Obtaining a home loan while self-employed has all the same steps and qualifying metrics as any other loan. We measure credit. We measure loan-to-value. We measure income, and we measure expenses. Qualifications are either inside the box or not. There is no subjectivity. In our experience, the most common obstacle for our self-employed clients is documenting income. After all, when you have no employer, no salary, self-reported income, and the ability to issue yourself a W-2 for any amount, how exactly do lenders document and measure your income for qualifying? Here are the four best ways to document income for our self-employed clients.
Traditional Tax Returns
Using federal tax returns filed with the IRS provides the best availability, rates, and down payment flexibility. A lender will calculate income directly from last year’s (or the previous two years’ taxes). They start with the net income and then add any wages paid during that calendar year to the owner, depreciation, home office deductions, and amortization. As we said above, there is no subjective measure. If there is not enough income on the tax returns, then no amount of equity or good credit will help. This may often represent a conflict for business owners. Most businesses adopt tax strategies to mitigate net income and taxable income.
Bank Statement Deposits
When we move away from tax returns as the basis of income, we move into a category of loans called “non-conventional” or “non-QM.” These have rates and down payments that are typically less advantageous than conventional. The best programs allow us to evaluate a business’s bank deposits over the most recent 12 or 24 months. We look for valid business deposits, so deposits like transfers and loans are excluded. Once we determine the total deposits, we apply an expense factor. The expense factor will be 20%-50% of deposits; it depends on the type of business and the number of employees. An example is a consultant with no employees using a 20% factor, while a manufacturing company with employees would use 50%. The math for a service business with $300K in yearly deposits with no employees looks like this: $300K x 80% / 12 mo = $20,000 p/mo.
1099’s + P&L’s
Much like bank statements, we can measure income using the 1099’s using a Profit and Loss. You get similar outcomes in terms of loan options, so they are grouped. As with bank statements, we use 1099 income by adding the totals and applying an expense factor. Using a profit and loss statement, we look at the net income and divide it by the 12 months. P&L’s typically need to be prepared by a third party.
A “No Ratio” loan is a genuine no documentation and no income verification loan. Unlike any other option, we list no income or employment on the application. There are two main types of loan programs that offer this. One is for investment property and relies on the estimated market rent from the appraisal to qualify. Most require a 1:1 ratio of rent to expense. For example, if rent is $3,000 and the total property expense (PITI) is $3,000, then the property qualifies. Some lenders do much less than 1:1. The other type of loan is a community mortgage. This loan allows primary home purchasers to omit any employment on the application. It is helpful in situations where all other options have failed. For example, a business is owned entirely by one spouse, but that individual has damaged credit. Another good example would be a business that is less than two years old.
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As we move further away from substantiated income, the program options become more restrictive and carry higher rates and costs. Because these rates and terms are worse than others, we like to start at the top to find ways to make the best options fit.
While we like giving you the information so you can get an idea of where you might fit, we highly suggest you do not “self-select.” Our entire job is to help find the best loan for your exact situation. The best thing you can do is to have a call with one of our Loan Officers before you think you want to buy. We’ll take the time to work with you, understand your situation, and create options for now or in the future.