As a business owner, when it comes your finances it’s not all business – sometimes it’s personal.
That’s because decisions about business finances and personal finances can intersect. For example, things like paying yourself, investing, and tax-time strategies. Another one to add to the list: home financing.
A great business banking partner will look at the whole financial picture – both the owner’s business finances and their personal finance needs. In this article, we’ll draw on the expertise of Edmonton-based Personal Banking Account Manager Tammy Madon to break down three aspects of home financing that have unique considerations for business owners, and how a bank that understands the overlap of personal and business banking can provide a clear advantage in helping you navigate them.
#1: Stress tests, the rate you’re really qualifying against, and how income factors in.
Whether you’re refinancing, applying for a new mortgage or looking to switch, federally-regulated entities like banks require you to pass the federal government’s mortgage stress test. Lenders that aren’t federally regulated (such as credit unions) may also use this test. Below we outline how a couple of its conditions can impact business owners.
Condition – The stress test may assess you on a higher interest rate than what’s being offered by the lender: This is to help ensure you can comfortably make your mortgage payments. Regardless of whether or not you have mortgage loan insurance through Canada Mortgage and Housing Corporation (CMHC), you’ll be tested with the Bank of Canada’s conventional five-year benchmark mortgage rate or the rate provided by your lender plus 2 per cent — whichever one is higher.
What this means for business owners: Business owners who are taking a minimum income from the business to minimize their taxes can find it tougher to qualify against a higher interest rate.
Condition – You’re qualifying on your last two years of income: Mortgage guidelines require two years of income to qualify your financials. Those two years are the basis for the stress test.
What this means for business owners: This can pose a challenge for owners who’ve been in business for less than two years, as well as those with irregular income.
How your banker can help
Ok so there’s a rundown of the federal guidelines and how they might affect business owners’ home financing. The good news is there’s lots for bankers to consider when determining how to best support business owners through this process, say Madon.
“It’s not cut and dried, it’s not black and white – we look at the whole picture,” she says. “We look at the strength of the company and the strength of the borrower. Generally, there are a number of strategies and options we can explore together with the applicant.”
Some of these may include:
- Looking at all of the applicant’s income and the company’s income – and evaluating what the applicant could potentially draw from the company. This includes doing a cash flow analysis and reviewing current and historical revenue to determine if there’s an upward trend.
- Guarantor or co-signer: Adding someone who has stable income from a different source might be an option.
- A larger down payment: This could lower the loan-to-value ratios if the applicant is self-employed, a newer business, or not yet established.
- Context counts: How can the applicant’s experience factor into assessing their risk? If the applicant is new to owning the business, did they just take over the company? Were they a previous employee of the company, or perhaps an employee of a similar type of company?
- Relationships matter: Does the applicant already have an established and positive relationship with the bank on the business side? What’s the company’s and the applicant’s reputation like?
Pro tip: If you’re already a CWB client and have a good relationship with us for your business banking it can work to your benefit when assessing your risk and determining rates.
#2: Proving your income isn’t as simple as getting a letter from your employer.
“Often business owners will own multiple companies, or they’ll have holding companies,” says Madon. “This can be complicated to present to the mortgage approvers and demonstrate the credit risk because we need to able to show where they draw their income from, the organizational chart of who owns what, as well as what percentage of the company they may own or companies they might own.”
Madon explains business owners will also have different types of income, not just salaried. This could include dividends, capital gains, and drawing dividends not just from the company but from investments, too.
While there’s admittedly extra complexity for business owner applicants, Madon says that working with a full-service bank like CWB provides a clear advantage: they can bring in the support of other specialized teams such as commercial, cash management, and wealth management.
#3: Your business’ needs are a factor in choosing the right product – or a combination of products.
“Every client is different and when landing on the best fit for home financing, you need to factor in both the needs of the applicant and the needs of their business,” says Madon.
Fixed mortgages: Although the benefits of locking in a great rate for five years seem obvious, some business owners may find a fixed-rate mortgage doesn’t meet their needs. For instance, the property must be owner occupied for the duration of the term. So, if the business owner is looking for a mortgage on a rental property or a house to flip, there may be better solutions.
Business owners also need to be able to move their money, so if they need extra income to help their business the lack of flexibility may be a drawback. That’s where a Home Equity Line of Credit (HELOC) could be a better fit.
Home Equity Line of Credit (HELOC): A HELOC (at CWB this product is called HOMEWORKS®) either on its own or in combination with a mortgage can be a popular option for business owners, says Madon.
“Lines of credit typically work well for business owners, and we can still lock a portion down in a mortgage, too. Our role is to offer the best rate for the mortgage and the best rate for the secured line of credit – either as an alternative to a mortgage or with a mortgage,” she says. “HELOCs, which have a variable rate that can be more competitive than mortgages, enable cash at your fingertips to inject money into the business if you need to.”
Madon adds a HELOC can also be attractive for business owners with multiple properties. For example, if you sell one property there’s no penalty for using the proceeds to pay off the line of credit before the term is up.
Note: You’re still subject to the stress test when qualifying for this line of credit because it’s secured with your property. This ensures that if a client defaults on the HELOC and it has to be converted into a mortgage, they’ll still be able to qualify for that mortgage.
Pro tip: The stronger the relationship an applicant already has with CWB the more flexibility there can be to discount rates on the HELOC. For example, how many CWB products someone has, how long they’ve been a client, and whether they have both their business and personal finances with the bank. The same holds true when it comes to accessing preferred rates on business products.
Paying it down/paying it off: Say the business comes into some cash and the owner wants to put those funds towards their home financing. CWB mortgage products allow pre-payment without penalty of up to 20 per cent per year. And of course a HELOC can be paid down – or in full – at any time without penalty.
Ready to meet about a mortgage?
Be prepared to verbally provide:
- Your income
- Your monthly credit card payments
- How much you owe on your credit cards
- Your monthly loan payments
- If there’s anything on your credit report that might be concerning
Bringing it all together
For business owners, home financing can mean mixing business with personal. This includes some specific considerations when applying for lending and choosing the right products. A full-service bank with expertise in business and personal finances offers a strong advantage for supporting you through this process. Finally, as every business owner knows, relationships matter – and for a relationship-based bank like CWB, the strength of your relationship with us can be a significant factor both when qualifying for lending and determining rates.