RateWatch #374 – Self-employed Borrowers
September 20, 2003 by Dick Lepre
A better than expected but still "not so great" Initial Jobless Claims release coupled with an as expected +0.4% in Leading Economic Indicators.
The Jobless Claims report is "same old, same old." The economy may be growing but if it does
not create jobs the expansion will not support itself.
If you want some hopeful news for Treasuries, briefing.com reports a rumor from the FX markets
that the BoJ will intervene to support the dollar at the 115 JPY/USD level. Presumably, this money will go to buy Treasuries. The benefit will be short-term.
One of the most frustrating aspects of the mortgage business is dealing with the income of self-employed borrowers.
As tax season approaches each year, many Americans are glad to be self-employed. They love to take a ton of deductions, beat the heck out of their Schedule C's and pay little or no taxes. The result is satisfying except when it is time to apply for a mortgage. Mortgage lenders look at the net income on your Schedule C - not the gross income.
It gets worse. A reasonable assumption is that borrowers who are self-employed have less stabile income than, say, folks who work for the Post Office. What lenders want is a minimum of 2 years of self-employment income - documented with federal tax returns. This becomes a problem for "recently self-employed" borrowers. You may find that you are making more money - in terms of
disposable income - as a self-employed borrower, in fact, you're feeling good. You have your own consulting business. You're in control. You are ready for the American Dream - owning your own home. You apply for a mortgage. You get turned down. You decide to become a Communist but find that they could not get credit either and are out of business. Now you're thinking of joining a cult or a militia group.
Let's back up from the North Dakota border. How does a self-employed borrower get a good mortgage? Better still - how does the lender know that the borrower is self-employed? The lender knows that the borrower is self employed if he tells them so. Apart from the borrowers filling out the box that says "Self Employed" the lender might think he is if:
1) his job title is President or Chief Executive Officer
2) the company's mailing address is the same as the borrower's
3) the company's name is similar to the borrower's
4) the company's phone number is the same as the borrower's
5) the company's phone is answered by an answering machine with a weird outgoing greeting. One that does not sound corporate.
6) the borrower does not seem to have a regular pay cycle.
The self-employed borrower has 4 paths toward getting a mortgage loan.
1) The borrower actually has enough income brought forward from the Schedule C to qualify. A couple of notes here. In general, lenders will average the last 2 years of income. They do not want
to see heavily declining income. If your income last year is more than 15% below the previous year, you better have a darn good explanation. The income must be documented by tax returns not P&L statements.
2) The borrower has beaten up his Schedule C but has excellent credit and liquid assets. This is the perfect candidate for a "quick qualifier" or "stated income" loan. With this loan the borrower is
stating his present income without documenting it. This takes good credit and liquid assets. Good credit might mean a 680 or above FICO score. Liquid assets vary from program to program. This might be as little as 6 months of housing payments or a maximum of 6 months of stated income.
The incremental cost of such a loan is about 0.5 point in cost.
3) a "no stated income" or even "no stated employment" loan. This requires good credit without strict reserve requirements but usually has a rate about 1% higher than a fully-documented loan.
These are for folks with no documentable employment. Perhaps wealthy young folks who have never worked and have "dad's bucks." Perhaps folks who have just moved here with wealth from abroad.
4) The special case loan. Two cases that I can recall are dentists. They had each been self employed for less than one year. One has started a children's dental practice that was a "gold mine." We presented every dollar of income and expense for the past 10 months. This included bank statements, invoices and copies of checks. It worked.
The other was a person that had purchased a 20 year old dental practice and provided:
1) tax returns from the previous practice and a letter from the man who owned it
2) bank statements showing the new owner's income.
It must be understood that these are indeed "special cases" and require a high level of experience on the part of the loan officer and a clear understanding of the lenders rules.
Some Other Points
In former times, "QQ" (quick qualifier) or stated income loans were for Jumbo loan programs. If you have a conforming loan amount, you had to pay the Jumbo rate. With the coming of FNMA DO automated underwriting we wind up with what are "de facto" QQs. If they do not ask
for income or asset documentation then we may have a QQ. This is excellent because it reduces the paperwork needed.
If you own more than 20% of the company that you work for and are a W2 employee you may need to present the business' tax returns. Corporate tax returns (1120's) if the entity is a corporation and partnership returns if it is a partnership.
Note also that if you are self-employed and present a fully documented loan with tax returns you are likely going to have to sign a form allowing the lender to get a copy of the tax returns than you presented to the IRS. In no circumstance (unless you are perhaps a felon and planning on permanently leaving the country) should you present anything other than what you sent to IRS.
If the lender finds that what you gave them is not what you gave IRS you will be asked to completely pay off the loan within 30 days. You may also be charged with fraud. It ain't worth it. If any loan officer ever suggests otherwise, hang up the phone.
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