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Self-Employed
Mortgage
Every year, more individuals become self-employed. The increase in numbers has created a special category of mortgage loans for self-employed borrowers. Loans for the self-employed have existed for many years, but the recent revision of programs makes the process easier for the self-employed borrower.
There are many issues that self-employed borrowers must deal with in order to secure a loan. The primary problem is that while they are trying to reduce tax liability through minimizing current net income, loan underwriters are looking at that net income as a basis of the borrower's earnings.
In general, the self-employed aren't any more or less financial risk than employed borrowers. Yet, the application process in which borrowers are reviewed by underwriters can often make a self-employed borrower's financial position look bad. The self-employed borrower should be prepared to fill out more paperwork than is required for normal loan programs.
The documentation of the self-employed
The recent popularity of "no-doc" loans for the self-employed has greatly increased the ability of the borrower to obtain a loan. These loans carry a slightly higher interest rate, but allow the borrower to not prove his or her income. The borrower is given a loan without having to worry about their financial records reflecting their business success or ability to repay the loan.
Under normal Fannie Mae underwriting standards, a borrower is self-employed if he or she owns more than 25% of a business that makes an income. If the percentage of ownership is below 25%, the borrower is considered an employee of the business.
If a self-employed borrower decides to go the traditional, full documentation route, he or she must be able to provide:
1. Two years of business tax returns.
2. Two
years of personal tax returns.
3. Credit references for a business
credit report.
4. A year-to-date profit and loss
statement.
5. A current business balance sheet.
The borrower can expect to be asked for other financial documentation, including letters from accountants, business and personal bank statements and other financial records.
Loan underwriters average the net income of the business owner over the two years to establish an estimate of total income. For example, a borrower with a net income of $50,000 in 2004 and $100,000 in 2005 is credited with an average income possibility of $75,000 for 2006. This estimate is used regardless of proof that 2006 is on track to best 2005's income. If the averaged income meets the program's standards, the borrower has a good chance of being approved for the loan.
Many self-employed borrowers are not able to prove a high enough averaged tax return income to qualify for the loan program. Some businesses have a year that is off, due to many different reasons. The averaging method allows this year to pull down their regularly yearly business income. This is where a no-income verification loan becomes important to the self-employed borrower.
The basics of no-income verification loans
No-income verification loans allow borrowers to secure loans without having to prove their incomes. The borrower must be self-employed for at least two years and able to provide proof of sufficient assets. The borrower must also have excellent credit. The borrower is able to either state their current income or leave the income section blank. No verification is required of the income.
The interest rate on a no-income loan is usually one-half a percentage point higher than normal loan rates. There is typically a down payment of 20-25% required. While these loans appear to be perfect for the self-employed, like any loan they come with disadvantages.
There are several little details that can prevent the approval of a no-income loan. Other details can hurt the borrower down the road. Because the borrower is allowed to state any income he or she wishes to disclose, the program is often abused by borrowers. Two important changes were made to most self-employed loan programs to prevent fraud.
The first enhanced requirement requires borrowers to demonstrate that they have sufficient assets in relation to their income. These asset requirements can be quite strict. Some programs require a borrower to have at least 50% of their disclosed income in provable assets, not counting the down payment money.
The second changed requirement involves a back-up check with the Internal Revenue Service. Most no-income programs require a borrower to sign a permission statement at closing that allows the lender to obtain the borrower's tax returns from the IRS. The application is then checked against the income returns for any discrepancies. If misrepresentations are proven, the borrower could be facing criminal action for fraud.
Applying for a no-income verification loan involves some risk for the borrower. This risk is especially high if the borrower overstates the personal and business income. In addition, the business must be older than two-years to even qualify for a no-income program.
New no-doc loans offer an alternative for borrowers
There is a new type of program, called the no-doc loan. Any
borrower, self-employed or otherwise, with good credit can apply for a
no-doc loan with a 25% down payment.
There is no income verification
or analysis of the business. The IRS tax returns will not be requested.
The only assets required for a no-doc loan is a down payment and closing
costs. In some instances, even the asset documentation requirement is
waived. For a mortgage, an appraisal must be performed on the property to
assess the value.
On a fixed-rate, no-doc mortgage, the interest rate is approximately one-half a percentage point higher than on a traditional fixed-rate loan. There are plenty of options to choose from, including many types of adjustable-rate loans. A self-employed borrower can use the loan to buy a home now, refinancing when their personal and business financial records are sufficient enough to secure a lower-rate, traditional loan.
With more choices of loan programs, self-employed borrowers must be careful not to take on too much mortgage debt. Without an underwriter placing a maximum loan amount on a mortgage, the borrower must calculate a reasonable loan amount.
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