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The Dos and Don’ts of Self-Employed Mortgages

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If you are self-employed, you have to meet different requirements than the standard borrower. You probably don’t have paystubs or W-2s to provide the lender with to verify your income. Instead, you have your own paperwork, probably completed by yourself to provide the lender. As you can probably see, this is a conflict of interest, forcing lenders to ask for other documents when you work for yourself.

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Keep reading to learn the top dos and don’ts of getting a mortgage when you work for yourself.

Do Keep Careful Records

If there’s one thing that can help you as a self-employed borrower, it’s records. The more records you have, the more proof you have that can afford a loan. Lenders often ask for the last two years of your tax returns, but if you have more to provide, it could work to your benefit.

If you have an accountant or tax professional taking care of your books, you could be in an even better position. They will have a year-to-date Profit and Loss or other financial paperwork your lender may need. What you are trying to prove is that you have a steady stream of income that the lender can see rather than just a total on your tax returns.

You want to paint the picture of reliability and consistency, which careful records can do for you.

Do Start Planning Early

As a self-employed borrower, you should try to plan for the purchase at least two years ahead of time. Lenders are going to need your tax returns for the last two years. If you write off a large number of expenses on your tax returns, your bottom line will be lower than you actually make. This will work against you when you try to qualify for a mortgage.

If you plan ahead, you can minimize your write-offs for the time being. Let your adjusted gross income be higher for those two years. Yes, you will pay more in taxes, but you will be rewarded by qualifying for the mortgage you need to buy your home. Once you are in the home, you can go back to your write-offs, lowering your tax liability and even enjoying the write-offs of owning a home.

Do Pay Off Debts

Self-employed borrowers are already a higher risk than the traditional borrower. In order to make up for this risk, you need compensating factors. A low debt ratio is one of the best compensating factors you can provide.

If you have the money to pay your debts off completely, you put yourself in a better position. Of course, if you don’t have the money to pay them off in full, at least pay your debts down. Lowering your credit card debt as much as you can will help your debt ratio. The lower the minimum monthly payment is the lower your debt ratio, which puts you in a better position.

Do Have a Large Down Payment

Again, because you pose a higher risk being self-employed, the more money you can put down on the home, the better. While you can borrow as much as 95% on a conventional loan and 97.5% on an FHA loan, it’s not recommended for someone working for themselves. The lender needs to know that you have a vested interest. This way they have more assurance that you will pay the loan back.

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There isn’t a specific minimum amount self-employed borrower’s need for a down payment. The more you can put down, the better your chances of approval, though. It goes back to the compensating factors. A higher down payment means less risk for the lender.

Don’t Damage Your Credit

Pay close attention to your credit score during the years leading up to your loan application. Opening your own business can be expensive and sometimes can damage your credit. Take your time building your business and only borrow what you can afford to pay back.

If you know you did damage to your credit score, try to get it back up again. Pay your bills on time, lower your outstanding debts, and don’t overextend yourself financially. You should also avoid applying for any new credit during the year or two leading up to the mortgage application. This will help increase your credit score and show the lender financial responsibility.

Don’t Deposit Large Amounts of Money

As a self-employed borrower, your lender is going to pay close attention to your bank statements. If you do make any large deposits, make sure you have proof of their origination. For example, if a vendor owed you a large amount of money and they finally paid you, don’t just deposit in your account and not keep a copy of the check from the vendor and the deposit ticket.

Lenders are going to see the large deposit, sending up a red flag. If you have proof and an explanation for the deposit, they may allow the use of the funds. If you cannot provide proof of the payment, the lender will likely exclude the funds from those you can use for the home purchase.

Don’t Become Self-Employed Right Before Applying for a Mortgage

If you are employed now but are thinking of jumping ship and opening your own business, don’t do it within two years of buying a home. Lenders want reliability and consistency, which they need two years of paperwork to determine.

Lenders need to see that you have the experience and knowledge to succeed in the business. If you start a business 6 months before you apply for a mortgage, the lender has no history to use when determining your consistency and reliability.

Two years is the ideal length of time you should be looking for self-employed for before applying for a mortgage, but if it’s slightly less, you can try if you have compensating factors as discussed above.

Getting a mortgage as a self-employed borrower isn’t impossible, but it does require more work. The better you set yourself up beforehand, the more likely it is that you will get the loan you want. Use these tips to help you situate yourself for success.

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Can you Buy a Home Without Proof of Income?

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If your income is rather sporadic or you don’t have paystubs/W-2s to prove your income, it may be hard to get a mortgage. Prior to the housing crisis, lenders were very lenient with who they lent money to for a mortgage. Today, it’s a different story. The housing crisis killed the idea of accepting any type of mortgage without proof of how you will pay for it.

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It all comes down to the Qualified Mortgage and Ability to Repay rules. The Qualified Mortgage Act requires that lenders make sure applicants meet certain requirements before they can take out a loan. The rules are strict, which means fewer borrowers will qualify. In exchange, however, lenders are protected from lawsuits should a borrower default on their loan and lose their home.

Not all lenders follow the Qualified Mortgage rules, though. They choose to take a chance and allow less stringent guidelines. However, no matter what a lender decides, they have to follow the Ability to Repay Rules. Basically, this means the lender can prove beyond a reasonable doubt that you can afford the loan. In other words, they need proof of your income.

Don’t worry, though, there are ways around it. You don’t have to be the paystub and W-2 employee to get a mortgage. There are other ways you can prove your income and still get a loan.

Use Your Tax Returns

If you are self-employed, lenders will need to see your tax returns. They’ll usually ask for two years’ worth of tax returns. This allows them to see your income over that time and take an average. It also allows them to see what expenses you write off, as they will take those expenses right off your income as well.

Your expenses are one area that your tax returns could hurt you. Even though it’s perfectly legal to write off certain expenses to lower your tax liability when you own a business, it could hurt you when you apply for a mortgage. Lenders are required to use your net income reported on your tax returns, not the gross income you claim. It’s to your advantage to hold off on writing off those expenses in the year or two before you know you will apply for a mortgage.

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Use Your Bank Statements

If your tax returns won’t yield the greatest results when you apply for a mortgage, consider using your bank statements as proof of income. This works well if you are self-employed or even if you work for someone but are paid commission or bonuses.

Your bank statements need to show consistent deposits in order for the lender to use the income as you state it. Regular deposits at the same time each week, every other week, or month will show the lender the consistency of your income. Lenders often use this money at the value of the deposits unless there is a reason to deduct unreimbursed expenses.

You’ll Need Compensating Factors

No matter which category you fall into, you’ll need to show the lender that you have compensating factors. For them to take your loan at face value without standard proof of your income is a big risk for them. In order to offset this risk, they need to know that you are a financially sound risk. You can prove this by:

  • High credit score – The higher your credit score, the financial responsibility you show the lender. Try increasing your score as much as possible during the time leading up to your mortgage application. The lower your credit card balances, and the more timely your payments, the better your score will be.
  • Low debt ratio – The lower your debt ratio, the lower risk you pose to a lender. If a lender is willing to take your alternative form of income, they want to know that you are not overextended on your debts. Staying below the program maximums will help your chances of approval.
  • Stable income – It’s hard to have stable income when you work for yourself or on commission, but making it as stable as possible is important. However, there are ways to prove stability even before you started your own business. The more experience you have in the industry you open your business in, the more reassurance it gives the lender that you are a good risk.

Proof of income is a vital component of the approval process for a loan, but there are ways around the ‘normal practices.’ You’ll need to find a subprime or alternative lender that is willing to think outside of the box, though. Your big box banks are going to have the stricter guidelines when it comes to income. It’s the smaller banks that have the ability to make their own rules because they keep the loans that will suit you best in this case.

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Can You Get a Home Renovation Loan With Low Documentation?

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Renovation

Low documentation loans took a back seat after the housing crisis. Lenders became leery of stated income loans. They chose to require full documentation for all loans, including home renovation loans. However, today, they are making a comeback. You may even find that you can fix up your home without fully documenting your income.

We help you discover just how this works below!

Great Credit Scores are a Must for a Renovation Loan

First, you need a great credit score. No lender will consider you for a low documentation loan if you are high risk. A great credit score shows the lender that you are financially responsible. Just what makes up a great credit score is subject to opinion, though. Each lender has their own preference. Because these lenders keep these loans on their own books, they can make up their own rules.

Using Personal and Business Bank Statements to Qualify

Self-employed borrowers often have personal and business bank statements that show their income. If you need to use a combination of both, you’ll also need to provide a Profit and Loss Statement. The lender uses the P&L to determine your income. Keep in mind, though, the expenses you claim must be normal for your industry. The lender will look closely at your expenses to make sure.

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Once the lender determines your average income, they’ll look at your personal and business bank statements. They want to see deposits equal to the amount of your average income. They often allow a fudge factor of 5% either way, but anything less than 5% of the amount will raise a red flag.

Using Only Personal Bank Accounts

If you don’t want to disclose your business bank account information, you may be eligible to use your personal accounts alone. You’ll have to be able to prove regular deposits from your business in order to qualify, though.

The lender may not need a P&L for this type of verification. Instead, they’ll look at your personal bank accounts and at the regularity of deposits. They’ll generally need 24 months of your bank statements in order to qualify you for the loan. They may also ask for a few months’ worth of your business bank statements in order to ensure that your business and personal accounts remain separate and that they don’t share funds.

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Using Only Business Bank Statements to Qualify

Lastly, you can use your business bank statements alone to qualify. You’ll need to provide a P&L for the lender to determine your regular income. They will then ensure that you have the appropriate deposits in your business bank account.

In this case, you’ll also need proof from a third party that you operate a business and that everything you state is true. This usually comes from your CPA or tax preparer. It helps give the lender reassurance that the money you provide them truly is yours.

Qualifying for the Renovation Loan

Once you prove you have the credit score and the income for the renovation loan, the rest is easy to satisfy. The lender will likely want to know what renovations you will make. This way they can get a true value of the home after renovations. This helps them determine if the loan is a favorable one for them to write.

Some lenders may require that you get approval for the renovations from them before you begin. This helps them determine what you use the funds on and how you proceed. For example, they want to prevent you from sinking money into your home that won’t provide a return on your investment. If they give you $20,000 and you use it to make cosmetic changes, it won’t have any effect on your value. However, if you renovate your kitchen or bathroom, you’ll likely see a return on your investment.

Lenders each have their own requirements when it comes to renovation loans with low documentation requirements. The good news is that they are out there! You will have to search for them and compare the offers from different lenders. Make sure you know all of the details before settling on a lender to make sure you get the best deal possible.

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The Role of Bank Statements in Successfully Getting a Mortgage

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Computing

Whether you are applying for a stated income or a traditional mortgage, your loan officer could ask for your bank statements. These documents are used to verify and document your income. Lenders are required to do their due diligence on your ability to repay your debt and your bank statements and other asset documentation will prove that.

Because most loans are underwritten via an automated platform, e.g. Desktop Underwriter®, the need for bank statements may crop up during underwriting. Nontraditional loans such as bank statement loans are based off on the flow of money into bank accounts so that they go hand in hand with the loan application.

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Bank Statements and the Mortgage Process

When making loans, lenders must ensure that the borrower has the capacity to pay the debt to be incurred. They would look into the income of the borrower to make this determination.

Moreover, lenders need to check if the borrower has enough assets (readily convertible to cash) that can cover the down payment, closing costs, and reserve requirements.

Bank statements can cover both for the lenders in their quest to track the assets and income of the borrower. They are also helpful in verifying the identity of the borrower and the information as it pertains to asset accounts set forth on his/her mortgage application.

Usually, lenders look at deposits that fall outside of the declared income source of the borrower, e.g. an unexplained large deposit used for down payment. Or it could be recurring withdrawals that pertain to an undeclared debt obligation.

Mortgage borrowers like you can present your personal bank statements. If you are self-employed or are a majority owner of a business, both personal and business bank statements may be required.

Bank Statement Loans

These loans perfectly sum up the role of bank statements when applying for mortgages.

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Niche lenders who make these mortgages usually require personal/business bank statements for 12 consecutive months, thus dubbed as 12-month bank statement loans.

These lenders recognize the struggle of self-employed borrowers to have their real income verified because of write-offs on their federal tax returns. Interestingly, some bank statement loans don’t require tax returns and their related tax transcripts.

What’s important for the lenders is a reliable, steady cash flow that they will use to calculate income. To arrive at income, lenders take the average deposits during the given period, net of debits and withdrawals.

They will then take into account recurring monthly expenses to get average monthly income. From the average monthly income and recurring monthly expenses, they can come up with the debt-to-income ratio of the borrower.

Indeed, good credit, liquid reserves, and provable income via bank statements are the main ingredients to a successful bank statement loan.

As with any other loan, expect to meet loan-to-value ratios, down payment requirements and asset reserves as well.

Don’t estimate the power of bank statements especially if you have difficulty getting financing under standard mortgage programs. You can always look at alternative or nontraditional loan products like bank statement loans.

Happy shopping!

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What Different Paperwork is Required for Stated Income Loans?

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What Different Paperwork is Required for Stated Income Loans?

Stated income loans are not a thing of the past – they still exist, and in fact, are making quite a comeback lately. More and more people are becoming self-employed thanks to the downfall that the economy took, making fewer jobs available, which forced people to look outside of the normal ways of making money. This, in turn, has forced lenders to open up the door to stated income loans in order to keep the housing history thriving. So what is different about these loans when it comes to qualifying?

No Tax Returns

In most cases, you will not need to provide your tax returns for qualifying purposes. Some lenders might want to see them just to see that you do make money and that your write-offs are the only reason that you do not qualify since the lender can only use the bottom line income on your tax return, not the gross income. In some cases, lenders are able to add back specific expenses into your net income, making it easier for you to qualify for a fully documented loan. In the cases that the tax returns do not help your case, however, the tax returns do not need to be used – the lender can ask for alternative documentation to provide to the underwriter.

Bank Statements

In almost every case, bank statements are necessary in order to qualify for a stated income loan. This might seem strange since you are “stating” your income, but the lender has to have some type of verification that you physically receive the money, which is usually done with your bank statements. You will have to decide which type of bank statements to provide the lender though – either business or personal bank accounts. If you choose business accounts, you cannot also provide your personal accounts because there is the risk of using the same funds twice (receiving them in your business account and transferring them to your personal account). In addition, if you do not own the business by yourself, you will have to split the amount of assets in the business bank account, which could lower the income that you are able to claim, so choosing the right bank account is a crucial step.

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CPA Letter

If you are choosing a stated income loan, it is likely because you are self-employed. Because this means you will not have W-2s and paystubs to prove your income from a reputable source, lenders require that you obtain a letter from your CPA stating that you are in business for yourself. This letter must be on the CPA’s letterhead and include the following information:

  • The name of your company
  • The date you started your business
  • The date the CPA started handling your finances and taxes for you
  • Any other pertinent information he has about your business

The reason behind the CPA letter is to have a non-interested party verify your self-employment. Just having you say that you are self-employed is not enough verification for a lender; they need to diminish their risks as much as possible.

IRS Form 4506

Even though you do not provide your tax returns for qualification purposes, some lenders require your tax transcripts just to prove that you filed taxes. They will not use the income reported on the transcript, but will just use it for verification purposes. It is another layer of protection for the lender as they are taking a chance on you by providing a loan without fully documenting your income. The Form 4506 is just a form you need to sign and provide your social security number, giving the lender permission to obtain your tax transcript.

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Rental History

If you have not owned a home in the past, the lender will require some type of housing history from you in order to qualify for a stated income loan. This does not mean if you are a first-time homebuyer that you will not be able to get a stated income loan – but you will have to show financial responsibility with housing payments in the form of rent. Lenders typically want a 12-month history of your rent payments. The verification must either come directly from your landlord on an official Verification of Rent form or from your bank account in the form of canceled checks to show not only that you paid the rent, but the date that the landlord cashed it and that they were always on time payments.

The Remaining Documents

The remaining documents needed for a stated income loan are those that are also needed for a standard loan. These documents include:

  • Uniform loan application
  • Standard appraisal
  • Gift letter for any gift funds you receive from family, friends, or your employer
  • Title documents
  • Credit reports and proof of any liabilities
  • Proof of homeowner’s insurance
  • Proof of flood insurance if the home is in a flood zone
  • Any letters of explanations for unique circumstances surrounding your loan

The stated income loan might require you to get a little more creative with your documentation to obtain a loan, but it is worth the effort. The stated income loan is looked upon a little stricter than a fully documented loan because of the higher level of risk you provide the lender when you cannot fully verify your income. The lender needs to make sure that all of the bases are covered in order to minimize the risk they face.

Every lender requires different documentation for any type of loan, but especially the stated income loan. Because this is a non-qualified mortgage, the lender does not have to abide by the standard QM guidelines, but can add their own requirements, called lender overlays to ensure that the loans they provide are low risk and profitable for them. As stated income loans continue to increase in popularity, lenders will begin to open up the possibilities for a variety of borrowers, but for the time being, you might have to search a little harder to find a lender willing to provide you with a loan.

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