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Mortgage Approval When Your Business Doesn’t Look Good On Paper

Gina Pogol
The Mortgage Reports contributor

Make Your Business Look Good To A Mortgage Underwriter

You can get a mortgage if you are self-employed.

The process can be a little tougher than experienced by a “standard” W2 employee. But it can be done.

Most small and large business owners experience the same issues when it comes to getting approved for a mortgage.

Often, they are more concerned about running their business than making their tax returns look good to an underwriter two years from now.

This is where a lot of the problems lie. It’s not that your business isn’t doing well, it’s that it doesn’t look “great” on paper.

Here are common challenges that business owners discover during the mortgage process, and how to overcome them.

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4 Common Challenges For Self-Employed Mortgage Applicants

Mortgage lenders require two years of tax returns to prove business income, although there are exceptions.

In any case, you may find that your mortgage lender comes up with a different income for you than you do.

Here are four situations your lender may have a problem with.

  • You’ve been in business less than two years
  • Your yearly income fluctuates
  • You write off too many expenses
  • You commingle business and personal bank accounts

If you’re self-employed, just accept the fact that you will need to bring in more paperwork than a salaried employee. It’s not that big of a deal.

Now that you’re prepared, also get ready to look at your business through a mortgage underwriter’s eyes.

Now you are in the right state of mind to take on the challenges of getting a mortgage approval as a self-employed applicant.

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Challenge #1: New Business

About one third of businesses fail in the first two years, according to Forbes.

But not yours. Yours is strong and healthy. But the thing about mortgage underwriters is that they have to assume the worst. As disturbing as that sounds, that is their job.

Now that we know this, we can see why they want to make sure your business is as strong as you know it is. And we can convince them that this is in fact the case. No problem.

Making this argument, however, becomes more difficult with a new business. Knowing that new business often fail, mortgage lenders want to see some longevity before entrusting you with six figures of their money.

However, there are exceptions to this rule. If you are performing the same work as a business or freelancer that you previously performed as an employee, you may be eligible for financing with at least 12 months of self-employment.

Yep, just one year.

You might opt for an FHA loan if you are less than two years into the business. This type of mortgage green-lights this situation in its policy manual.

In order for lenders to grant the two-year exception, the rest of your application should be pristine.

You should have good credit, some extra money in the bank, and a strong first year of running your business.

Challenge #2: Uneven Income

Mortgage underwriters aren’t the roller coaster type.

They much prefer slow and steady, especially when it comes to self-employed business income.

If your business income improves steadily year over year, you’re golden.

If it’s up one year, down the next, you could have some explaining to do.

In either case, you can be approved. No problem. One scenario just might require more paperwork.

Here’s the pattern underwriters like to see.

  • Tax return from two years ago: $75,000
  • Last year’s tax return: $100,000

A more problematic scenario:

  • Tax return from two years ago: $100,000
  • Last year’s tax return: $75,000

In both scenarios, you averaged about $87,000 per year. But scenario two shows declining income.

Underwriters are tasked with thoroughly investigating your income pattern, and if it appears to be trending down, your application may be turned down. Fannie Mae says:

If the trend is declining, the income may not be stable. Additional analysis must be conducted to determine if any variable income should be used, but in no instance may it be averaged over the period when the declination occurred.

In other words, the underwriter can’t use income from two years ago to boost a low number from last year.

This is not an insurmountable challenge, though.

Some businesses just operate on bigger timelines – for example, a developer might have nothing but outgo for a year, when land is bought, builders are paid and homes are built – and the next year have mostly income, when the houses are sold.

If that’s your normal pattern, have your accountant provide an explanation and supply additional tax returns to reassure the lender.

Verify your new rate (May 19th, 2019)

Challenge #3: Lots of Deductions

Self-employed applicants’ cash flow (money available to pay the mortgage) may bear little resemblance to their taxable income.

But the underwriter must use income as it appears on the tax returns, not what you think of as your income.

Self-employed borrower income calculation goes like this.

  1. Start with your gross business income
  2. Subtract deductions
  3. Add back depreciation and depletion

At the end of the day, that calculation might not reflect your actual cash flow.

For instance, if you bring in $100,000 with your business.

You pay $10,000 per year on a car lease, which the business pays for.

Your income is $90,000 according to the lender, less any other business expenses.

So can you amend your tax returns to reverse write offs? In other words, can you opt to pay taxes on a business expense to qualify for the mortgage?

While there is nothing in most lender guidelines prohibiting this, amended returns are listed in Freddie Mac’s screening guidelines as a “red flag for loan fraud.” Generally, it’s not a good idea to amend a tax return just to qualify for a loan.

However, there’s nothing wrong with amending returns after buying or refinancing a home.

Challenge #4: Commingling Funds

Some business owners are really casual about their business and personal accounts.

Their groceries are paid for with their business Costco card, and sometimes they use personal money for business purchases. This can make it harder for the underwriter to approve the application.

For example, if you purchase $20,000 of business equipment with your personal credit card (because of the rewards, etc.), that $20,000 gets deducted on your tax return. But then it appears on your personal credit report, the underwriter will include the monthly payment in your debt-to-income ratios. You’re getting a double-hit for the expense.

The solution is to keep business and personal separate. If it’s too late, however, go through your credit report, your bank statements and your financial statements and tax returns, and sort everything out for the underwriter in advance (or pay your accountant to do this).

An overworked mortgage underwriter with a stack of files and a tight deadline may find it’s lot easier to decline an application than to decode the income.

Verify your new rate (May 19th, 2019)

Bank Statement Mortgages

Most of the issues surrounding self-employed applicants stem from mortgage reforms that require lenders to verify your ability to repay the loan. However, the law does not say that it must be done with tax returns.

Programs have emerged that allow self-employed borrowers to prove their income using 24 months of bank statements.

Understand, though, that the interest rates are about two percent higher than those of prime (qualified) mortgages, and you’ll have to put at least 20 percent down. Programs like these should probably be considered last resorts.

What Are Today’s Rates?

Self-employed borrowers have access to the same low mortgage rates as salaried applicants do. Rates are low, and lenders are eager to approve mortgages.

Get instant access to today’s mortgage rates. Request a quote, which requires no social security number to start, and comes with your live credit scores.

Verify your new rate (May 19th, 2019)