Posted 09/29/2017

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New rules in effect for self-employed mortgage borrowers

Mortgage rules for self-employed borrowers loosen up

Craig Berry

The Mortgage Reports Contributor

Self-employment mortgages get simpler

For the 14-million self-employed borrowers nationwide, it's getting easier to get approved for a mortgage.

Recently, Fannie Mae issued new loan guidelines related to self-employment income.

Some of the highlights include a documentation reduction from two years of federal income tax returns to one, in certain cases; and, a new income calculation for business owners with little or no history of distributions.

The new loan guidelines are also more friendly toward "moonlighters".

Borrowers with self-employment income from a second, non-salaried business are no longer required to show proof of income if they're qualified based on the income from their "salaried" job.

Even better? Today's mortgage rates remain firmly south of 4 percent. It's an excellent time to shop for a mortgage.

Verify your home buying eligibility (Nov 19th, 2017)

Getting approved for a mortgage when you're self-employed

When you're buying a home or doing a refinance loan, there are specific steps to get approved for mortgage.

First, you apply for your loan, which you can do in-person, online, or by telephone.

The application will require information regarding your annual income, your savings, and your debts; as well as your employment history and a record of where you've lived.

Once completed, your application is given to a bank employee called an "underwriter".

Your underwriter will review the information provided, making requests for clarifications, where needed; and, for documentation which can prove the information you've provided.

For example, if your bank accounts show an atypical, large deposit made within the last 60 days, your underwriter may ask for proof of the deposit's source.

You may also be asked to provide other documentation, too, at the underwriter's discretion.

The underwriter's job is to make sure your loan meets the minimum qualification standards set forth by the bank.

This process of review is called "underwriting".

It's only after underwriting is complete that the loan can be issued a "Clear-to-Close", which means that your application, indeed, meets the bank requirements. You'll close on your home shortly thereafter.

However, the underwriting process varies from applicant-to-applicant and loan-to-loan. The documentation required by an underwriter is different for every mortgage borrower.

For self-employed borrowers -- especially -- documentation requirements can seem onerous.

In addition to the typical requests for bank statements and credit reports, self-employed borrowers are required to show federal income tax returns and additional documentation showing the vitality of their respective businesses.

Recently, though, self-employed borrowers have caught a break.

Lenders have recently reduced the amount of paperwork many self-employed borrowers are required to produce. And, for some with "second jobs", the paperwork requirement is now waived altogether.

Verify your home buying eligibility (Nov 19th, 2017)

Mortgages for self-employed borrowers

Since late-August 2015, Fannie Mae has been working with a looser set of guidelines for the nation's self-employed borrowers.

The policy updates encompass three areas :

  1. Self-employed borrowers with no history of "taking paychecks" (i.e. business distributions are irregular or non-existent)
  2. Self-employed borrowers who don't have two years of federal tax returns to support their business
  3. Salaried borrowers with a second, self-employment job for which the income is not required to qualify

Proving business income

For self-employed borrowers with a history of paying themselves, new mortgage guidelines as of June 2016 state that the borrower no longer needs to prove access to the business income.

The applicant, however, may still need to show that the business has adequate liquidity to support income withdrawals.

One year of tax returns

For self-employed borrowers without two years of federal tax returns, guidelines have been loosened to allow one year of returns, provided that those returns show 12 months of self-employment income and that a cash flow analysis of the business appears sound.

Self-employed side income

It's the third provision which may be most welcome to self-employed mortgage borrowers -- especially those who don't rely on their "side business" to support their home or household.

Under Fannie Mae's new rules, borrowers qualifying for a mortgage using the income of their "salaried" job are no longer required to provide proof of income for their self-employment.

This provision applies to borrowers living off retirement income, social security income, pension payments, and/or dividends as well.

If your mortgage application shows sufficient household income sans self-employment dollars, the requirement to show federal income or corporate tax returns as it relates to self-employment can now be waived in underwriting.

Note that these rules apply to conventional home loans only. Guidelines for FHA and VA loans may be different.

Self-employed co-borrowers

Also part of this announcement is how lenders view self-employed co-borrowers.

A co-applicant's self-employed income need not be verified if that income is not being used to qualify for the loan.

For example, a wife who creates software on the side or a husband with a small e-commerce business no longer needs to disclose her or his income or loss on that venture.

That could help more families qualify, because sometimes write-offs can eat into household income. While business write-offs are great for reducing taxes, they are murder on the amount of income you can use to qualify for a mortgage.

More about qualifying for a mortgage as a self-employed applicant

Prior to the housing downturn, self-employed borrowers had a variety of loan options available to them.

You could prove your income just by showing 12 months of bank statements.

Rarely will you find a lender offering no-income verification, or stated income loans today. Self-employed borrowers must prove their income with tax returns.

The problem is, tax returns often don’t paint a “real life” picture of your income.

Verify your home buying eligibility (Nov 19th, 2017)

Tax returns don't always reflect "felt" income

Self-employed mortgage loans have gained a reputation of being difficult, or even impossible. This perception is often overblown.

It stems from the fact that a large number of self-employed borrowers don’t show enough income, at least according to a mortgage underwriter’s interpretation.

Self-employed borrowers write off as many expenses as possible so that they can get a break on their tax bill. This tactic is what often prevents them from qualifying for a mortgage.

For instance, you took in $60,000 last year. But you wrote off $20,000 in business expenses like mileage and equipment.

As the underwriter sees it, you only made $40,000 or about $3,300 per month. It "felt" like you made much more than that.

If you apply for a mortgage at $1,500 per month, you might not be approved. Your mortgage payment alone would require 45% of your “on paper” income, even if you know you can afford more.

You might also be inconsistent with income, either due to business fluctuations or how much you write off year over year. Lenders will look for significant fluctuations between years of taxable income and typically use the lower of the most recent two years.

Prepare to explain significantly lower income in the most recent year. The underwriter will need to verify it was a one-time event and not a downward trend in your business.

Despite challenges, getting approved for a mortgage loan as a self-employed borrower does not have to be difficult. The caveat is whether or not you can prove enough income, and for how long.

Plan two years in advance for your mortgage

To qualify for a mortgage in the next couple of years, self-employed borrowers should speak with an accountant and a mortgage professional now. It’s important to know how much income will be necessary based on the price range of the home you’re trying to purchase or refinance.

Unlike salaried workers, self-employed business owners can alter how much they make on paper by writing off more or less in business expenses. A two-year strategy pays off when you eventually apply for a loan.

Generally, self-employment will not hinder your approval as long as you can document the following.

  • Adequate income
  • Proof of self-employment for at least two years

Some loan types such as FHA mortgages require only one year of self-employment, if you have been in the same line of work for at least two years. Check with your lender to see if you are eligible for an exception to the two-year guideline.

No need to fear the extra documentation

Self-employed individuals will have to provide more documentation than a salaried W-2 applicant. That’s just a fact.

But it doesn’t have to be intimidating. You have kept good records. It’s only a matter of making copies or creating a PDF version of all your income paperwork that is easily transferred to a lender.

From there, the lender organizes your paperwork and makes a case for your approval.

A list of documents you should gather is as follows.

  • Two years of personal tax returns
  • Two years of business tax returns including schedules K-1, 1120, 1120S
  • Business license
  • Year-to-date profit and loss statement
  • Balance sheet
  • Signed CPA letter stating you are still in business

Tax professionals are very accustomed to providing necessary documentation for a mortgage. Your CPA may even be able to email you all your required documentation the same day.

With documentation in hand, applying for your home purchase or refinance becomes very easy.

What are today's mortgage rates?

For self-employed borrowers, it's now easier to get mortgage-approved than during any period this decade. And, with mortgage rates low, it's an excellent time to consider your options.

Take a look at today's real mortgage rates now. Your social security number is not required to get started, and all quotes come with instant access to your live credit scores.

Verify your home buying eligibility (Nov 19th, 2017)

Craig Berry

The Mortgage Reports Contributor

With 17 years in mortgage banking, Craig Berry has helped thousands achieve their home ownership goals. Connect with Craig on Twitter or Facebook.

The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.

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