Mortgages for the Self Employed
69Mortgages for the self employed were generally difficult to obtain even before the mortgage industry's meltdown. In the current economy, obtaining a mortgage to purchase or to refinance a home is harder than ever, especially for those who are self employed. There are, however, a number of things a self employed person can do to prepare for the mortgage application process that will greatly increase their chances for approval and greatly reduce the time and stress involved with the entire loan process.
How Self Employed Mortgages Work
Typically, whether using a local bank, mortgage broker or mortgage company, a person will have to produce documentation to verify income, assets and employment during the loan process. For regular employee, the income verification will include recent paystubs and the last two W2s. The paystubs will show year to date income, withholdings, and will pinpoint the exact level of income. These are some of the main criteria a mortgage underwriter is looking for to establish approval. Things are very different for the self employed individual. Being self employed, there is no paystub or W2 for the underwriter to review. The underwriter will require that the self employed person provide two years of tax returns including all schedules. This in itself is dramatically more paperwork to produce than two paystubs and two W2s.
Once the underwriter has obtained the tax returns, the income level is computed from the pre-tax net found on line 31 of schedule C. This is a very significant point, because the net income on line 31 is almost always very minimal and does not represent the true income of the self employed person. Self employed people will use every business expense they can to reduce their net taxable income to avoid having to pay a large amount of taxes. This is good in a tax sense, but bad from an income verification sense. With a small amount of net income, self employed people have trouble proving that they have sufficient income to qualify for the mortgage. In addition, underwriters typically are stricter with the self employed, because they have no way to do an independent verification of employment.
Applying for a Mortgage for Self Employed
Before applying for a mortgage, a self employed person should take time to review and repair his or her credit. This hold true for any mortgage applicant, but goes double for the self employed, as they are generally held to a higher credit standard. If a person has enough lead time, he or she can incorporate the business and take compensation as a traditional employee with withholding and W2. This eliminates the issues with income verification. Alternatively, if a person has enough lead time, he or she can forego taking a number of business expenses as deductions and show a higher net income on the tax return in anticipation of the income verification process. This will cause a higher tax liability in the short term, but will greatly improve the chances of loan approval in the future. In addition, many underwriters will require that the self employed individual have been in the same line of work for a minimum of two years. If unable to establish this from the tax returns, the underwriter may require the applicant to produce some form of business license that verifies that they have been in business for at least two years.
To apply for a mortgage for the self employed, a person should contact a local bank or mortgage company and have an initial interview with a loan officer. During this interview, the loan officer will collect the information necessary to complete a standard mortgage application and will obtain permission to pull a credit report. It is a good idea to be ready to provide the loan officer with two years of tax returns during the initial meeting, so issues with income level can be addressed early in the process.
When making the decision on where to apply for a mortgage, a self employed person should be aware of the differences between a local bank and a mortgage company. The local bank will typically have more latitude in making judgment calls and exceptions, but will usually require a larger down payment on purchases and will have a slightly higher interest rate. The mortgage company will have the best rate and the lowest down payment, but the approval and underwriting process will be more stringent.
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