Are You Self-Employed in New Jersey and Need Mortgage Financing? 5 Things You Need to Know

Nothing beats being your own boss, except maybe when you go to apply for a mortgage loan. When the time comes that you need financing for your home, getting qualified and approved involves a different set of circumstances than what’s typical for the salaried borrower.  But it’s nothing that proper planning can’t conquer.  Self-employed borrowers obtain mortgage financing at favorable rates just like everybody else.

Here are 5 things you must keep in mind:

1. Your Credit Score Means Everything – Lenders do require higher credit scores from self-employed borrowers.  It’s always important to keep scores high.  But if you know you will soon need a mortgage loan, you must really focus on getting the score as high as possible.  Don’t apply for new credit or close accounts.  Keep credit card balances low relative to the card limit.
2. Compensating Factors – Income, credit, assets and property equity are important underwriting factors.  That being said, falling short in one of these critical areas can sometimes be compensated for by exceeding the usual standard in one of the other.  For example, having less equity might be outweighed by having a very high score or significant assets.
3. Verification of Income – If the mortgage you now have was closed a few years back, then odds are you did not have to verify income for mortgage approval.  Stated income was the vehicle you probably used.  Today, stated income is like the pony express.  In order to qualify in 2010, income will have to be verified via tax returns and financial statements.  A “No Income Verification” is still available, but it does require 40% equity.
4. Your Business Status When You Apply –  When you are a wage-earner, underwriters assume you are having some level off success if you are bringing home a paycheck, bills are getting paid, and you have a good credit score.  The same doesn’t hold true for the self-employed.  To obtain mortgage approval, as a self-employed person, you must prove you have been in business for two years AND have been successful for two years.  “Successful” means two (2) years of earning enough to qualify you for a mortgage. If you just started Poppa’s Cat Sitting 12 months ago and you can only show you’ve earned $3,000, the loan won’t get approved.
5. Equity in the property – Having equity in the property will make the transaction easier, to say the least.  This one piece alone could keep the underwriter’s antennae from rising too high since the ultimate risk for the lender is the property without sufficient equity.

Here are some areas the self-employed should consider:

• Do your tax returns show a decrease in business income over the past few years?  If yes, that’s not good for underwriting.  Income will be averaged. Taking a very simplistic example, if you earned $200,000 last year, but only $125,000 in the prior year, income will be averaged at $162,500.  On the flip side, if your business shows a history of decreasing income, the underwriter could decide not to average at all, but instead use the most recent lowest income year. 
• For FHA loans, one year of successful self-employment could be considered if you have at least one year of previous successful employment in that same or related industry.
• If you have a spouse (or other 2^nd borrower) who is a salaried worker in a different business, then you would need to show less income from self-employment to qualify.

Why was stated income so popular years ago and why did it disappear?  It has always been understood that for a self-employed borrower, taxable income probably does not necessarily reflect the amount of cash flow available for debt or mortgage repayment.  Depreciation and many other write-offs and write-downs will decrease taxable income, but will not decrease spendable income.  So, stated income became the norm.  But then, the devil got involved with stated income – meaning that anybody and everybody began using the stated income option.  Problem was that many of these were W2 employees, did not earn anything near the stated income, and many loans foreclosed.  After the current housing meltdown began, stated income was one of the first things to get killed.  Some states even made them illegal.  Sadly, this will and has affected the group of borrowers for whom it was originally designed.

So, what’s Plan B?  For self-employed borrowers or anyone with significant tax deductions, we use a self-employed income analysis form in conjunction with your tax returns.  Certain items are added back to income.  Take a look at the form here:  Fannie Mae Cash Flow Analysis.  It will give you a heads up.  By all means, share it with your accountant.  If any recent return is so tax-favorable to you that it will kill your chances of mortgage approval, keep in mind that a tax return can always be amended.

If you have questions about self-employed qualification, give me a call.

Until my next post . . .

New Jersey Mortgage Rates

Tagged as: Purchasing a New Home, Refinance, Self-employed