Can I Get a Mortgage If I'm Self Employed?

Crazy week this week for sure.  The last week of February 2020 has brought us a fear of a pandemic due to the Corona Virus, the DOW lost 3,500 points, mortgage rates approached record lows in the low 3s and mortgage applications are up over 1.5%.

I decided I needed to take a break from the mountain of new applications we have and send out some information for all you self employed people looking to take advantage of this crazy market (present company included).

It seems like refinance fever has taken over(not Corona Virus related at all) and all types of borrowers are looking to lower their rate and or take cash out of their homes.  So, can you get a mortgage if you’re self employed?  Well, I have some good new, but like most news anchors this last week; I am here to report some doomsday, apocalyptical, end of days bad news.  Ok, maybe that is an exaggeration, but the same feeling you are having watching your retirement account disappear this last week, I can guess for some readers that their current income situation maybe just as bleak.

I remember when I first became self employed.  It was a milestone I will never forget.  The world seemed brighter – no more punching the clock for “the man”, I had control over my own destiny and I held the keys to my future earnings and success.  Of course one of the major benefits I couldn’t wait to exercise was utilizing business expenses and tax write offs to lower my tax liability to Uncle Sam.

Being self employed has a ton of benefits – setting your own hours (of course this means you get to choose the 80 hours you work a week instead of having someone tell you which 40 hours to work, LOL),  watching a business grow with your hard work, and of course writing off business expenses.  This last one is where the wheels come off when trying to get approved for a mortgage.

What self employment income is used to qualify for a mortgage?  I thought they looked at my yearly earnings.

Many self employed applicants we receive list their gross sales or receipts as their annual income.  Unfortunately, this is not the income most lenders will use to determine if you qualify for a mortgage.  Once you have taken all of your expenditures out and tax deductions you are left with a net income that is the jumping off point for a mortgage underwriter to calculate you usable monthly or yearly income.  Fannie Mae and Freddie Mac both have cash flow analysis sheets that need to be filled out to determine your final income that can be used, so like I stated earlier your net income is just the jumping off point to get to the final #.

Does it matter that I receive a 1099 or K1?  Does it matter how my business is taxed?

Yes – it all matters.  To complicate things ever further each type of self employment is treated just a little bit differently.  I will attempt to not over complicate it for you the reader, but on our end there is a lot that goes into it.  Here is a basic overview of what you can expect when trying to qualify.

1. 1099 income – if you are a contract worker for another company you will receive a 1099.  This income is filed on your personal tax returns (1040) on schedule C.  Schedule C is a basic profit and loss statement.  The total income from your 1099 is listed and then you show your business expenses, both actual business expenses and paper losses such as depreciation, home office expenses and or mileage deductions.  We take your final income or loss and add back to it any depreciation, depletion, business use of home and amortization/casualty losses you deducted and then subtract non-deductible travel/meal expenses.
2. K1 income – if you are apart of an S Corp, LLCs taxed as S Corps or a partnership, you will receive a yearly K1 identifying your portion of the company’s income or loss for the year.  Businesses that are set up in this manner do not pay income taxes and pass all income or losses on to the shareholders.  These share holders are responsible to pay their portion of income taxes on their personal return.  If you receive this type of income and you own more than 25% of the business we will also require your business returns to determine what we have to futher deduct or add back to arrive at your final income.

How is my final income determined?  What if I made a lot more money last year than this year?

Once a final income calculation is done, we can use that number to determine your monthly or annual income.  Self employed applicants must be ready to show a full 2 year history of their self employment to even get their foot in the door.  There are circumstances we will only need one year of your tax returns, but you must be in business for at least 5 years to qualify for only a year’s worth of documentation.  So I tell all my clients that after the 2 year mark we can begin to see what you qualify for.

Self employed income is averaged over the previous 2 year history provided, unless there is a decline in the income, then we use the lower amount to qualify.  For example if you show $100,000 in income in 2017 and $125,000 in 2018, we will average the 2 years to get $112,500 or $9,375 a month in usable income.  However, if you show $125,000 in 2017 and $100,000 in 2018, we will use the lower amount of $100,000 or $8,333 per month.  This is a big difference per month and may lead you to miss out on the home you are wanting to purchase.

Plus, be prepared to explain any decline in income that you have experienced. Underwriters are trained to look for stable income and if you lost money from year to year, they will need a solid explanation that does not include factors that may be causing your business to become unstable in the future.  Investing more money in expansion or marketing are great examples of good reasons that your income declined.  Lost customers due to a new competitor or increased legal bills due to law suits are not going to get you into your new home.  While I would love to lend to everyone, lenders are more cautious than they were in 2005 before the great recession.  Hmm, I wonder why???

What are some common pitfalls when trying to use self employment income to qualify for a mortgage?

My biggest piece of advice is to gather your previous two years personal and business tax returns and make an appointment with a reputable mortgage loan originator near you.  Make sure you ask if they have experience doing loans for self employed individuals.  Get some referrals if possible to ensure you are working with someone credible and really knows what they are doing.  If you are in the state of Texas, then reach out to Wiser Lending and ask for me – Eric Weishaar.  I have spent years doing these loans and even consult for other mortgage lenders on how to calculate self employed income.

Here are the biggest pitfalls to watch our for:

1. Self Employed income is averaged over 2 years – unless your income is declining from year to year.  in this case, the lower amount is used instead.
2. Lenders do not use “Gross Income or Receipts” – Net income is used as the jumping off point, then a cash flow analysis is performed to arrive at the final income used – underwriters add back and deduct certain write offs per Fannie Mae and Freddie Mac guidelines.
3.  If you pay yourself a salary/W2 for working in your business, but show a loss on your business returns, the W2 income cannot be used to qualify.  Your business must be showing profits to use any salaried income.  This is business 101, if a company has losses each year how could it afford to continue paying its employees, even you the business owner.
4.  If you plan to file a tax return to show more income to qualify be aware that most lenders will require that the IRS has accepted and processed these returns in order to use them to qualify.  Also any tax liability that you owe will need to be paid or an IRS payment plan must be in place.  Some lenders will even require that the first installment is paid.  This amount will also be added to your liabilities, so you must be able to afford the payment to the IRS.
5. Expect your loan process to take a little longer to complete.  Lenders do a ton of due diligence on self employed files and these added conditions will cause the process to be extended.  It doesn’t mean you’re looking at months and months, but on average we see a 25% increase in our turn times to complete self employed files.  If you need to move quickly or expect the process to be in and out, please revisit your expectations and understand self employed income makes the deal complicated because of the amount of rules that have to be followed.

Contact Us Today to Get A Quote on your new loan purchase or refinance.  All self employed income is welcome and we will work very hard to ensure you get the best deal possible and most out of your hard earned self employed income.  The above info is reserved for Conventional Loans.  We do offer Non-QM loans that use bank statement programs for self employed folks as well.  The rates are higher, but if purchasing a new home or getting needed cash out is a must, then we can explore those options for you as well.

Just a few more reasons why Wiser Lending is the wiser choice for home loans!  Thanks for reading and good luck fellow entrepreneurs and self employed gladiators!

Eric Weishaar

President | NMLS# 207659