The Rules For Self Employed Mortgages
Self Employed Mortgages: The Process Is Easier Due To Recent Changes
The guidelines have been loosened for self-employed home buyers. For example, you might only have to supply one year’s worth of income tax documents as proof of your income, if your application qualifies for the automated underwriting process. Also, a new income calculation is being used by lenders for business owners who have no or little history of distributions. New loan guidelines are also more friendly for those who “moonlight.” Individuals with self-employed part-time gigs don’t always need to document the income if they qualify with only using their regular job.
The Mortgage Approval Process For Applicants Who Are Self Employed
When you are refinancing or buying a house, there will be a series of specific steps that you will need to go through.
First of all, you will need to apply for a loan. You can do that by telephone, online, or in-person. Usually, the loan processor or officer will verbally take your information and submit it to an automated underwriting system (AUS). Normally, you won’t need to fill a lot of forms out. However, you will need to document your income, any investment/retirement/savings balances, and all of your debt. Lenders will run a credit check and want to know about your employment history.
Underwriting Borrowers Who Are Self Employed
Based on the information that you provide, a response will be generated by the underwriting system within minutes, either declining, approval or referring your loan to be underwritten by a human. The human underwriter will then take over. If you are approved by the AUS, your documents will be checked by the underwriter to ensure they match the information that is on your application. For example, if you stated that you earn $6,000 per month, then your tax returns or W-2s should match that number. Also, your bank statements should match the amount that you say you own. If the system declines your loan or cannot make a decision, then a human will look at your application to see if you qualify under their manual underwriting guidelines.
Only Taxable Income Is Considered By Lenders
What often trips up a self-employed mortgage applicant is they may state they earn $6,000 per month. However, their taxable income may only show $4,000 per month. A somewhat complicated form is used by underwriters to come up with what is called “qualifying” income for borrowers who are self-employed. They start off with your taxable income and then certain deductions such as depreciation are added back in since they are not actual expenses coming directly out of your bank account. However, they may also subtract “windfall” or “extraordinary” income. If an income source doesn’t seem to be ongoing and stable, then usually it cannot be used to qualify to get approved for a home loan.
Other Supporting Documents
Lenders will also review your assets, to ensure the down payment is coming from a source that is acceptable. They don’t want you cleaning your business account out for your down payment, for example, since that could jeopardize your livelihood.
They also want to ensure that you don’t have any undisclosed loan. So, for example, if an unusually large deposit was made to your bank account within the past 60 days, the underwriter might ask you to prove the money’s source. You might need to provide additional documentation as well, at the underwriter’s discretion, such as a statement fro your accountant or a business license.
After you have been given the green light by the human underwriting, you will have been approved for credit, meaning you, the borrower has met the lender’s guidelines and will be able to close on a property as long as it complies with the requirements of your lender. However, the underwriting process will vary from one applicant to the next and from one loan to the next as well. Underwriters may require various documents for each mortgage borrower who is self-employed.
How long do you need to have been self employed in order to obtain a mortgage?
In order to obtain a mortgage, you might not need to show a self employment history of 24 months. For example, Fannie Mae states that you might qualify with self employment of 12 months if you have prior experience in your field, and you have income that is much or more of what you earned in the field prior to becoming self-employed.
Mortgages For Borrowers Who Are Self Employed
Fannie Mae, since August 2015, has allowed for a looser set of guidelines to be used for the country’s self employed borrowers. There are three areas that are encompassed in the policy updates:
- Self employed borrowers without a history of “taking paychecks” (i.e. distributions from the business are non-existent or irregular)
- Self employed borrowers who do not have federal tax returns for two years for supporting their business
- Salaried borrowers who have a second, self employment job do not need to document this income if it is not needed to qualify for a mortgage
Business Income Proof
For self employed borrowers who have a track record of paying themselves, the June 2016 mortgage guidelines state that the borrower does not need to prove access to their business income any longer. However, the applicant might still have to show that the business earns enough in order to support the withdrawals of income.
One Year of Income Tax Returns
A self employed borrower might qualify with only one year of income tax returns. The returns must show 12 months at least of self employment income.
The debt-to-income ratio of the applicant must also meet the guidelines of the lender (usually it is 43 percent maximum, but for exceptionally qualified borrowers might go up to 50 percent).
Self Employed “Side” Income
This third provision might be the one that self employed mortgage borrowers welcome the most -especially those who don’t have to rely on their “side business” in order to support their household or home. Under the new Fannie Mae rules, borrowers who qualify for a mortgage using the income from their “regular job” will not need to prove what they earn on the side from their own business. That totally makes sense; why would you need to prove income that you don’t need in order to qualify for a loan? The provision also applies to borrowers who are living off off dividends, pension payments, social security income, or retirement income also.
Not that those rules apply to conforming home loans (Freddie Mac and Fannie Mae). Other loans might have different guidelines.
Self Employed Co-borrowers
In a similar fashion, if you qualify to get a loan with your own income, and you have a self employed co-borrower, that business might be ignored by lenders in underwriting. Why would you want that business to be ignored? Because many start-ups and small ventures don’t show income on their tax returns. On paper at least, they generate losses. Although business write-offs are good to help reduce taxes, they can wreak havoc on your qualifying (taxable) income whenever you are applying for a home mortgage.
Nearly all lending guidelines specify that income will not count unless it is ongoing, consistent, and stable. If your income isn’t reliable and regular, you cannot use it. However, numerous businesses go through many ups and downs. For example, a home developer who is getting a new community started may have many expenses in one year, purchasing property, obtaining permits and building houses. The business might show big losses or a small income. However, the night years, the houses start to sell and his the income of the business skyrockets. If you try applying for a loan in the “down” year, then you will need to prove to your lender that you have a healthy business and that the pattern is normal. To prove this, provide the underwriters with three to five years of taxes along with a statement from your accountant. Be prepared to explain any significant reductions in income year-over-year when applying or a mortgage when you are a self-employed borrower.
Alternative Options For Self Employed Applicants
Mortgage loans for self-employed applicants have earned the reputation for being hard to obtain ever since the housing downturn. That is due to the fact that numerous self-employed borrowers do not show a sufficient amount of income if the lender defines “income” as being the bottom line of the tax return. Also, the old “no-income verification” and “stated income” loans that were used in the past by these borrowers have disappeared. When the taxes are being prepared for the self-employed borrower, they deduct as many expenses as are legally possible. This is a reasonable thing to do since they pay self-employment taxes along with “regular” income tax. However, there are alternative programs that are available where all of the business cash flow that actually comes in is allowed to be counted as income. There are often referred to as “bank statement” programs.
Under those guidelines, you will provide 24 months of personal and/or business bank statements. The lender will analyze the amount of money that is going into your bank account every month, take an average, and then use this amount (or a formula that is based on this amount) for determining the qualifying income. One thing to note is those programs normally have higher mortgage interest rates.
A personal loan is a potential option that a self-employed borrower could use. It might be easier to qualify for a personal loan compared to a mortgage. If you are wanting to refinance your home in order to cash-out, then the easier route might be a personal loan. If you were looking to purchase, a personal loan may be a stretch, unless you are buying a sub-$100,000 property, since that tends to be the maximum on those loans.
Either way, if your business needs an infusion of cash or some quick money (whether you are trying to get a mortgage or not), then a personal loan may be the right jolt that your company needs to get to the next level.
If you are a self\employed individual who is wanting to buy a house, plan it in advance. Find a mortgage professional to work with, and also involve your accountant. You can change the methods you use for writing off business expenses and how much taxable income you report. Or you can amend past year tax returns to show a higher income. Note that there are certain deductions, like depreciation, that will not hurt you. Those deductions are added back to your taxable income by the underwriter. Your accountant can review the form that is used by the underwriter, and determine how lenders view your income now.
Gather the following documents for lenders if you are self employed:
- Two years of business tax returns including schedules 1120S, 1120, and K-1
- Two years of personal tax returns
- Balance sheet
- Year-to-date profit and loss statement
- Signed letter from your CPA stating you are in business still
- Business license
Tax professionals are accustomed to these types of requests for mortgages. Your CPA might be able to email all of the documentation that is required on the same day.
What are the current mortgage rates?
Self-employed borrowers can get approved for a mortgage more than any time during this decade. Mortgage rates are low right now, so it is a great time to consider the options that are available to you. Please note that if you do not qualify under the standard guidelines, you might be able to buy the home you want under alternative programs.