August 25, 2019

Tier II lender a better option for self-employed homebuyers

BY 

Perilous times are in the offing if you are self-employed and looking for high ratio financing (beyond 80% of value).

Self-employed people try to minimize taxable income by maximizing expenses and writing off as much as they can. The opportunity to purchase housing, therefore, becomes onerous when lending institutions run their affordability modules based on taxable income and not gross income.

As an example, Paul runs a heating and cooling company. Last year, he showed “billing income” of $220,000. His net taxable income however was $54,000, since he gets to write off his vehicle expenses, upkeep, depreciation, rent, heat, light, and sub-contractors. The billing income has remained stable for the last few years and the taxable income has come down gradually from $58K three year ago to $56K last year and $54K this year. He owes no income tax.

Paul wants to buy a single-family dwelling for his family of four. The purchase price is $384,000 and he has $50,000 for a down payment. According to his bank, his debt servicing ratio (total housing costs including heat, property taxes and mortgage payments divided into taxable income) is 41%. The maximum allowable is only 35% so he fails to qualify.

His present rent is more than $2,000 per month and his budget can afford this expenditure. He does have a car lease of $400 per month. He called his bank to see why they restricted him to a 25-year amortization and was told that high-ratio mortgaging cannot exceed 25 years according to new federal government rules.

This is a 36-year-old individual, married with two kids. He knows he can afford this venture, but cannot convince his bank to lengthen the amortization to 30 or 35 years where he would be granted an approval at the 2.99% interest rate.

He told me his story over a coffee and I ran my own numbers. If we reduce the loan to 80% financing, then his bank and all the other Tier I lending institutions would go to 30-year amortization. Since he needs high-ratio financing (greater than 80% financing) the lending institutions must go through an insurance company who dictate the rules. They say maximum 25 years, so he does not qualify going that route. In any case, where would he get the extra money required for down payment ($34,000)?

He called me out of desperation. I listened to his story, ran his credit report and I told him that his bank was correct, no Tier I lending institution can grant him a normal mortgage because the insurance company (Canada Mortgage and Housing or Genworth) required for more than 80% financing say NO!

I can, however, grant his wish for mortgage financing using a Tier II lender. This new type lender will grant him a first mortgage of $305,000 amortized over 30 years and a new second mortgage for the remainder of monies required ($29,000) to purchase this home. These mortgages are more expensive, but had he been approved at his bank, they would have charged him some $9,000 in insurance premiums, hidden in the mortgage. Our Tier II financier will charge him only $4,000 and also hide it in the mortgage.

Here are his choices if he wants to buy this house: Deal with the bank at 2.99% with payments of $1,622 per month (but cannot get qualified), or deal with a Tier II lender at 4.5% (for both first and second mortgage) amortized over 30 years with combined payments of $1,703 per month (with an approval!). Paul decided to deal with an approval. He and his family move into their new home in 30 days.

 

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