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The Dos and Don’ts of Self-Employed Mortgages

June 14, 2018 By JMcHood

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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Are Tax Returns and Tax Transcripts Necessary?

February 27, 2018 By JMcHood

 

Requesting transcripts of your tax returns was a common policy for self-employed borrowers before the housing crisis. Today, however, lenders almost always request a transcript to verify your taxes, whether you are self-employed or not.

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Why Lenders Request Transcripts of your Tax Returns

Requesting the transcripts of your tax returns helps lenders verify the information you provided them. It shows that the returns you provided were not altered in any way. In other words, the information you gave the lender is exactly what you gave the IRS.

What is a Tax Transcript?

The tax transcript is not an identical print of your tax returns. Instead, it’s a line item document that shows the same (hopefully) numbers you provided on your tax return. The transcripts do not contain all of the schedules you have on your tax returns, but it will provide the numbers on those schedules. This is what the lender needs.

How Lenders Get Your Tax Transcript

In order for the lender to order your tax transcript, you must sign Form 4506-T. This allows the lender access to your tax transcript. They send the signed document to the IRS who then sends the lender your tax returns within a few weeks. It’s customary to sign the transcript form right away after accepting a lender’s offer so the transcript does not hold up your loan’s processing.

Why Tax Returns Matter

You might wonder why a lender even needs your tax returns. Isn’t paystubs or a P&L from your business enough? Tax returns just provide lenders with more proof of your income. It shows that what you say you claimed on your taxes is truly what you claimed. However, there’s another reason.

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Lenders often request tax returns from borrowers that own their own business or work on commission. These borrowers often claim many expenses on their taxes. These expenses take away from their gross income. The lender can only use the net income you claim on your taxes. So your tax return income may not match the income on your paystubs or P&L. The lender can only use the income on your taxes, though, which may hurt you.

As far as a layer of protection, though, the lender matches the tax returns with your other proof of income. If there is some type of inaccuracy, the lender will start investing the reason. They may come directly to you for an explanation or they may do some verifying on their own. It could greatly delay the underwriting process, so it pays to make sure everything matches before applying for a loan.

If you own your own business, the lender will need to verify that there isn’t a business loss that you tried hiding with your income documents. This is why they use the net income from your tax returns, rather than the documents you provide. If there is a net loss, the lender must use this for qualifying purposes, which could harm your chances of approval. They do add back certain expenses, though, such as depreciation.

One last reason lenders care about your tax returns is to see if you owe the IRS money. This isn’t a deal breaker if you do; however, there are rules. If you owe money, you either have to pay it in full or have a payment arrangement set up. If you have the payment arrangement, you’ll also have to prove that you make your payments on time. There isn’t a specific amount of time you must have the arrangement, but the longer history you can show, the better off you’ll be.

Your tax returns play an important role in your ability to secure a loan. Make sure you provide the ‘real’ returns along with a signed 4506T so that the lender can get the process rolling right away.

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