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It’s taxes versus a mortgage for the self-employed

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Eighty of mortgage broker Dustan Woodhouse’s clients who were approved for a mortgage in 2011 wouldn’t have qualified for the same mortgage today.

In the summer of 2012, Canada’s financial regulator introduced Guideline B-20 as a way of tightening up the banks’ approval processes.

Part of B-20 requires banks to examine incomes more closely, but where does that leave self-employed people, who have had more trouble getting mortgages since that rule was brought in?

“It sort of came in under the radar a little bit and caught a lot of [self-employed] people off guard when they were probably not used to having any real issues with arranging financing in the past,” says Gerry Orr, president and owner of Alberta Mortgages in Calgary.

The main problem for self-employed workers is that they typically lower their taxable income through business expenses and other deductions, so what they declare is often an inaccurate reflection of their true incomes. In the past, they were able to simply declare their incomes and provide proof of self-employment, along with other documentation.

Today, self-employed individuals can still apply for a stated income mortgage at some banks, but B-20 also means that they need to put up at least a 35-per-cent down payment to avoid purchasing default insurance from the likes of Genworth Canada or Canada Mortgage and Housing Corp., Canada’s two largest mortgage insurers.

So while those 80 families of Mr. Woodhouse, an accredited mortgage professional with Canadian Mortgage Experts in Vancouver, can consider themselves lucky that they were approved before B-20 was put in place, what about other self-employed individuals or families in the current climate? What can they do to ensure that they can obtain the kind of mortgage they need?

According to many experts, it all starts with how much income you’re declaring when you file your taxes.

“The key is to declare as much money as possible and not hide funds by any means because it’s going to hurt you in the long run,” says Mathieu McCaie, a mortgage agent for the Mortgage Group in Dieppe, N.B. “You’re either paying Revenue Canada or you’re paying it somewhere else to borrow the money, basically.”

And while prospective self-employed homeowners will have to submit a detailed, accountant-prepared general tax form, in full – not just the four-page summary that many people turn in – in addition to a notice of assessment to confirm that no taxes are owing, it’s one thing in particular that prospective lenders are looking for.

“Line 150 – documented income – is everything,” Mr. Woodhouse says. “That’s also the composition of that income. What they’re really looking for is earned income from your trade or your profession.”

With that in mind, how much income are they looking for?

“Typically, if someone’s operating a fairly successful business, they should at least claim $100,000 or just under if they want to continue purchasing real estate,” says Michael Marini, a mortgage broker with Dominion Lending Centres in Toronto.

“If it’s just for their own single purpose, just one purchase, they need to show an average two-year income. They need to ensure that their income is high enough in the last two years to qualify for the property that they want.”

With that two-year period in mind, planning is of the essence. Purchasing real estate and establishing a successful business do not necessarily mix in the short term, so you’re better off building up your business before deciding to buy a house, experts suggest.

“If you’re not two years in the business, that’s going to be a real challenge to purchase a house,” Mr. McCaie says.

For those who don’t qualify via the banks and other A-list lenders, there are other routes, such as credit unions, that are not subject to the B-20 regulations and can take on more risk from their borrowers.

“Through alternative lending channels we can use gross income by showing bank statements that show you have income coming in, you’re just not declaring it, and give them a mortgage,” he says.

Such a loan might come at a higher cost, however.

“Really, it comes down to whether or not you’re willing to pay the interest premium and the higher down payments required with a B or private lender, versus arranging your affairs in such a way that your income personally on your notice of assessment reflects a higher level,” says Mr. Orr.

Or, as Mr. Woodhouse puts it, would you rather pay a premium on your mortgage, or would you rather pay income tax? “It’s your choice.”

Follow Paul Attfield on Twitter: @paulattfield

Fixer-uppers not for the faint-of-heart – Ask a Vancouver Mortgage Broker

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When Eileen Muzzin and her partner, Dan Pedersen, were searching for a home in Vancouver, they knew they wouldn’t be buying a place with granite countertops or a peekaboo view. With a modest budget – by Vancouver standards – they ultimately decided on a fixer-upper on the city’s east side.

The couple got a 2,000-square-foot home with walls painted red and gold, a weak electrical system, various objects buried in the backyard and a kitchen that was last renovated in 1961.

“We were digging in our yard and found a rolled-up carpet two feet down,” Ms. Muzzin recalls. “There were really old bricks there too, which we ended up reusing between our garden beds.

“We basically bought the crappiest house in the neighbourhood we wanted to live in,” Ms. Muzzin says.

The two were smart to buy in a community they coveted. There’s truth behind the cliché “location, location, location.”

“You can fix a home but you can’t fix a neighbourhood,” says Vancouver real estate agent Kel Parry.

What the home also had was good bones. The trick to purchasing a fixer-upper without ending up with buyer’s remorse is distinguishing between a home that has “potential” and one that could turn out to be a disaster.

To do that, a home inspection is a must. But that’s just the starting point, says Mr. Parry, who himself bought a fixer-upper with his wife many years ago in North Vancouver.

Hire a contractor to give you estimates on fixing problems. “If you can, get two or three quotes. Once you start getting those numbers down, tack on another 30 per cent for contingency,” he says.

“The first thing I tell clients when they’re considering a fixer-upper is, whatever you’ve budgeted, make sure you have more than that,” he adds. “There are always hidden costs.”

Aside from using savings, credit cards or lines of credit for HGTV-style projects, buyers can secure financing at the time of purchase through mortgages such as the CMHC Improvement program or Genworth’s Purchase Plus Improvements program.

Fixer-uppers typically need expensive renovations of kitchens and washrooms. Other common and costly jobs include repairing or replacing the roof and windows as well as upgrading the electrical and plumbing systems.

Some repairs are deal-breakers, with structural and foundation problems typically falling in that category.

“If you’re looking at a property that will continue to cost you money in the long run, and will cost you a lot of money right out of the gate, you want to get a professional opinion on that,” Mr. Parry says, adding that it’s important to do a property-information search with the city or municipality. “Structural and foundation issues are big.”

An oil tank buried in the yard is another red flag, says Vancouver home inspector Tom Munro, founder of Munro Home Inspections.

“Oil tanks are the ultimate deal-breaker,” says Mr. Munro, who claims to be the only inspector in the Greater Vancouver area who scans for buried tanks using a magnetic sensor. “The tank needs to be disposed of properly. You need to get an oil-tank-removal certificate, and then you need an independent soil-sample analysis.”

Aside from the environmental impact, cleanup can be costly. One North Vancouver homeowner had to spend $85,000 on the removal of a tank and the ensuing decontamination of her property in 2012.

Mr. Munro has found other buried treasure during home inspections. He discovered a Volkswagen Beetle in one backyard where the swimming pool used to be. In the fixer-upper he bought himself recently, a previous owner had deposited all of the old appliances under a few feet of dirt.

Then there’s the accompanying stress of renovations. They can take a toll on relationships as well.

“If you anticipate a number of projects, you have to be prepared to live in that situation with dust, with tarps, with all the things that come with living in a construction zone,” Mr. Parry says. “It’s very disruptive, especially if you have young children. If you can get renos started before you move in or even stay with relatives or in a hotel for a short period, those are worth considering. Some people don’t mind it, but it’s not for everyone.”

Mr. Munro says with a laugh: “I’m a marriage counsellor as much as a home inspector.”

For Ms. Muzzin and her partner, living amid the mess has so far been worth it. They enjoy working on their home and going to salvage lots for unique finds.

They installed a beautiful claw-foot tub with polished chrome feet in the main bathroom they renovated themselves. They hired professionals to replace the roof and upgrade the electrical system. Next up is that 1961 kitchen, with its linoleum floors and teal-coloured everything.

“I love having my own home to work on,” Ms. Muzzin says. “But it’s not for the faint-hearted.”

Follow us on Twitter: @GlobeMoney

Applying for a fixed-rate mortgage? Why you need to do your homework

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Imagine you’ve applied for a five-year fixed-rate mortgage. Then, before you close, the lender drops its best five-year fixed interest rate. You’d expect that new lower rate, right?

Most people in this position would. But with some lenders, that’s not the way it works.

If you’re going mortgage shopping, take a minute to understand your lender’s rate-drop policy before you send in your application. Too many people don’t and it ends up costing them.

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BOOK EXCERPT When it comes to home buying, smaller is better DECODING THE MORTGAGE MARKET Should you get pre-approved for a mortgage? Ten things to know Five-year mortgages holding firm, but just wait The government-backed Canada Mortgage and Housing Corp. is raising its prices for home mortgage insurance. CARRICK TALKS MONEY Video: Carrick Talks Money: Don’t get stuck in the mortgage penalty box Your Personal Investor Dale Jackson looks at the cost of longer amortization periods. VIDEO Video: If you choose lower mortgage payments now, you may regret it later Homeowners may be feeling nervous after the Bank of Canada’s recent talk of changes to interest rates. Canadian Press business reporter Romina Maurino looks at what this could mean for your mortgage. MONEY MONITOR Video: How would an interest-rate hike affect your mortgage? How rate drops normally work Typically, if you’ve been approved for a mortgage and the lender drops its rates before your closing date, the lender will lower your rate as well. Every lender has its own policies, though. For instance:

· Some lenders allow you only one rate drop. Others allow multiple. · Some lenders only permit rate reductions up to seven days before you close. Others give you their best rate right up until your closing date. · Some lenders automatically lower your rate. Others require your banker or mortgage broker to manually request the rate adjustment. In this latter case, you better have a reliable mortgage adviser or keep tabs on rates yourself.

The best-case scenarios are those lenders with “look-back” policies. This means they’ll look back and give you their lowest rate from the time you applied until the time you closed. Those lenders are few and far between but any good broker knows who they are.

How other lenders operate More and more lenders are adding “no-float-down” clauses to their fixed mortgage rates. This is particularly true with certain non-bank lenders.

“No float down” means your rate cannot be adjusted lower if that lender comes out with a better deal. Those lenders make those lower rates available for “new business only.”

Now, you may be thinking, “I’m a good client, why should a new customer get a better rate than me?” The answer, lenders say, is profitability. When you get a fixed mortgage, the company funding your mortgage generally “hedges” that rate, meaning it pays for an expensive form of rate insurance. This ensures the lender doesn’t lose big if rates jump and it has to honour the lower rate it promised you.

If rates fell and the lender didn’t have a “no float-down” clause, it would incur the cost of that rate hedge and have to give all of that rate savings back to you, the customer. But with mortgage competition so fierce and margins so tight, some lenders can’t afford to do that anymore.

When rate drops matter If fixed rates are rising or going sideways, “no-float-down” policies shouldn’t hurt you. If fixed rates are in a downtrend, however, it pays to have that rate-drop option, other things being equal.

I say “other things being equal” because float-down privileges are rarely the deciding factor when choosing a mortgage. A lower upfront rate or better mortgage features can often negate the disadvantage of no-float-down restrictions.

Moreover, the odds of rates dropping decline the closer you are to your closing date.

In case you’re curious, fixed mortgage rates drop from one month to the next about 38 per cent of the time. That’s been the case since 1951 at least, according to Bank of Canada data.

Historically when rates have dropped – versus the prior month – the average decrease has been 0.23 percentage points. Even if you ignore 1973 to 1993, a volatile period of surging and plunging rates, the average decrease was still 0.17 percentage points. On a $200,000 five-year mortgage, a 0.17 percentage point rate drop would save you about $2,500 in interest.

If your mortgage does come with a rate-drop feature, contact your mortgage adviser about 10 days before you’re scheduled to close. Don’t take it for granted that someone will notify you automatically if rates are lowered. Ask if your lender has offered cheaper rates since you applied for your specific term and rate hold period. (Those last three words are important because lenders generally don’t let you have their lowest 30-day “quick close” rate if you originally applied for a 60, 90 or 120-day rate.)

Make it a point to understand your lender’s rate-drop policy. Every tenth of a per cent matters and you never know when interest costs will dip.

There are 300-plus lenders to choose from in this country. If you pick one with a “no-float-down” policy, be sure the rest of the mortgage terms make up for it.

Robert McLister is a mortgage planner at intelliMortgage Inc. and founder of RateSpy.com.

Follow Robert McLister on Twitter: @RateSpy.com

First-time homebuyers are feeling the weight of Canada’s housing boom

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Many times over the last few years, John Norquay has been stricken with pangs of anxiety over not being a homeowner.

Should you rent or own your home?

Bank of CanadaPeople say that when you grow up, you buy a home. But owning doesn’t make sense for everyone and in some cases, it might be more financially beneficial to rent. Find out more They strike when he attends housewarming parties for friends. They hit when he hears that friends bought in the condo building where he is renting and the value of the unit has already shot up.

But the 35-year-old Toronto immigration and refugee lawyer graduated in 2005 with $75,000 in student debt and while he tackled his loans ahead of saving for a down payment, home prices have only climbed. “I decided to wait but I don’t know if I’ll end up regretting that,” he says. “It seems like every other month there’s an article about the condo market bubble bursting; I kind of gambled there and I think I lost.”

It used to be a rite of passage for young people, a way to announce your adulthood to the world by buying your first home. But fewer young people today are able to achieve this dream. A recent CIBC report showed that the home ownership rate among first-time homebuyers (25 to 35) fell from 55% in 2012 to the current 50%.

With the rise in housing costs, many first-timers are locked out of the market, unable to save the gargantuan down payment or qualify for a mortgage.

Related From $99,999 to $1-million plus: Here’s what Canadians can buy in Florida real estate Renewing your mortgage? Here’s why you should pick up the phone Outside of Toronto, Vancouver and Calgary, Canada’s housing market is ‘mediocre at best’ According to a BMO report released in March, first-time homebuyers plan to spend an average of $316,000 on their first home, up from $300,000 in 2013. (Those in Vancouver expect to spend $506,500 while those in Montreal plan to pay $237,900.) Respondents to the study expect to put an average down payment of 16% or $50,576.

Now, considering that the average home price in Canada was more than $416,000 in May, if you wanted to put 20% down, you’d need $83,200. That’s a daunting figure for anyone.

Six in 10 hopeful homeowners say their home-buying timeline has been delayed, with 39% citing rising real estate prices as the main reason for delay.

“You’ve been in the workforce for a few years and you don’t have a lot of assets; it can take several years to break into the financial market,” says Penelope Graham, an editor at Ratesupermarket.ca.

As tuition fees rise and students graduate with more debt, many find that they’re devoting funds to debt repayment versus saving for a down payment. (Mr. Norquay’s debt payments amount to $750 a month.)

And if graduates don’t find steady employment right away, accumulating a lump sum is even harder; more young people today compared to previous generations opt to return to school when they have trouble breaking into their fields.

The youth unemployment rate in 2012 was 2.4 times that of adults — marking the biggest gap since 1977, a Statistics Canada report said.

“If you look at youth unemployment and underemployment, that’s definitely another factor. The ability of young people to earn has been compromised,” says Benjamin Tal, deputy chief economist with Canadian Imperial Bank of Commerce.

He calls today’s young adults “the lost generation” — a group that is falling behind economically.

A new report by the Conference Board of Canada echoes his findings: the average disposable income of Canadians between the ages of 50 and 54 is now 64% higher than that of 25- to 29-year-olds. That’s up from 47% in the mid-1980s.

With young workers facing lower wages, rising home prices and tighter mortgage restrictions (reducing total amortization to 25 years, capping maximum debt ratios for households to qualify for a mortgage loan), the goal of home ownership moves further away for many.

So what are people doing instead? They’re spending more time living with mom and dad. They’re renting. Renting often suits a younger demographic who might appreciate mobility and fewer responsibilities. Plus, home buying comes with maintenance costs and upkeep and each time you buy a home, extra funds are needed to cover things such as lawyer fees, land-transfer taxes, and other transaction expenses that typically add 10% to the purchase price.

Some experts argue that investing one’s savings in assets with higher potential returns is a better option than sinking everything into the housing basket, especially if you might be planning to move anytime soon.

“The one compelling argument I have seen in support of renting is that if someone is wisely investing, it can be a bigger payout in the end,” Mr. Norquay says. “I am not at all the saver type, and those articles have only increased my desire to want to own. Basically it would be a way of forcing myself to invest.”

Why is he a bad saver? “I like to go out and have fun and I like to travel.” More than two-thirds of Gen X Canadians told a TD survey that they wanted enough flexibility to be able to afford things like travel after paying their monthly mortgage.

Mr. Norquay now rents a $1,950 two-bedroom condo unit with a roommate near his downtown legal aid clinic. Three years ago, he hoped to buy a home with a friend and got pre-approved for a joint mortgage; but they couldn’t find the right property.

Though some say people should take advantage of the record low mortgage rates and get into the housing market as soon as possible, Sadiq Adatia, chief investment officer at Sun Life Global Investments, suggests first-timers should continue to wait.

“First-time home buyers should wait to buy as the market is quite frothy at the moment and it is only a matter of time before we see a pullback,” Mr. Adatia says.

“Though rates will also go up at some point, our belief is that housing values will decline prior to that, giving buyers a great opportunity to take advantage of lower prices, but also lower rates. Those opportunities do not come often.”

As it stands today, houses are becoming less affordable, according to RBC’s most recent affordability index which measures the percentage of pre-tax household income that is needed to service the cost of owning a home (including mortgage payments, utilities and property taxes). In Vancouver, 82.4% of household median pre-tax income is needed to service the cost of owning a bungalow at current prices. That compares with 56.1% in Toronto and 34.5% in Calgary.

In places like Toronto and Vancouver, competition is steep so first-timers could face bidding wars which ratchet up prices and prompt some buyers to drop important conditions such as a home inspection.

“Without having a bit of help from friends and family or being able to sell something, it’s very difficult for a first-time homebuyer even on two incomes,” says Mike Bone, a 31-year-old account manager at a marketing consulting firm. He and his wife are looking to buy a home in Toronto for $550,000 to $700,000 but have found that bidding wars inflate all of the prices.

“We’re trying to balance getting in there and not making a stupid decision. It’s frustrating but we understand the high demand and the low supply of single-family homes. Lately, we’ve been looking at new builds and low-rise condos.”

Mr. Bone says he hopes that they’ll have some luck as the weather cools and in the interim, they’ll continue to build up their savings.

But how do you even start saving up that big chunk of money, especially if you’re doing it alone?

The majority (61%) of first-timers told a BMO survey that they’ve made cutbacks to their lifestyle in order to save for their first home. Meanwhile, 30% expect parents or family to assist in their purchase; this percentage rises to 40% in Montreal and Vancouver.

The minimum down payment for a home is usually 5%, says Jeff Cody, managing partner of Mortgage Brokers City Inc. in Ottawa. “But if you put less than 20% down, the mortgage has to be insured against default,” he adds. The more you put down, the lower your insurance premium, which start as high as 3.15%.

You need a strategy.

Mr. Norquay will finish paying off his student loans in October; then, he’ll start accumulating more for his future home. He also has savings in an registered retirement savings plan and wants to take advantage of the home buyers’ plan. Under the home buyers’ plan, Canadians can take $25,000 out of their RRSP and pay it back over the next 15 years without incurring any penalty.

Save as much as you can before taking the plunge, Ms. Graham says. “Aim to pay more than a 5% down payment,” she says. “No one wants to hear this but if you go into your first home purchase with more capital up front, it means you’re going to take out less of a mortgage and over the long run, you’re going to pay less interest and you’re going to build your equity faster.” • Email: mleong@nationalpost.com