Why The Self-Employed Borrowers Are Treated Differently Than The W2 Employees?

October 28, 2020


By Saeed Ghaffari

What’s Going On With The Economy

Being self-employed and working for yourself comes with pros and cons. The main reasons people choose to work for themselves are freedom and the upside in potential income. While neither is guaranteed, there is no escape from some of the disadvantages that are packaged in this American rosy dream.

While we are not here to discuss the pros and cons of self-employment, we are here to shed light on how self-employed borrowers are dealt with when it comes to mortgage lending and the general lending guidelines pertaining to them.  Let’s get rolling.

Underwriting a loan application is all about assessing the risk factors associated with the borrower applying for the loan. The major risk factors come in 4 different categories, credit history, equity in the property and borrower’s income and employment. Self-employment poses a higher risk to lenders in general, but for a person owning the business to qualify for a loan, he/she must show a history of 3+ years in the business with sufficient income necessary to qualify for the requested loan amount reported on the last 2 years of federal tax returns. 

I doubt it if you didn’t know, a secret advantage (although thanks to President Trump, it’s no longer a secret!. Thank you Mr. President) of being self-employed is to hide your income and avoid paying your share of the income taxes to the state and federal governments.  In other words most self-employed people make a lot more than what they report on their taxes.  Apparently that was not a secret to the banks and mortgage lenders and they have come up with certain provisions and loan programs to accommodate those risky self-employed with the propensity to hide their income. So here are some unconventional provisions/loan programs designed to help these folks:

  • State Income Loan
    If a self-employed borrower meets a certain criteria (holds a credit score, has 5+ years history of owning the business and places enough down payment / equity, usually 30% or more), lenders may approve his/her application without requesting for proof of income via 2 years tax returns.
  • 1 Year Tax Return
    Some lenders consider taking the income off of 1 year tax returns (the latest) instead of averaging the income over 2 years of returns. So if the borrower’s income filed on the latest year tax returns is better than the year before, which is usually the case with newly started businesses, the lender takes that income instead of averaging the income on 2 years of tax returns. Of course compensating factors such as higher credit scores and more equity must be present.
  • Bank Statement Loans
    This program is designed for those who show a tremendous cashflow in their business accounts but aggressively write off expenses to lower their tax obligation. For these type of borrowers, the lenders, depending on the type and nature of the business, take a certain portion of the monthly average deposits in their business accounts as their income. (Have any of our president’s done that before? I bet they all have, only one got caught). These borrowers also must meet certain minimum guidelines when it comes to credit history, equity and other risk elements.

The above loan programs are an indication of lenders going out of their way to accommodate the self-employed, not necessarily out of the goodness of their hearts, but certainly for profit.  Anytime a borrower does not fit the box of underwriting guidelines, a certain premium is added to the rate and fees of the requested loan to pay for the added risk associated with that borrower and some for the lenders’ profit.

In closing, it is prudent to clarify how self-employment is determined when it comes to mortgage underwriting, that is a sole proprietor, anyone owning 25% or more of a business entity and all who are independent contractors receiving 1099s instead of W2s from employers.  Yes, I have been poking fun at the banks and the self-employed here, but here is the good news; If there is a will, there is a way, and it applies everywhere. 

At mortgage concierge, our goal is to help those who need assistance with structuring their loan, and guidance to what steps needs to be taken, keeping each client’s best interest in mind.  It is easy to walk in to a branch and apply for a loan, there are many people who follow guidelines and follow ABC’s mandatory provided handbook.  At this point your loan either gets denied or approved with many conditions.  

At mortgage concierge, we foresee any issues which might arise by reviewing your documents, understanding your needs, and examining all possibilities, and then structure your file as such so this time consuming, confusing path becomes very easy to understand and exciting to get the end results in which was guided towards from start.

Its a great time for self employed borrowers to bring their expenses of monthly mortgage payments lower, and save more money for another investment property or other business opportunities. 

Should you have challenges with your qualification, don’t give up, connect with us. With over 30 years of experience and connection to numerous lenders with multitude of loan products, we’ll find you a solution. When there is a will, there is a way!

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