Non-Qualified Loan

What’s the Deal with Self-Employment Income?

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What’s the Deal with Self-Employment Income?

We have often heard of self-employed individuals and their troubles getting traditional mortgage products. With the write-offs and deductible expenses their self-employment income can be allowed of, the figures on paper look smaller and cast doubts over their ability to repay their mortgage. Things could get more complex if their self-employment history spans less than two years.

This discussion only makes one curious of the nature of the self-employment income. Who are the self-employed? What kind of taxes are they paying or the deductions they are getting? Let’s look at this type of earned income below.

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Are You Self-Employed?

You are considered self-employed by the Internal Revenue Service if you are one:

  • Who carries a trade or a business as an independent contractor or a sole proprietor.
  • Who maintains a membership in a partnership conducting a business or trade.
  • Who is engaged in a trade or business for profit on a full-time or part-time basis.

Tax Obligations

Your tax obligations as a self-employed individual consist of an income tax and self-employment tax, which is basically your Social Security and Medicare tax. The components of this self-employment tax are similar to the taxes withheld from wage earners.

You are to file (i) a tax return annually and (ii) an estimated tax paid quarterly.

To know if you are required to pay both income and self-employed taxes, determine first your business’s net loss or profit. Subtract your business expenses from your business income:

  1. If your expenses are greater than your income, this results in a net loss. This can be deducted from your gross income, subject to limitations.
  2. If your expenses are less than your income, this results in a net profit. This forms part of your income.

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If your net earnings as a self-employed are at least $400, then you are required to file an income tax return on Form 1040. But if these earnings net less than $400, you are not required to file Schedule SE to Form 1040 subject to you meeting other filing requirements.

Meanwhile your estimated tax covers your (i) income tax and (ii) Social Security and Medicare taxes that may have been otherwise withheld by your employer. Use the Form 1040-ES to figure out your estimated tax payments.

For your annual tax return, you will use:

  • Schedule C is for reporting income (or loss) from your business, or
  • Schedule C-EZ is for reporting business expenses of $5,000 or less and so on.

The aforementioned Schedule SE is also used to report your Social Security and Medicare expenses.

Allowable Deductions

A self-employed individual is required to report all his/her income and claim all of his/her allowable deductions from expenses.

One deductible is the expenses you incur in using your home for business. This is called the home office deduction that is applicable to homeowners and renters and all types of homes.

Self-Employment Income and Non-Qualified Mortgages

The hurdles faced by the self-employed because of the nature of their income have been remedied partly by non-qualified mortgages whose guidelines vary lender to lender. One lender may not verify income as in stated income loans, another may base verification on liquid assets, and another one could forego tax returns in favor of bank statements.

However the lender considers your income, your loan application is hinged on your source of monthly mortgage payments, your self-employment income being that. Be responsible in keeping records of your income and expenses so it’s easier to document how much you make.

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A Roundup of Mortgages for Today’s Self-Employed

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It’s not that they don’t have adequate income/assets to take on a mortgage. It’s just that self-employed borrowers can’t show in pay stubs, Form W2s, and sometimes tax returns their ability to repay their loans. There are a number of mortgages that are made for or admit the self-employed professionals of today. Here’s a non-definitive list of loans starting from those requiring no income verification.

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Option 1: No Income Verification Loans

Also known as no doc and stated income loans, these mortgages are underwritten based on your credit score, employment history, and down payment. Credit scores required can be in the 700 range and equity at 40%.

Lenders will verify your self-employment and in lieu of W2s and pay stubs, your personal and business bank statements good for a year. These bank statements should match your income statements.

With the financial regulatory reform of recent years, stated income loans are not the liar loans of the past. Their documentation may not be full but lenders compensate it with other factors as mentioned above.

Option 2: Bank Statement Loans

These loans are akin to stated income loans, requiring a 12-month history of individual and/or business bank statements. LTV can be between 75% and 80% as it varies per lender.

Typical requirements are business license and related permits, tax returns and tax return transcripts. There may be other requirements that depend on, among other things, the length of your self-employment history, e.g. two years or less.

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Option 3: Conventional Loans

While loans sold to GSEs Fannie Mae and Freddie Mac require full documentation (they still do), they have loosened up their guidelines for the self-employed.

For Fannie Mae’s part, a self-employed borrower’s income can be verified using his/her individual or business tax returns or both for the past two years, as applicable. The self-employed borrower, which is defined by Fannie as “ any individual who has a 25% or greater ownership interest in a business,” will need to show two years’ worth of prior income as proof that this source of earnings will likely continue. Those who have been self-employed recently may provide their latest federal tax returns.

Back in September, Freddie Mac introduced a pilot program for first-time homebuyers with low income and alternate income sources like self-employed professionals.

Option 4: FHA Loans

Two years seems to be the “magic” number for mortgages for the self-employed as FHA loans also require that you should have a steady flow of self-employment income for the last two years. This will be shown by duly signed and dated tax returns and schedules for the past two years. Income statements and balance sheets are also required.

Take note that the FHA requires full documentation but the perks can be worth it. For one, your down payment could be as low as 3.5% depending on your credit score.

These are just some options that you can look into when shopping for mortgages. Lenders may offer you other options, talk to one today!»

Non-QM Mortgages are Great for the Self-Employed Borrowers

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Almost 10 million workers are self-employed in one form or another in the United States. This is great news for those that were unable to secure a job after the downfall of the economy. It is also good news for the economy as more money is passing through it to keep things on the up and up. The downside of self-employed workers, however, is the inability to secure a mortgage. Fannie Mae and Freddie Mac have strict guidelines in regards to self-employed borrowers. Not only do they have to provide at least 2 years’ worth of tax returns in order to use the income for qualification purposes, the income they claim on their tax returns is the only income allowed. If you are like most business owners and you take advantage of every tax advantage and write-off available (who wouldn’t?) then getting a mortgage just got even harder, unless you are looking at non-QM mortgages.

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Less than 2 Years in Self-Employment

It makes sense why Fannie and Freddie require business owners to be in business for two years. It shows consistency as well as the ability to keep your business afloat. But, if you were among the unlucky that lost your home during the housing crisis and are trying to pick up the pieces, not to mention the fact that you are finally making a good living, you want to get into a new home. This is possible with non-QM mortgages.

Just what are non-QM loans? They are loans that are not protected by the government. What this means is that borrowers have the ability to go after the lender in a lawsuit if they were to suddenly become unable to afford the loan. The only way the lender would suffer the consequences is if it could be proven that the lender did not do due diligence in determining if the borrower was able to afford the loan. Most, if not all, lenders do not just hand out loans any longer. They do not take your word for it regarding income, assets, or employment. Everything gets verified. Where they differ from any other loan, however, is that they keep most of the loans on their own books or they sell them to private investors. These individual banks or investors are willing to take the risk on those self-employed for less than 2 years. Of course, they are looking for compensating factors, such as:

  • Someone in the industry for many years before they opened their business
  • An expert working at the company that can help them stay afloat
  • A professional CPA handling the books

Something that can show that your business is legitimate and that you are in it for the long haul can help you get into a mortgage while self-employed.

Using Self-Employment Income

One of the largest downfalls of self-employment is the amount of expenses you write off. These write-offs come directly off of the amount of income you claim. In the end, this makes your debt ratio higher and your ability to get a loan much lower. If the income is lowered too much and you do not qualify for a loan, you can turn to non-QM loans. Depending on the lender, you may be able to add certain expenses back into your income, lowering your debt ratio and increasing your chances of obtaining a mortgage. Because there are no regulations on the non-QM mortgages, with the exception of ensuring that you can afford the loan, every lender has different guidelines. You will have to shop around with various lenders until you find one that will take your exact situation.

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Work on your Compensating Factors

While you are trying to determine if you will qualify for a loan, whether qualified or non-qualified, you should be working on your compensating factors. These are things that do not pertain to your income, but make your loan profile less risky. They are things like:

  • The amount of liquid assets you have on hand to help you in the event that your income does not provide enough for your mortgage payment
  • A high credit score. It is not always easy to improve your credit score, but if you know you want to shop for a home, start making sure your outstanding balances are low compared to your available credit; make your payments on time; and take care of any collections or judgements

Anything that makes your loan file look less risky is what lenders are after when trying to qualify you for a loan. Granted, there are hundreds of different programs out there that will eventually meet your needs, but if you are looking for low rates and decent terms, you will want to make your loan application as attractive as possible.

In the end, non-QM mortgages make it possible for the self-employed to be homeowners much sooner than any other loan type. If you do not want to wait until you own your business for at least 2 years and have 2 years’ of tax returns to show for it or if you know your tax returns will not show enough income, then the non-qualified loans are the best option. If you shop around within a short amount of time, you will not negatively affect your credit score, yet will have many options to choose from, allowing to you take the one with the most attractive terms.

You do not have to worry about any loan taking advantage of you, as subprime loans are a thing of the past. Non-QM loans are not subprime; they are alternative lending for borrowers that do not qualify for traditional loans. The underwriting guidelines will differ, but the need to verify every aspect of your loan will not. You will not find stated income, stated asset, or no documentation loans – you should be prepared to provide documents to cover every base to ensure the lender that you can in fact, afford the loan that you are trying to obtain.

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