How Do Lenders Calculate Self-Employed Income for a Mortgage?
Most lenders take the net income on line 15000 of your T1 General for the last 2 years and average it. They confirm it with your Notice of Assessment from the Canada Revenue Agency. Some lenders then add back expenses that didn't cost you cash, or gross your income up by 15%. The same tax return can qualify you for noticeably different amounts depending on which method the lender uses.
How do banks calculate self-employed income for a mortgage?
A bank wants to know whether you can afford the payments, and it looks at what you earn and what you already pay each month. For an employee, a pay stub answers the first part. For a self-employed borrower, the bank uses your tax return, because it's the income the government has checked.
Most lenders take line 15000, your total income, from your last 2 T1 Generals and average the 2 years. If the most recent year is lower, many lenders use the lower year on its own, since a falling income tells them less about next year than the average does.
What does the Notice of Assessment prove?
The Notice of Assessment is the letter the Canada Revenue Agency sends after it processes your return. It proves 2 things to a lender: the income you filed is the income the government accepted, and you don't owe unpaid tax. Canada Mortgage and Housing Corporation lists the last 2 years of Notices of Assessment, backed by the T1 General, as the standard documents for self-employed borrowers.
An amount owing on the notice is a common reason for delay. Many lenders want it paid before closing, or paid out of the mortgage, because the Canada Revenue Agency can rank ahead of them.
What are add-backs, and which expenses can be added back?
An add-back is an expense you deducted for tax that some lenders will put back into your income, because it lowered your taxes without taking cash out of your pocket. The 2 most common are capital cost allowance (the yearly depreciation on equipment or a vehicle) and business-use-of-home expenses (part of costs you'd pay anyway as a homeowner).
Not every lender allows add-backs, and the ones that do don't all allow the same items. Meals, travel and wages paid to others are real cash costs and usually stay deducted.
What is the 15% gross-up for self-employed income?
Canada Mortgage and Housing Corporation lets lenders gross up income from a sole proprietorship or partnership by 15%, or use the add-back approach, to reflect the fact that self-employed people deduct expenses employees can't. The 2 are alternatives, so a lender uses one or the other on the same income. Some lenders apply the gross-up on insured mortgages only, and some don't use it at all.
How much does the method change what I qualify for?
The figures below are an illustrative example for a sole proprietor, made up to show the arithmetic.
| Year 1 | Year 2 | |
|---|---|---|
| Gross revenue | $180,000 | $200,000 |
| Business expenses | $110,000 | $115,000 |
| Line 15000 income | $70,000 | $85,000 |
| Capital cost allowance plus business-use-of-home | $10,000 | $10,000 |
- 2-year average of line 15000: $77,500
- With add-backs: $77,500 plus $10,000 equals $87,500
- With the 15% gross-up instead: $77,500 times 1.15 equals $89,125
The gap between $77,500 and $89,125 is $11,625 of qualifying income. At most lenders that's the difference between one price range and the next, from the same 2 tax returns.
What documents do self-employed borrowers need for a mortgage?
Plan on your last 2 T1 Generals with all schedules, the matching Notices of Assessment, and proof the business is active, such as a business licence, GST registration or articles of incorporation. Incorporated owners add 2 years of company financial statements. Lenders also ask for 90 days of bank statements to show where the down payment came from.
Gathering these before you apply keeps the approval from stalling at the condition stage, which is where most self-employed files lose time.
How do lenders calculate income if I'm incorporated?
If you run a corporation, your T1 General shows only what you paid yourself, as salary (a T4) or dividends (a T5). Most lenders start there. Dividends are taxed at a lower rate, and some lenders gross them up to compare them fairly with salary.
Profit you leave in the company doesn't show on your personal return at all. Some lenders will count a share of the company's retained earnings if you own the business outright and the financial statements show the profit was there. Expect to provide 2 years of corporate financial statements alongside your personal returns.
What if my tax return doesn't show enough income?
There are 2 main routes for a borrower whose declared income is lower than what the business earns.
- Insured stated income. Sagen's Business for Self program insures mortgages up to 90% of the home's value for owners self-employed at least 2 years, with income stated by the borrower and judged against the type, size and age of the business. Commission earners are excluded.
- Alternative (B) lenders. These use bank statements, contracts or company financials to support income. They cost more and usually charge a fee, so the plan is to move to a regular lender once 2 stronger tax years are on file.
Our BOSS framework maps which route fits a file, and the self-employed income calculator runs the numbers on your own returns.
Frequently asked questions
How many years of tax returns do I need as a self-employed borrower?
- Most lenders want the last 2 years of T1 Generals and Notices of Assessment. With less than 2 years in business, some lenders accept a shorter history if you worked in the same field before.
Do lenders use my gross revenue or my net income?
- Net income, the line 15000 figure after business expenses. Gross revenue shows the size of the business, but the lender qualifies you on what's left after costs, plus any add-backs it allows.
Can I add back depreciation to qualify for a mortgage?
- At some lenders, yes. Capital cost allowance is the most common add-back because it reduces your tax without a cash outlay that year. Ask the lender before relying on it, since policies differ.
What if my income dropped last year?
- Many lenders use the lower, more recent year when income is falling, instead of the 2-year average. A short explanation of the drop, and year-to-date figures showing a recovery, can help.
Can I get a mortgage with stated income in BC or Alberta?
- Yes. Insured stated income programs, such as Sagen's Business for Self, and alternative lenders both operate in BC and Alberta. You still document that the business exists and has run at least 2 years.
Should I claim more income on my taxes to qualify?
- It's a trade-off between tax paid and borrowing power. Run both numbers with your accountant 1 or 2 years before you buy, because the lender reads the years already filed.