that will give the lender more confidence.
Parental Leave. If you are currently, planning on, or just about done a parental leave, regardless of the income you are currently collecting, as long as you have an employment letter that outlines your guaranteed return to work position (and date), you can use your return to work income to qualify on your mortgage application. It’s not the parental leave that the lender has issues with, its the ability you have to return to the position you left.
Term Contracts. This is hands down the most ambiguous and misunderstood employment status as it is usually well qualified and educated individuals who are working excellent jobs with no documented proof of future employment. A term contract specifies that you will be paid to do a certain job from a start date to an end date. This is not a lot for a lender to go on when evaluating your long term ability to repay your mortgage. The real conflict here is that although most term contracts get renewed or extended, your employer is not making any guarantees.
So in order to qualify income on a term contract, there are several different ways lenders look at it. The best would be to establish the income on at least a 2 year period This is where the 2 year NOA or T4s come into play, the lender would simply take a 2 year average and use that. However sometimes lenders also like to see that the contract has been renewed at least once before considering it as income towards your mortgage application.
Self-Employed. This could be an entire article on its own. Lenders view self-employed individuals with greater speculation, there is no doubt about it. In previous years there have been programs that allow self-employed individuals to “state” or “declare” their income, and as long as it was reasonable for the industry, the lender (and more importantly the insurer) would accept it. However the insurers decided it was too risky and have pulled these programs. There are a few lenders still offering these type of programs but they require a considerable downpayment.
In order to qualify for a mortgage using self-employed income, you will have to be in business for a minimum of 2 years as the lender will want to see 2 years history of your business income on your T1 Generals (Statement of Business Activities) and your Notice of Assessments (NOAs). Depending on what is contained in your T1s, some lenders will allow you to add 15% to your Line 150 to come up with your average income.
The real big problem here is there is typically a large gap between what a self-employed persona “makes” compared to what they “claim” for tax purposes… and no, not illegally, through write-offs. Small business owners are allowed to include a lot of the expenses incurred while doing business as deductions on their tax return, thus minimizing the income they actually pay tax on. Good for the pocketbook, bad for mortgage qualification.
Are you employed full time, part time, on a contract, or working 3 casual jobs? Each type of employment carries with it it’s own risk profile to the lender. The more secure your job is, the higher the likelihood of you having your job long term, the better the risk you are to the lender.
Full Time Employment. Typically this refers to working 36-40 hours a week, year round. This can be either hourly or salary. So if you make $24.00 an hour and are guaranteed 40 hours a week to figure out your annual income you would take $24.00 x 40 x 52 for $49,920. Your employment letter should outline the amount of hours you work, and your hourly wage (or salary), this is the figure the lender uses in the calculations towards how much they will lend to you.
Part Time Employment. Typically this refers to working less than full time. Part time employment is not necessarily a bad thing depending on your status. A permanent part time position is just as secure as a permanent full time position. However if your position is not permanent or your hours are not guaranteed, the lender will want to see that you have been making consistent money over the last 2 years and request proof.
2 or More Part Time Jobs. A lot of people who work part time enjoy working many jobs casually, and that is acceptable to the lender however there are a few catches. As previously mentioned, permanent status, passed probation with guaranteed hours is the best, less than that and the 2 year average will be required. Also, with multiple jobs, if the hours add up to more than 40 hours a week, most lenders will want to see that you have been able to keep up that pace over at least a couple years and will request your 2 year average.
Casual Employment. You might be picking up on a theme now, casual employment is acceptable to the lender, but will have to be substantiated by 2 years average.
What does tenure mean anyway? In Canada, originally tenure referred to a contractual right of a teacher or professor not to have his or her position terminated without just cause. It is awarded after a probationary period. For standard employment and as far as a lender is concerned, tenure is the length of time you have been working in a certain profession along with the level of education and experience necessary to hold that position.
Although most employment decisions are based around employment status and type, tenure can play a big part in how comfortable the lender is with your mortgage application if your employment status is a little shaky. For example, what happens if you are a nurse who has been working at the same hospital for 12 years on a permanent full time basis, but you just accepted a new position on a different unit, that comes with a mandatory 1 year probation? The lender would be more likely to make an exception for you in this scenario than say if you were selling office furniture for the last 6 months and now have decided to start framing houses.
The length of time you have been working in an industry, regardless of company or position, impacts the lenders decision to extend financing to you. Of course the more education and more experience you have, the better.
Other Income Scenarios
Employment Insurance Income. So, you are unemployed because you lost your job, and want to buy a house. Although there is a high likelihood that you can find a place to buy cheaper than what you are paying in rent, if you don’t have a job (even if you are collecting employment insurance), lenders are not going to jump to lend you money. Your best bet would be to find employment.
Disability Income. Disability income can sometimes be used on a mortgage application if it is guaranteed income and you will be receiving it ongoing. Permanent disability is considerably better than temporary disability.
Pension, Retirement, or Trust Income. It is possible to use retirement income on a mortgage application, again it will mostly depend on how secure the income is, is it permanent and for how long you will be receiving it.
Seasonal Income. Seasonal income can be used on a 2 year average, however if you collect employment insurance, it will not count towards your annual income.
So there you have it, as you can see, the lender has a lot to think about when it comes to looking at your employment situation and deciding if they want to lend money to you for a mortgage. Next in the series, we will take a look at how your credit history plays a part in the lender’s decision as well.
If you have questions about how your income might look to a lender, or any mortgage questions for that matter, contact me anytime!
It's me again! I will be posting articles with more in depth information regarding specific mortgage scenarios. I do my best writing when my kids are asleep...