Many potential home buyers in Manhattan Beach and the Beach Cities are self employed. They often own their own business or work on a contract basis for a major company. They make a substantial income, although the amount may fluctuate from month to month. They have money in the bank and good retirement account balances. However most of these 1099 income folks have learned a bitter lesson; it is almost impossible for them to get a loan on a home.
If you are self employed and not mega-wealthy, obtaining a mortgage can be really tough, if not downright impossible. Prior to the new banking regulations, getting a home mortgage if you owned a business, worked freelance, on contract or were otherwise self-employed was possible, if complicated, using stated income, bank statements and other alternatives to W2 income statements.
Today 1099 workers are often treated as semi-criminals by their friendly lenders. While members of congress tout the entrepreneurial skills of the self employed and refer to them as the backbone of the country, they refuse to create a sound program allowing them to get a mortgage.
Unfortunately stated-income loans got a terrible reputation during the melt down as lenders used them to qualify unqualified borrowers. Consequently the folks who legitimately qualified for these loans lost out. New regulations on so-called stated income loans make getting that mortgage almost impossible for self-employed-Schedule C taxpayers. Ask any lender about a stated income loan and they will chuckle silently unless you are considered one of the ultra wealthy with a lot of money in their bank.
For typical W2 employees, the requirement for proving income for both conventional home loans and FHA loans is a copy of two year’s tax returns. Lenders take the net adjusted gross income for the two years and average it, or if the most current year is lower than the preceding year, they use that number.
Since many self-employed folk take exemptions for home offices, vehicle use and other legitimate business expenses that reduce their tax load, their adjusted gross income typically is somewhat lower than their usable income. Different lenders in this new banking era require different documents and proof of income in order to verify usable income for mortgage purposes.
Here are some ways you can improve how lenders see you:
- Find a mortgage professional experienced in self-employed mortgage qualifications. An experienced and knowledgeable loan officer can show you how to increase the amount of your income that qualifies by adding back depreciation on vehicles, properties or equipment, depletion, business use of home and salaries or owner draws that the business paid to you.
- Know how to qualify for an FHA loan (see below). This might seem silly in the Beach Cities but FHA loans go up to $725,000 so they can work if you have a large down payment.
- Some alternative loan programs still accept bank statements and proof of deposited amounts to verify income instead of tax returns. These programs work well for buyers that have cash-based businesses, haven’t yet filed their last year’s tax returns or that have minimized their tax liabilities. Alternative loan programs are note available at market rates, however, so what you save in taxes may go to higher interest rates.
- Make sure your credit score is above 700 and your current credit usage is low. If you’re using credit to increase your credit score, make sure you are paying the cards on time and that the available credit remains high compared to usage.
- Prepare a comprehensive profit and loss statement year-to-date for your business. Providing a third-party validation — outside bookkeeper or accountant—of your income or that the use of business funds for your home down payment will not affect the business’s future viability minimizes the potential concerns a lender might have about your down payment sources.
- Be prepared to pay a higher down payment. If a lender knows you’ve been able to save up a higher down payment based on your current expenses, they’ll look more favorably at your ability to make your mortgage payments.You can also expect them to require larger reserves than normal.
Qualifying for an FHA loan:
According to FHA.com, the self-employed can qualify for an FHA home loan. They advise self-employed applicants to plan ahead (about a year in advance) in order to make sure they can meet the qualifications. Showing reliable income over two years, keeping accurate records of income, expenses, taxes, issues requiring credit repair or dealing with disputes on credit reports takes time. If you do these things, however, you’re more likely to qualify for an FHA loan.
So, is it easy? No. Is it impossible? No. Can it be done? Yes! You just need to be able to prove that you’re a good risk.
When looking for a home, be sure to advise us if you are self-employed. We can help you get started on the pre-qualification and pre-approval process so that you are far down the road when we find the home of your dreams.
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