Self employed applicants for a home mortgage loan are income qualified based on the business net profit from the income tax returns. Laws now require lenders to document a borrower’s ability to repay the loan by this method. Sometimes self employed mortgage loan applicants are penalized under mortgage loan underwriting rules. Preparation is important because it may take a year or two to fix some problems. Any self employed person who thinks there may be a mortgage loan in their future should read this guide. Please consult your tax adviser or CPA before making changes to your business.
Who is considered self employed?
If you own 25% of more of a business, the underwriter will consider you self employed. If you are an independent contractor, file a schedule C for your work income or your employer does not withhold income taxes, than you are considered self employed by a mortgage underwriter. Employees of Corporations who own 25% or more of that corporation are considered self employed. The underwriter will use your W-2 income plus or minus the net business income for the previous one to two years.
How does the underwriter calculate qualifying income?
The underwriter will look at your net profit to determine your qualifying income. Net Profit is line 31 on the 2008 IRS Schedule C. Depreciation (line 13) and sometimes expenses for business use of your home (line 30) can be added to qualifying income. If you own a partnership or corporation, a few other business expenses can be added to the qualifying income such as amortization/casualty loss and depletion. Farms can add back Co-ops and depletion. Usually income is averaged from the previous two years’ tax returns, but not always. We have been able to use the most recent year’s income only in some cases.
What should you do to help qualify for a mortgage loan?
Open a separate business bank account.You business should have a separate bank account and all business bills should be paid from that account. Debts on your personal credit report can be removed from the qualifying debt ratio if you can demonstrate the business pays that debt by showing the last 12 months of cancelled checks from the business account. If the account is not old enough, you paid one month from a personal account or in cash, or debt payments are co-mingled with personal accounts – then that debt cannot be removed from your qualifying debt ratio.
No new debts
If a debt is too new to provide 12 months of cancelled business checks, then that account will probably be included in your debt ratio. Also, new debt is a usually a derogatory credit score factor. If you plan to apply for a mortgage loan in the next year, hold off on all other new credit.
True commercial accounts usually do not show up on your personal credit report and therefore will not be counted in your debt ratio. Just in case, be sure to pay the debt from your business bank account.
A co-borrower is typically a person who will reside in the home and be on the title with the borrower. Income and debts of borrowers and co-borrowers are combined to determine the debt ratio. Often, a co-borrower is a spouse but not always. Co-borrowers equally share individual responsibility for the debt with the borrower.
A co-signer is usually someone who does not live in the home and often is not on title. A co-signer is personally guaranteeing your mortgage loan. They are responsible for the debt. If your business income is not sufficient to qualify, a qualified co-signer can make the difference. Not all loan programs allow co-signers.
Two years is the typical requirement to use self employed income. Sometimes, a shorter time period is acceptable.
Often, the existence of the business for two years must be verified. Typical ways to do this are by business licenses, a CPA letter or a yellow pages listing. I have encountered some self employed borrowers who can provide none of these. This can present a challenge. We find a way to verify the business exists, but it is faster and easier to do so if you follow the conventional means.
No one enjoys paying income taxes. There is sometimes a choice to be made between paying income taxes and the ability to qualify for a mortgage loan.
The first step to buying a home is a pre-approval for your home loan. Bring your income tax returns to your mortgage loan officer. Different loan programs have their own rules – Fannie Mae, Freddie Mac, FHA, VA, USDA and so on. Meeting with a mortgage loan expert is especially important for the self employed applicant.
Contact me when you are ready for your mortgage loan pre-approval. Small business owners and self employed customers are a specialty of mine. I serve the business community on the executive board of the Nazareth Area Chamber of Commerce and other organizations. In addition, my eleven years experience in the mortgage loan industry and personal experience as a third generation small business owner helps me relate to and assist my self employed customers.
Daniel D. Thierry, CRMS
Home Financing Advisor
License ID 132253
