You might have heard of the stated income mortgage as being a “ self-employed” person’s mortgage, but in reality, it is not the only way for self-employed borrowers to get a loan. The only reason that borrowers that work for themselves must use a stated income mortgage is when they cannot fully verify their income. This is usually due to the fact that these borrowers write off a great number of expenses on their tax returns in order to lower their tax liability. While this helps in terms of paying their taxes, it makes their income look lower to the lender, making it hard to qualify with a higher debt ratio and low income. If on the other hand, your self-employment is fully verifiable, you are more than welcome to apply for a fully documented loan, just be aware that you will have to provide all schedules of your tax return in order for the lender to properly determine your average income. Typically, lenders take a two-year average of self-employed income, which means if the year before last year you had a rough year, yet last year was great, the average income will be lower than you anticipated the lender using.
What’s the Difference Between the Mortgage Types?
There are a few differences between the stated income mortgage and a fully documented mortgage. They are as follows:
- The most obvious difference is the way you verify your employment; with the stated income loan you do not verify your income and with a fully verified loan, you document your income
- The interest rate is typically higher on a stated income loan because it poses a higher risk to the lender, which means a higher interest rate
- There are fewer lenders that offer the stated income mortgage than offers fully verified FHA, VA, or conventional loans
Both mortgages enable you to purchase a home and give the same types of terms, including 15, 20, or 30-year fixed terms as well as several adjustable rate terms. The largest difference, in the end, is usually the interest rate and the fees charged.
What does the Mortgage Lender Need?
If you are self-employed, you will need to provide the lender with different documentation than you would if you were a salaried employee. Typically you will need to provide the following:
- Tax returns for the past two years
- Bank statements for the last 12 months for both personal and business accounts
- Letter from your CPA verifying that you are in business for yourself
- Proof of the license for your company
- An executed IRS Form 4506
The lender will take these documents and evaluate your income to determine if you qualify for a fully documented loan. The income will usually be taken as is, meaning the bottom line after you write off all of your expenses, but there are some exceptions to the rule:
- Large expenses that are non-recurring
If you have any of these expenses written off on your taxes, you might be able to add them back into your income, to help make your income higher. This is one of the reasons you should always talk to your lender about your ability to use a fully documented loan – if the lender allows specific expenses to be added back into your income, you might qualify for a fully documented loan, saving you plenty of money down the road.
How you can Plan
The good news is that you can plan ahead for your desire to obtain a mortgage. This is especially important if you are self-employed. If you know that you plan on purchasing a home in the next year or two, consider your choices for tax filing this year. While you might save some money on your tax liability, you will likely pay the price by having to take on a stated income loan, which means more fees and a higher interest rate. It pays to do the math ahead of time. If you plan on staying in your home for a long time, you will want to do whatever you can to obtain a low-interest rate. In some cases, this could mean lowering the amount of write-offs you take in order to maximize your qualifying income. The higher your income, the more likely it is that you can use a fully documented loan, rather than a stated income loan.
Another way to plan is to start saving as much money as you can. The higher the down payment that you have, the lower risk you pose to the lender. In addition, once you put the desired down payment down, if you have reserves on hand, you can use them as a compensating factor to help you qualify for the loan. Even if you have to take a stated income loan because your income does not look high enough on your tax returns, having six to twelve months’ worth of reserves on hand helps to lower your risk. This means that the lender will likely be able to provide you with a lower interest rate, saving you money in the long run.
Talk to your lender to see what you might qualify to receive given your self-employment income. If you draw a salary on a regular basis, it might be easier to qualify, but even if you do not, there are ways to maximize your qualifying income so that you can use a fully documented loan. If you must take a stated income loan, just make sure to shop around with different lenders. Some lenders will be able to take higher risks and not have to change you as much as other lenders charge. Remember, you can always negotiate different fees and interest rates as well – do not just settle for the first quote you are provided, you have the right to shop around and negotiate until you get the terms you think are most affordable.