Self Employed and Seeking a Mortgage? Don’t Despair!
A self-employed borrower is defined as someone who owns more than 25% of a business and/or who receives a 1099. If the borrower falls into the “self-employed” category, don’t despair! Diane Pyshos, Sr. Mortgage Consultant, A&N Mortgage Services, recommends contacting your mortgage professional to prequalify your income at least 6 to 12 months prior to your need for a mortgage.
1. How can you optimize self-employment income? Your mortgage professional can perform three evaluations for you: (a) calculate income needed to pre-approve your desired loan amount; and (2) evaluate your tax returns to determine your actual income, based on underwriting guidelines; and (3) report the net income shortfall to you and your accountant so that changes can be made to the next year’s tax return. In many cases, small changes with expense deductions can make the difference between qualifying for the loan or not. “The IRS will never mind reduced expense deductions resulting in a slightly higher income!” Diane says.
2. What if net income looks really low? “I know this is hard to believe, but underwriters actually “add” back certain expenses when calculating allowable income for underwriting purposes. Expenses such as “business use of home” and “depreciation” can be added back to the adjusted gross income. Your mortgage professional should be able to evaluate your tax returns before it is sent through a formal application process thereby notifying you if there is any income shortfall to meet your loan amount goals.
3. What documents are required?
* A professionally prepared balance sheet and profit and loss statements for YTD income since your last tax return was filed
* If the personal tax return includes other income on Schedule E, two years corporate, SubS, Partnership, LLC, sole proprietorship, SubS and K-1’s will be required for any entity in which borrower owns 25% or more and K-1’s for any entity owned receiving K-1 income.
* Internal Revenue Service Form 4506-T (which is usually prepared by your mortgage professional). This allows lenders to request tax transcripts
4. What if the tax return shows lower net income in the most recent tax return vs. the prior year? The lender will use the lower income number. If your recent tax return shows higher income than the previous tax return, the lender will calculate a two year income average.
5. What if the down payment will be coming from the business bank account? In order to use business funds for a down payment, the borrower must own at least 51 percent of the business and a CPA must state that taking money out will not negatively impact the business. Plus, the property must be owned-occupied. Business funds cannot be used to purchase rental properties.
6. Do lenders require self-employed borrowers to have a higher credit score than W-2 borrowers? For conforming loans (=/<$417,000), there is no difference in credit score requirements for self-employed borrowers. However, for jumbo loans (<$417,000), higher credit scores are required for self-employed borrowers.
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Diane Pyshos is a contributing author to Living Well in Chicago,
and she is a preferred partner of Anne Rossley Real Estate.