Since the wake of the housing crisis, mortgage lenders are tightening the requirements needed in order to obtain a home loan, and in today’s economy where a large number of Americans are shifting into the world of self-employment, self-employed borrowers are having a very difficult time when it comes to securing a mortgage.
Lack of jobs is one of the main reasons that many Americans are finding financial security in self-employment, and in the second quarter of 2012, the Small Business Administration stated that there are approximately 9.9 million Americans that are currently self-employed. While self-employed individuals can without a doubt prove their income, it is still shaky ground when it comes to obtaining mortgages when the terms are between 15 and 30 years.
Freelance writer Sally Herigstad who resides in Enumclaw, Washington, knows first-hand the hurdles that self-employed individuals should expect to face when applying for a home loan. In order to qualify, a large down payment was needed, and she and her husband were finally approved after offering a down payment of 26 percent. While they both knew that obtaining a mortgage may be more difficult than it was just five years ago, they truly had no idea just how hard it would be.
“Some of the hurdles were uneven self-employment income, a start-up expense two years earlier that the lender categorized as ongoing, and the requirement that we qualify for payments on both our old house and our new house, despite the fact that we planned to rent out the old house,” Sally stated.
After Sally’s first loan officer was unable to help them obtain financing, she and her husband moved on to an agent who came highly recommended through their real estate agent. While delays arose and the couple faced losing their home to a short sale, the loan officer came through and they were able to successfully close in October.
Sally Herigstad is definitely not the only self-employed American that has faced a variety of obstacles when securing a loan. Joe Parsons, managing partner of PFS Funding in Dublin, California, stated: “Everybody has a higher burden of documentation. For self-employed borrowers, what used to be the godsend was stated income loans.”
Before the housing crisis, stated income loans were the best choice for the self-employed. Lenders were not required to verify the income of the borrower through W-2s and tax returns. In today’s lending world, however, the rules are quite different. Most borrowers are required to show their lender at least two years of their Schedule C, the form that is used by the self-employed to document income or business loss.
If the borrower’s income increases between the first and second year, the lender will average the two years. If the second year’s income is lower than the first year, the lender will use that calculation. If a self-employed individual is operating more than one business, they are required to provide two years of tax returns for any company in which they own 25 percent more, which can mean quite a bit of paperwork frustration for the borrower.
For the self-employed, documenting the source of their funds for down payments is often an additional stressor in the borrowing process. Parsons states: “Any deposits more than about $400 or 500, if they are not clearly identified as to their source, they will need a paper trail. Many self-employed borrowers who use their business and personal accounts interchangeably or they have cash from a brick-and-mortar business they cannot document acceptably.”
One of the biggest hurdles that the self-employed face is that mortgage eligibility is based on net income, which means business deductions can actually count against the borrower. Patrick Ruffner, Vice President of Mortgage Lending at Guaranteed Rate in Chicago states: “Self-employed borrowers try to write off as many expenses as they can, but that tactic may hurt them when securing a loan.”
One possible exception is depreciation on business related purchases, which can be equated back into the net income of the borrower in order to help them qualify. “Let’s say you have a car that you have purchased for your business. You can write off some depreciation. It’s a paper loss, not a cash loss, so whatever you’re claiming for depreciation can be added into your net income. ” Mr. Ruffner stated.
With tax day quickly approaching, any self-employed professionals that are planning to apply for a mortgage in the next two, or even three years should discuss their options with their accountant, and for self-employed professionals that are currently working on a long-term project, it may be a good idea to request to be brought on staff as a W-2 employee.
Gloria Shulman, mortgage broker and founder of Centek Capital Group in Beverly Hills, California stated, “You could offer to sign a contract that exempts a long-term client from unemployment claims or other legal challenges when the project ends. This strategy can put a self-employed professional on a payroll as a freelancer but provide the W-2 banks want on a mortgage application.”
Gloria Shulman also recommends that potential borrowers buyers lower their price range, especially on a first home. She suggests that a net income of around $50,000 a year will look much better if an individual is applying for a $220,000 loan versus a $429,000 loan. She also adds, “If you expect your net income to rise, this strategy will help you quickly build equity toward a larger home down the road instead of just paying rent every month.”
In today’s up and down economy and job market, the number of self-employed individuals is rapidly increasing. There is something to be said over having control over your income, and the reality is, the self- employed will most likely be the ones that gain momentum in the job world in the years to come. While there are significant hurdles that may arise when applying for a mortgage, self-employed individuals can obtain the loans they are seeking by making sure that they have proper documentation of their income and substantial cash reserves.