Don't be left in the cold
Self Employed Income Can Buy a Home
You have been
self-employed for a long time, or you have a sideline gig business, or you are just
opening a new income stream; but you don’t think you can buy a home or refinance.
You have a marvelous CPA who uncovers every possible write-off and although
your gross income is high, the net number is what traditional lenders use.
For some
borrowers trying to buy a home, monthly income isn’t exactly easy to calculate.
For instance, when the borrower doesn’t get a pay stub and W-2.
Freelance
workers, business owners, commissioned employees, those with large percentage of
bonus income, and other independent consultants are considered “self-employed”.
Their income is determined by looking at things like profit-and-loss statements,
1099s and the past two years Federal tax returns. Lenders do not use state
filings, so don’t provide the extra paperwork.
You don’t need
to know how to calculate your self-employment income. I suggest you send me all
your IRS returns for the past two years and we analyze, discuss, and review
before I even pull your credit report. I need the 1120 Corporate returns, K-1,
partnership returns, and your personal federal returns to dig out depreciation,
interest paid for business loans, and any additional income to the bottom-line
net number. I will add up the income and average it over 24 months, 36 months
and past 12 months. I can also look at the gross income and propose we do a
bank statement loan based on gross in a certain time period and divide that
income in half. Later in this article I will discuss the ins and outs of the
many bank statement loan programs.
The first spread
sheet of numbers I create is the recent past two years self-employment
requirement. We work together to show you have a website, or location or
advertising established to show there is a legitimate business in operation. I
may ask for a business license. I will check with the Secretary of State to see
if your Corporation or LLC is in good standing and open for the past two years.
Mortgage lenders
use the definition for a self-employed borrower as anyone who receives more
than 25 percent of their income in non-salaried pay is reviewed as a
self-employed person. This primarily includes those who work on commission or
bonus. It also includes persons who own rental properties.
The lender’s definition of self-employed excludes those who
own less than 25 percent of a business. A common example might be a
partners where an investor or junior person who does not have controlling
interest in business operations.
If you are
self-employed, you will have to hand over more documentation than a salaried
borrower would. Here are a few extra items you’ll need to provide:
§ 2 years’
personal tax returns with all schedules
§ 1099s
§ W2s from your
self-employed business (if you pay yourself a salary)
§ All pages of
the Federal personal returns for the past two years
§ 2 years
business tax returns with all schedules
§ K-1s
§ 1120 (Corporate
Tax Returns)
§ 1120S
(Partnerships and S Corps)
§ Year to date
profit and loss statement showing current income is on track with previous
years I suggest you email me all the income documents at the same time you call your CPA to prepare the year to date profit or loss. It's the numbers on the returns that hold the most weight. Showing a huge profit on the P and L varying form the returns, well, isn't going to be that useful. But don't show larger than normal loss.
§ Explanation to me if you receive most of your income at a specific time of year. In this
case, it can look like your profit and loss statement is on track for lower
income than in previous years. I will help you write this letter.
Various Types of self-employed businesses:
Sole Proprietorship: One person owns and
controls the business. Income is reported on schedule C of your personal tax
return. An example would be the single owner of a landscaping company.
Generally a sole proprietorship is a smaller company.
Partnership: Two or more people own and
control the business. Profits from the business are split between the owners.
Corporations: Stockholders own the
business. These are large companies. A borrower who is 25% owner of a
corporation is unusual to see on a mortgage application.
S Corporations: This is a corporation with
a limited amount of stockholders. If you are owner of an S Corp, you’ll need to
supply your 1120S tax return.
You may have
the world’s greatest accountant; but he/she did not help you with getting a loan,
he/she helped you to not pay much in income taxes.
There are
several things that can trip up a self-employed borrower when applying for a
home loan and providing tax returns to the lender. The fact is most
self-employed persons do not show much net profit. Since the net number is what
is used, for the past ten years since the crash it has been difficult for
business owners to purchase a home or refinance to lower interest rates.
If you work
full time and have a side business, do not plan on deceiving your lender into
not seeing the losses. Typically, you schedule C on tax returns. Lenders
require you to sign a 4506T upfront when you apply. This form is verified with
the IRS to check your income verses what you stated, the w-2 forms, and any
verification of employment. A week or so into the transaction when the 4506T
transcript returns with losses showing, now you have set up suspicion of what
else you may be hiding, and the loss is discounted from your income. It is
always best to consider your loan officer like your priest.
Mortgage
lenders, banks, investors and the secondary market are heavily regulated. They
must be ready to prove that every loan they close is a qualified mortgage. Perhaps
you have not applied for a home loan in more than ten years, today everything
is checked more than twice. If you recently opened shop for your side business,
a loss for just one year is considered.
If you closed
your business after filing the previous year’s tax return, your loan officer
guides you towards the proof needed to show the business officially closed.
Employee Expenses In the past you could claim
non-reimbursed business expenses including mileage. These show on form 2106 in
2017 or 2018. These deductions are counted against your total W-2 income. An
example of employee business expenses are tools and supplies not provided by
the company, non-reimbursed mileage to work-related meetings, and cell phone
charges if you use your personal cell phone for work.
Two-Year Self-employed Average Income: When a lender
reviews business income, they look at not just the most recent year, but the
past two year filed with IRS period. They calculate your income by adding it up
and dividing by 24 (months).
Your loan
officer should be experienced enough to tell you if your excuse for the income
decline will be acceptable and is believable or you can prove to be true on
paper. Remember your file is not viewed by only one person. Most loans are sold
on the secondary market and the investor has to believe and accept your written
letter, and they don’t know you and can’t speak with you.
Cash Flow Analysis Lenders review with a magnifying
glass your bank statements to examine the cash flow of the business. Are there
non-sufficient funds charges? Is the net at month end enough to purchase goods
needed?
You may want to
use funds from your business accounts from your down payment. Sometimes, the
underwriter asks for a letter from your CPA saying that taking money from the
business won’t harm ongoing health of the business and you have one hundred
percent access to the funds. This may seem silly, as you can write a check as
you please; but necessary for the file and for others who may review the file
after you close.
Fannie Mae and
Freddie Mac have spread sheets which calculate income for self-employed
individuals based on each line item income or loss. Lenders may use their own
method of figuring your monthly income. Some lenders have stricter guidelines
called “overlays” which make the way they come up with your monthly income very
different from one bank or mortgage company or end buyer of the promissory note
and loan.
If your
business is new (one year filed return or no filed returns) often you start operating
at a loss. Lenders will weigh the loss against other current income you may
have, this is why you need an experienced loan officer who gathers all the
facts and comes up with an individual plan for your needs.
The
self-employed borrower does endure more scrutiny that the standard pay-stub and W-2
employee.
There are
fortunately other income options to use as verified income for home loans.
These other
categories of products are not sold to Fannie Mae, Freddie Mac or our
government. They are often bought by hedge funds, pools of private investors
and more. Bank statements can be used to extrapolate income. I will ask you for
24 months banks statements. We need one account. Let me repeat, we don’t take a
couple different accounts and compile. I can use 24 months or 12 months or the
last one month and half of the deposits less transfers from other owned accounts
or one-time deposits are used then cut in half as the total income.
Bank statement
loans use the deposits, your FICO lowest middle score, liquid assets, property
type, property use, and property loan to value to determine the interest rate.
Thirty- year, fifteen year, seven, and five-year loans are available. In
general, I am going to convince you for the longest term (the thirty year if
available) because in the future you may not have net income to refinance to a more
conventional loan. The difference in interest rate between a “full
documentation loan with income taxes” and a bank statement loan may be 1-2
percent higher. This is not a hard money loan.
Hard money
loans are priced a much higher jump from 6.95 to fourteen percent depending on
the total number of risks. Lower FICO, property that may take longer to sell,
layers of risk determine the interest rate. To choose a hard money loan you as
a borrower must have an exit strategy. Usually the best plan is to sell in the
short range as plans to increase income or wait for sunshine rarely unfold in the
short term.
IF you are
purchasing an investment property there now are loans that only review the
subject income and rents.
Fortunately,
there are now options for self-employed borrowers. Let’s work together to see what
is available. Please call me at (949) 784-9699
C G Barbeau NMLS 324982
I’ve been
helping buyers close on their dream property for thirty years. There are
solutions even if the bank turned you down. Equal opportunity Lender.
