Are you self-employed and are wondering why it’s so difficult to qualify for a mortgage loan? In this video, we’re going to talk all about the self-employed and the specialty home loan products available just for them. We’ll look at everything from taxes to a case study example so you have all the information you need.Verify your mortgage eligibility (Aug 19th, 2022)
Buying A House While Self-Employed
If you’re self-employed, you might wonder why it’s so hard to get a conventional, jumbo, FHA loan, or VA loan. You might also be completely shocked by how difficult it is for somebody that’s self-employed—just like me—to get a standardized mortgage loan. However, this is why there are some specialty loan products made just for you.
To better understand how the process works, we’re going to answer a few questions. For one, what’s the definition of being self-employed? Why is it so hard to get a mortgage? What are the specialty loan products (called non-QM) for the self-employed?Verify your mortgage eligibility (Aug 19th, 2022)
There are also a few other things to consider, such as the ability to repay. Documents needed are the Schedule C from your tax returns and a K1 or W2 if you pay yourself.
Profitability Of The Business
Ultimately, the biggest kicker that self-employed people don’t realize is that it’s all about the profitability of the business, not the revenue. This is where a lot of self-employed potential homebuyers miss the mark. Ultimately—if you have the right CPA—you’re going to have $100,000 of revenue per year but might have $75,000 worth of applicable write-offs.
This means you have less of a tax obligation. Your profit in this quick example is only $25,000—which does not translate into much usable monthly income. This is technically the biggest issue that self-employed people have. But don’t worry: we’re going to show you how to overcome it.Verify your mortgage eligibility (Aug 19th, 2022)
Self-Employed Tax Structures
Lenders define “self-employed” as a borrower who has an ownership interest of 25% or more in a business or one who is not a W2 employee. However, there are a couple of exceptions. Typically, you have to be employed for two years, though you might be able to qualify with just one year of self-employment if you can show a two-year track record in a similar line of work.
There are generally four different structures of a company that you might be familiar with. The first is Schedule C income or a Sole Proprietorship. This also includes those who are 1099 or report all of their income on your Schedule C of your personal tax returns. Next, we have a partnership. This is two or more people that hold responsibility for the business. Your tax returns that would be associated with that are a 1065 and a K1 that transfers any profit from the business to your personal tax returns.Verify your mortgage eligibility (Aug 19th, 2022)
Another option is the LLC, which is a very popular type of business entity structure. That business is completely legally separate from the people who run it. You’re also going to use a 1065 business or corporate tax return format and get K1s for any profits or losses that carry over to your personal side.
Next is a corporation. I personally have an S Corp for my company here at Fiel Good Mortgage, of which I am the Sole Proprietor. This is the business structure that my CPA decided to go with, and I file the 1120-S. You also would have a K1 that transfers any profits and losses from the business entity to your personal tax returns.
Why It’s Difficult
So why is it so dang hard for self-employed people like you and me to get a frickin’ mortgage? Sometimes, it feels like you constantly have to jump through hoops. The truth is the government sets forth the ability-to-repay guidelines for most standardized loan products.Verify your mortgage eligibility (Aug 19th, 2022)
Government loans are VA, FHA, and USDA loans. Conventional loans are also called conforming loans, and these standardized products are backed by Fannie Mae or Freddie Mac. Because the government has its hands in everything, they come up with the rules of how mortgage lenders (like myself) have to look at you as a borrower. They also dictate what documentation we have to analyze and calculate the income.
Non-Qualified Mortgage Products
In addition to standardized loans, there are also specialty non-qualified mortgage products. Banks understand that you’re doing well with your good credit and big sizable downpayment. They also know you’re making money because you’ve been in business for two or more years typically.
Banks put these loans on their books to offer you a slightly higher interest rate over your standardized loan product. The kicker is that they’ll qualify you for money that you technically write off, which is also why you cannot qualify for those standardized conventional VA, FHA, and USDA loan types.Verify your mortgage eligibility (Aug 19th, 2022)
These loans are kind of like short-term Band-Aid loans, which you’ll usually have for one to two years. Your lender can work with your CPA to make sure your tax returns and all your carry-throughs are correct. While you might have to pay more taxes if you do it this way, you’ll be able to qualify for standardized loan products after a period where we can use your usable income.
Specialty Loan Programs
There are a few different specialty loan products. These include 12-month bank statement programs and 24-month bank statement programs. Those programs will look at your monthly deposits into your business account and analyze how much your average deposit is. They’ll also look at how much your liabilities are going out. That variance is what they’ll use for your usable income.
The P&L (profit and loss) document is prepared by your CPA. Using these figures, we don’t even need tax returns in this in this scenario, which is really nice. It’s called Lite Doc, and it’s a super powerful and popular product. If you’re a 1099 employee—such as a contractor, consultant, or traveling nurse—we have a one-year 1099 program.Verify your mortgage eligibility (Aug 19th, 2022)
These are just a few of the products; there are plenty more available. Ultimately, the key to figuring out what loan product would be best suited for you starts with a pre-qual certificate. This will give us a basic understanding of what you might qualify for. My team will scrub up some of your answers, get you onto my calendar for a discovery call, and then I’ll start to structure our next steps in customizing a loan product for you.
Ultimately, we would always start with the most cost-effective loan product and then work our way down. If we can’t qualify you for the best, we’ll look at other loan products offered to you and present those to you in our findings.
Per the underwriting guidebook from Fannie Mae and Freddie Mac, some factors have to be looked at. Government loan products follow these guidelines pretty closely, and they dictate how we have to look at you as far as a self-employed borrower. When determining whether an individual that has 25% or greater interest in a business is considered self-employed, a few factors must be analyzed before approving a mortgage.Verify your mortgage eligibility (Aug 19th, 2022)
These include the stability of the borrower’s income, the location and the nature of the borrower’s business, the demand for the product or service offered by the business, and the financial strength of the business. It also includes the ability of the business to continue generating and distributing sufficient income to enable the borrower to make payments on the requested mortgage.
The length of self-employment generally requires lenders to obtain a two-year history of the borrower’s prior earnings, demonstrating the likelihood that the income will continue to be received. The underwriting guidelines state that “if the person has a shorter history of self-employment of 12 to 24 months, that might be considered, as long as the borrower’s most recent, signed, federal tax income returns reflect the recipients of such income as the same or greater level in the field that provides the same products or services as the current business or an occupation in which he or she had similar responsibilities to those undertaken in connection with the current business.”
Gathering Your Documents
If you’re self-employed and you pay yourself a salary, we’re also going to analyze whatever Schedule C you might have. If you have Rent Roll Schedule E or farm income, we’re going to look at all of that as well. So what documents do you need to provide?Verify your mortgage eligibility (Aug 19th, 2022)
In order to get a standardized loan product, you’ll typically need two years of personal tax returns and two years of business tax returns—along with any K1s that might be associated with that. You’ll also want to provide a P&L year-to-date profit and loss statement for the business if there’s declining income. It will also allow us to be able to use higher income levels if your year-to-date is better than your last year’s.
You’ll also want to supply two months’ assets statements from your personal and business assets, just in case we would need to utilize business assets for the transaction. The rule of thumb with our team is that it’s better to have it and not need it than need it and not have it right. When we’re trying to get the absolute best credit terms for you, we’re going to want all of the documentation that we need. We’re then going to supply the underwriting team with what we need to get you approved.
A Case Study
As I mentioned, the Lite Doc P&L Program can be very helpful. We had some awesome clients whose CPA was fantastic. They were under contract prior to finishing their loan application with us. We gathered all of their documents and sent their file for a conventional loan to two different lenders just for quick review, as they were just barely two years in existence.Verify your mortgage eligibility (Aug 19th, 2022)
These clients had a heavy machinery company with huge machines for excavation. This means massive loans, massive liabilities, and massive capital expenditures in those first two years. However, they were also doing a crap ton of revenue; we’re talking multiple millions of dollars of revenue. This is because they’re basically putting in infrastructure for new developments up here in the mountains.
Because they paid themselves W2s, we could use a factor of that W2 income. However, their CPA wanted to keep the business from paying a bunch of taxes besides payroll taxes. They took a loss on their K1 carryover, and their income dropped by approximately $50,000 from the $120,000 salaries that they made.
In essence, $70,000 was their usable income. When you’re buying a $1.4 million house, even if you’re putting down 25% (or $330,000), that’s just not enough income. That ability-to-repay is where the default was. The banks that we sent the loan to for the conventional product, obviously denied it—because there wasn’t enough “usable” income per those guidelines.Verify your mortgage eligibility (Aug 19th, 2022)
A bank from Florida that we use for our clients here in Colorado had the Lite Doc P&L program. We had these clients’ P&L from their initial loan application, so we evaluated that with our underwriting staff at the bank. They told us what potential corrections we could make, we got it signed off on by the CPA, and the underwriter approved their loan.
Our clients now have eight acres in the high country right by Monarch Ski Resort. They can go rafting, biking, golfing, and skiing all on the same day. Salida is a really cool place in Colorado, and we were able to help get them their home.
We’re Here To Help
The key takeaway for the self-employed is to always have a fallback plan even if somebody denies you. As a broker that has multiple banking partners, multiple banking relationships, and has been doing this for 13 years, there’s always a way to figure out how to get you money or come up with an action plan to get you money in the future.Verify your mortgage eligibility (Aug 19th, 2022)
While it might not be a yes right now, it might be a yes in X amount of time if you make a few changes or find another option. You always want to have a structure and a plan, and you want to feel comfortable with who you’re working with. If you have any questions or would like to work with me and my team, please reach out and I’ll be happy to connect.
If you liked this video, make sure to subscribe so you never miss a new episode. Feel free to let me know what you’d like to see in the future, and stay tuned to see what I feature next!Show me today's rates (Aug 19th, 2022)