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Monday, January 26, 2015

Applying for a mortgage when self-employed

By Darren Robinson

Those who are self-employed are used to a high level of autonomy. They make their own decisions, steer the course of their businesses and don't have to work beneath a power-drunk boss. Some consider this to be the American dream. Yet there are a few disadvantages to being self-employed. One such disadvantage is the fact that the self-employed have an uphill battle when it comes to securing home loans compared to those who have steady work histories with reputable employers.

Demonstrating consistent income

The first challenge that self-employed borrowers face is that they must prove that their income is legitimate and that it hasn't significantly wavered over the past few years. This is often quite difficult for the self-employed who've endured financial troubles in this rocky economy. Even if a self-employed mortgage applicant's income has recently stabilized, his home loan will be determined according to an average of his income across the past two years as reflected on his tax returns. This is a problem if his income has decreased over this time period.

For example, if a self-employed business owner made $100,000 in 2013 and only $50,000 in 2014, his qualifying income will average out to $75,000. Some lenders will consider an applicant's income from the previous year as well as this year's profit and loss statement if provided by an accountant. Yet this is typically only on the table if the applicant's income has decreased by 20 percent or less over the course of the past year. Other lenders won't consider whether the borrower is making more money this year, even if it is in the six figure range. The onus is squarely on the mortgage seeker to find a lender who will view of his income in the most favorable light.

Stated income loans

While stated income loans were originally designed for the self-employed, they've been scaled back as too many secured home loans that they were unable to repay. These loans are making a bit of a comeback but only for mortgage applicants with extraordinary credit scores (720 on up), a significant down payment (35%) and at least 6 months worth of cash reserves to pay for monthly expenses beyond the mortgage. Stated income loans for the self-employed are available on the secondary market. They may once again be available from private lenders but self-employed borrowers will be required to prove that they can repay the loan in a timely manner and they'll probably have to pay at a higher interest rate than was required of stated income loans in the past. Finding a mortgage broker with experience in self-employed mortgages can really ease this situation for you.

The tax game

Self-employed borrowers in search of a home loan are required to fill out the Internal Revenue Service Form 4506-T. This permits mortgage lenders to view a self-employed applicant's tax transcripts. Applicants are not allowed to send tax transcripts directly to lenders. These documents must be acquired directly from the IRS. Self-employed borrowers should consider the fact that expenses reported on their taxes might hurt their chances of obtaining a mortgage. While the reporting of expenses can reduce tax liability, it also decreases net income. Net income is the figure that is utilized when determining one's income qualification for a home loan.

So if a self-employed individual claims $70,000 in income and $70,000 in expenses, there is just about no chance that he will qualify for a mortgage. He'll have an uphill battle to prove that he suffered a one-time loss or that he bought something that will boost his business for the years to come.

In the end, the self-employed who are searching for a home loan have a tough decision to make. They can claim expenses and reduce their tax bill or they can pay more in taxes and boost their chances of qualifying for a large mortgage.

Demonstrating the business's existence

Self-employed business owners must also prove that their business exists in order to be considered for a home loan. Most lenders require at least two years worth of business tax returns. Other ways to prove the existence of a business include an actual business license, client statements, a statement from an accountant or 1099 income statements.

If the self-employed applicant hasn't been in business for two years, he likely won't be eligible for a home mortgage. There are some exceptions to this standard but they only occur if the applicant can present evidence of a full year of self-employment through tax documents in addition to W2s from his previous employer. Most lenders require that the applicant's previous employer be in the same field as his own business to demonstrate that he made a financially sound decision when venturing off on his own as an entrepreneur.

The self-employed can help their cause

It is clear that the self-employed have quite a challenge in securing a home mortgage. Yet self-employed mortgage applicants can be proactive and take specific measures to better their chances of securing a home loan. For example, those who apply for the loan with a co-applicant will still need to prove their income as outlined above but they'll have an improved chance of securing the home loan with the co-applicant's income taken into consideration. It also helps to make a sizable down payment. This is especially true of those who are right on the edge of qualifying for a loan and those who are seeking a small sized loan but have a weak debt to income ratio.

About the author: This article was submitted by Darren RobinsonDarren is a top rated Barrie Mortgage Broker, whose ultimate goal is to ensure that he obtains the best mortgage strategy available that fits your life, while maintaining fast, professional and courteous personal service.

Image license: Alexander Stein/Pixabay; US-PD