It’s no secret that one of the most critical 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. Mike Pacheco of Qualified Home Loans, an independent mortgage company that specializes in helping self-employed individuals secure real estate funding, shares 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 have evidence of their income using the last two years' income tax returns. Coming up with this information and 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 believe they make before write-offs compared to the amount the lender decides they actually make in net qualifying income, according to their 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.
Pacheco shares the three categories of loans available for self-employed individuals. These depend on the method of qualifying and how income is documented.
1. Full Doc (Tax returns) - These are the best loans with the lowest down payment, the best interest rates, and often have government backing (Fannie Mae, Freddie Mac, FHA, VA). In 2008, in response to the mortgage crisis, the government created a requirement that lenders document that clients have some "ability to repay." For someone self-employed or a small business owner, tax returns are required. No magic program offers these premium loans to self-employed clients who cannot document income on taxes. These rates are typically from 2.625% - 3.375% 30-year fixed loans depending on occupancy, purpose, property type, loan-to-value, etc. These often have limited to no costs to obtain.
2. Alternative Documentation - Alternative documentation uses a different method of qualifying in lieu of tax returns. Here are some examples: using business bank statements/deposits to calculate income instead of taxes; qualifying a rental property exclusively off its anticipated rent; business P&L's are used as income documentation; and others like asset depletion. The options here become somewhat endless, but the terms are always less desirable compared to full doc loans. These programs range from as low as 3.25% to 5.875%, depending on how it is qualified, credit score, LTV, etc. For example, a purchase with 40% down using 12 months' business bank statements and great credit is likely to be at 3.25-3.45%. That same client with 10% down is expected to be at around 5.0-5.25%. These loans typically have costs to obtain.
3. True No Documentation - Some lenders, called community development lenders, are afforded a unique carve-out that allows them to do a true no-doc loan, even for owner-occupied loans, and no income is measured at all. These loans can provide non-traditional prime mortgage financing to low-income households, small business owners, immigrants, and other diverse borrowers. Tax returns are not used to tell the whole story, and instead, lenders base underwriting decisions upon character, credit, equity, and the borrower's overall circumstances. These loans require 25% down or cash out to 65% of the value. Rates are between 5.5% and 5.625%, and the loans do typically have costs.
Business owners, really anybody, would prefer a full doc loan, however, Pacheco has seen an issue working with self-employed clients this past year.
The COVID-19 pandemic has had devastating effects on the world economy in 2020. We've seen record unemployment rates and unprecedented business revenue losses, making 2020 a bad year for many business owners. The best loans are not available because 2020 filed taxes don't support enough income for many 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. We cannot even consider the time a business was forced close in qualifying either. It defies common sense, but loans are about rules- not logic,” shares Pacheco.
Filed 2021 taxes represent a unique opportunity: a clean slate.
Many programs are allowing applicants to entirely ignore 2020 tax returns and use just their 2021 taxes. 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. This puts 30-yr fixed loans under 3.0% in reach. Purchases can be done with as little as 5.0% down payment. You may be able to take cash out of your home for improvements, and even drop your rate at the same time. Your 2021 tax returns could be the key to unlock amazing loan opportunities that are currently unavailable to you.
Pacheco comments on this opportunity, “If you’re self-employed, 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.
Qualified Home Loans works with self-employed home buyers all the time to help them qualify for a mortgage loan that works. Contact them today, so they can review your 2020 taxes with you and help you to plan.
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