It’s no secret that one of the most important factors in getting qualified for a mortgage loan is documentable income. Lenders, both large and small, justifiably want to know that you have money rolling in on a consistent basis, as this is a good sign that you’re able to repay the money you borrowed. Traditional home buyers are able to prove this by providing a W2 from their employer indicating just how much money they make week-to-week or month-to-month. However, things get a little bit trickier when we start talking about mortgages for self-employed individuals. Here’s why…
Unlike a traditional home buyer, self-employed home buyers can’t simply produce a W2 to prove their income. Instead, self-employed applicants are expected to produce evidence of their last two years in tax returns (up until recently). Coming up with this information, in addition to other supporting documentation, can be tedious, but it’s required when applying for a mortgage. However, the real challenge comes when it’s time to clear up any discrepancies between what a self-employed borrower thinks they make in income, and what their tax returns say.
The most common problem self-employed individuals encounter when applying for a home mortgage loan is differentiating between how much they claim they make, and the amount the lender decides they actually make in net income, according to their tax returns.
Despite having plenty of cash flow on hand, not to mention access to credit through their business accounts, self-employed individuals are often shocked when they learn just how much their net income actually is after factoring in tax write-offs and other business expenses. For example: A self-employed electrician may make $200k in gross sales, but if they write off $190k, they’re left with $10k in taxable income. Their gross revenue is much different from their net income.
Fannie Mae and Freddie Mac, as well as the FHA and VA, all base their lending decision on net income shown on the tax returns. There are non-conventional loan programs available that qualify without tax returns (such as ones that use bank statement deposits). However, these loans all come with higher interest rates, higher costs, and higher down payment requirements.
Self-Employed Borrowers: Recent Challenges
The COVID-19 pandemic has had devastating effects on the world economy in 2020. In the U.S. alone, we’ve seen record rates of unemployment and unprecedented business revenue losses making 2020 a bad year for many business owners. As a result, many self-employed prospective home buyers have had to put off their big purchase until their income stabilizes. In addition, the best loans are not available because 2020 filed taxes don’t support enough income for most business owners. Even if 2019 was good and your business is on track in 2021 your “qualifying income” is likely based entirely on your 2020 tax returns!
Businesses seem to be more robust and healthy now. However, no amount of good credit, robust assets or equity can overcome the lack of income on 2020 taxes. For example: You’ve got perfect credit and $1.0M in the bank, but your 2020 taxes show poorly. While there are still loans for you, you cannot qualify for a refi and drop your rate from say 4.0% to the prime 2.75%. Fannie Mae and Freddie Mac don’t allow us to take into account the time a business was forced close in qualifying either.
Self-Employed Borrowers: The Opportunity
Filed 2021 taxes represent a unique opportunity: a clean slate.
Many programs now allow us to use only 2021 taxes and entirely ignore 2020 tax returns. Even carryover losses from 2020 would be ignored. 2020 taxes are not even provided to the lender.
This works for conventional and jumbo loans, owner occupied, second homes, investment properties, purchases, refinances, and cash out loans. Currently, 30-yr fixed loans at 2.75% APR with as little as 5.0% down payment. If you’re looking to refinance and take some cash out for home improvements you may be able to drop your rate at the same time.
You are back in the driver’s seat. Planning ahead to use your 2021 taxes to qualify for the loan you want is key. Not every loan and situation allows us to use 2021 taxes. Starting to gather your information and solutions now is especially critical for those looking to purchase. While it may be true that as a self-employed borrower means more work for you up front, we are fully equipped to help you succeed. We work with self-employed home buyers all the time to help them qualify for a mortgage loan that works. Contact us today, we can review your 2020 taxes with you and help you to plan.