Pre-2009 it was fairly straightforward for the self-employed to get qualified for mortgages. I bought my first house in 2000 – while fully self-employed - with no difficulty. There were issues involving appraisal, inspection and downpayment , but after 5 years in business with a good operating profit, qualification wasn’t something that I worried about.
Then, in 2003 when I re-financed the house to do some improvements it wasn’t an issue of getting approved, but more of the value of the additions versus the loan amount versus the appraisal. Fortunately, the neighborhood we lived in has risen in value enough to offset those concerns. The closing went well, the improvements/renovation was made and everyone was happy.
It never even entered my mind that qualifying for a mortgage would be an issue. After all, I now had nearly a ten year history of payments on my current house, my company was still profitable and the house - while a fixer-upper - would likely appraise even higher than the asking price.
What came next was a painful introduction to a very changed real estate and mortgage banking landscape. Thanks to the shock of so many foreclosures and a new distrust of stated-income products and similar mechanisms used to qualify the self-employed, there was no market anymore for people like me. I went from being a respected and proud entrepreneur of 15 years to a chump who couldn’t sell his house and move elsewhere because he couldn’t qualify for any mortgage at any rate.
Let me state that again – actual bankrupt people and folks who made a third of what I did could get a mortgage to buy a house, but I couldn’t even though my credit score was over 700.
To say I felt betrayed and ashamed and scared is a massive understatement. I tried three mortgage banks, two of whom I’d dealt with in my previous house and one Igot a referral to. I tried two local banks – none of them would touch my loan request. It was only because a friend of mine co-signed the loan for me that we were able to make it happen, and even that required a 20% downpayment.
Now, six years after that I’m about to zero the mortgage completely with cash and the house’s value has surpassed even my 2009 estimate. But of course it took twice as long and it cost a lot more than it needed to because I couldn’t get a construction loan. In 2011 I didn’t take nearly all the deductions I could have on my taxes so that I would show more income to my personal 1040 just so I could re-fi and get my friend off of the loan.
The question is, what can an entrepreneur, a sole-proprietor or a small-business owner do post-2009 to qualify for and get a mortgage or refinance?
The answer is that there are now many products for the self-employed in the mortgage industry. They just take a lot more work to do and typically take longer to get through than a “conventional” loan with a W-2 earner (or 2 of them in a double-income household).
Because of this extra work, most mortgage banking operations will (grudgingly) do them, but they certainly don’t prioritize them and as the borrower you feel like you’re supposed to apologize for being self-employed throughout the entire process.
There are several broad categories of programs that you can use to help support your case.
Rely on your tax returns and your bank statements to verify your income. These types of programs generally require you to give the Mortgage Banking company copies of your tax returns for the previous three years. You are also likely to have to sign what is called a 4506 or 4506-T tax form, which gives them the right to pull your tax return from the IRS at any point in the next 90 days. You may also end up being asked for a year (sometimes three) of bank statements.
The second type of program relies largely on bank statements for the business (I’m assuming that you have them) and yourself. This type of program is generally looking back three years into the cash coming in and out of the business and to you personally and largely ignoring your tax returns.
Asset depletion, despite the frightening name, is another viable option. In this scenario you have an asset like a 401k, a SEP, a Mutual Fund Account or a big CD sitting somewhere that you could, if all else failed, turn into cash to pay the mortgage. In this scenario your income is not taken into account because you could pay the mortgage for some period of time (generally six months) if push comes to shove.
The above options are generally the ones that are most widely available to self-employed borrowers. Other options do exist but in all cases they are generally more onerous than the versions mentioned above.
There are a few notes worth mentioning. First, there are still no real options for stating income – you must demonstrate where your income is coming from. Secondly, if you are a business owner, you must typically demonstrate positive cash flow or growth for at least three years. If you are a 1099 employee, you will need two years of consistent income. This means there may be a one to two year gap where you will find it next-to-impossible to qualify through any means, including the options above. However, with some help putting the case together you can do it. For example, in some industries all the money is made in short bursts. Some examples would include Catastrophe Adjusters, Tour Guides, Industrial Welders and so forth. What you generally have to do here is provide third-party verification that this is how the industry is structured and that the ups and downs and gaps all even out to an income that qualifies and that this income will continue.
Of course entrepreneurs and 1099’ers didn’t make the financial crisis or misuse the mortgage products created for their industry. It was the banking industry that abused these products. Stated income, for example, was blamed for much of the subprime mortgage crisis, as the tool was used to overstate applicants’ income, allowing them to qualify for mortgages they couldn’t afford at teaser rates. However, it doesn’t change the fact that the “rules” are different now and we have to, as entrepreneurs should, adapt to them.
I started Entrepreneur Mortgage Finance to address this issue. While it only affects only a small group of people, they’re the people who are ultimately driving our economy forward. And the population of entrepreneurs and freelancers is growing. 67% of employed millennials want to leave the traditional workplace and become self-employed. The World Bank of Data estimates that in twenty years, more than 30% of employment aged individuals may be self-employed.
While doing loans for the self-employed may be more work and less profitable than working with “regular” people, we feel it’s worth it. If you’ve been turned down to told no by traditional banks, we can help. Visit our website – emfloans.com, or contact us at firstname.lastname@example.org. We’d be happy to walk you through your options and help you find a mortgage product that doesn’t penalize you for being an entrepreneur.