I talk to a lot of self employed business
owners who want to buy a house but are grossly unprepared to do so.
In this video we re going to talk about how self employed business
owners can qualify for mortgages and how you can prepare yourself for loan approval.
My name is Chris O Connell and I m a mortgage loan originator and I m also a small business owner.
If you re a small business owner and you ve applied for a mortgage in the past,
you may have found banks and lenders have a different set of rules for you.
And they do, which is fine, you just have to know what they are and how
to use them to your advantage.
Traditional mortgage guidelines for self
employed borrowers are determined by Fannie Mae, Freddie Mac, and HUD and they re different
than a w2, hourly, or salaried employee.
There are also non traditional
mortgage products that you may qualify if you don t meet the traditional
mortgage guidelines, so watch this video til the end so you know all of your options.
The number one thing business owners need to know is how their income is calculated. For
traditional mortgages, banks and mortgage lenders will use what you re reporting on your
tax returns to calculate your income.
Now hold on, we don t use your gross income
or your business revenue, we use your net income that you re reporting on your schedule
C or your distributions listed on your k-1.
You probably file as a sole proprietor, LLC
or Corporation. So let s look at an example.
If you re a sole proprietor or
LLC you should have a Schedule C on your tax returns, which looks like this.
Your CPA s goal when preparing your taxes is to limit your tax liability and they
do that by writing off expenses and reducing your taxable income.
And that s great from a tax standpoint, but not necessarily when you re trying
to get approved for a mortgage.
After you write off all those expenses,
what s left is your net income reported on line 31,(insert sched C pic and point
to line 31) which is what lenders use.
So if you report $100,000 in
revenue and $90,000 in expenses, your net income is $10,000 per year.
But here s the second most important thing to know we add back certain expenses to your net
income which increases your qualifying income
These 4 items are Depletion, Depreciation,
Business use of your home, and Mileage.
So let s say you have some business equipment
and you have depreciation of $5,000. You would add that back to your net income.
And let s say you have another 4,000 miles on your car from business travel, you can
take $0.27 per mile or $1,080 and add that back to your net income as well.
The 3rd most important thing to know, is most of the time, a lender is going
to look at your last 2 years tax returns and take your average income to qualify.
If your business income is increasing from year to year, they ll average it.
So let s say your 2019 net income is $20k and 2020 net income is $40k and there are
add backs, the average would be $30k per year.
If it s decreasing, they take the lower amount.
So flip that around if 2019 was $40k and 2020 was $20k, they ll use $20k per year.
Now you might be asking, I m a business owner but I pay myself a w2 and have a corporation which
I have a k-1 for instead of a Schedule C.
That s fine, if you have a 2 year history of
paying yourself a w2, we can use that income just like a regular employee.
We would also use the k-1 however, either line 1 or the distribution on
line 16d, whichever is less. Same idea applies, if it s increasing, we ll average it, if it
s decreasing, we ll take the lower amount.
You can see how you might work with a CPA to
better prepare yourself to qualify for a mortgage given what we just went over.
And maybe you think, well I ll just show all this income and not report any
expenses so my income looks super awesome.
2 things to keep in mind. First is the biggest
thing, if you do report a lot of income, you may have to pay taxes! Any taxes owed
to the IRS must be paid in order to qualify for a mortgage or a payment plan would
have to be established and that monthly payment needs to be included in your debt ratio.
Second since COVID, lenders are going one step further to verify your income matches with
what you re reporting on your tax returns.
Underwriters will typically ask for a
minimum of your last 3 months business and or personal bank account statements to show
your revenue this should be close to what you ve reported on your tax returns in the past.
If the last few months have been slow, you can show the last 6 months if
that gives a more accurate number.
Or a letter of explanation about your
business and when the busy and slow times per year are might suffice.
Once a lender knows your income, the traditional mortgage is the same for
a business owner as anyone else, minimum credit scores, max debt ratios, etc all apply.
Okay so what if your tax returns aren t where they need to be and you don t have
time to prepare next year s returns and you want to qualify for something now?
Non traditional Busniess Bank Statement programs may be your best option. This is where a lender
takes either your last 12 or 24 months business bank statements, adds up all the deposits every
month and uses that for your gross income.
Then they ll usually take half of that, which
would be a 50% debt ratio which is generous and use that for your qualifying
income. No tax returns necessary.
That sounds way easier, what s the catch?
Typically there are 3 things to know.
1. Compared to a traditional mortgage product,
these programs will have higher rates, which are going to be at least 1% higher than traditional
mortgages, but can be 2 or even 3% higher
2. You will typically need a higher minimum credit
score 660 for instance instead of the minimum 620 for a traditional conventional
mortgage or 580 for FHA loans
You ll also need a larger down payment,
10% minimum vs the 3 or 3.5% minimum for traditional loan programs.
The best thing you can do is present your information to a qualified
mortgage loan officer the analyze your situation and tell you what your options are.
I ve even worked with borrower s CPAs to help buyers prepare for their future home purchase.
If you want to try and calculate your own income, click on the link in the description to get
a Fannie Mae s Cash Flow analysis worksheet, which also includes rental income, capital gains,
interest and dividends if applicable.