Self-employed borrowers get more scrutiny
When it comes to obtaining a mortgage, self employed borrowers are discriminated against. One possible explanation for this is that most new businesses fail in the first few years. However, once a business is established, a self employed borrower often has more job security than an employee of a large corporation, as witnessed by the massive layoffs that Silicon Valley has experienced over the past few years.
In order to qualify for the best rates with a fully documented loan, it is a standard requirement that self employed borrowers have been at their current business for a minimum of two years.
For a salaried employee, on the other hand, lenders are happy if the borrower has been in the same line of work for two years. Switching jobs is OK. Furthermore, if there has been a gap in employment due to a voluntary or involuntary layoff during those two years, a letter of explanation usually is sufficient to satisfy the lender the borrower really is a steady worker.
It is up to the self employed borrower to prove that he or she has been self employed and for how long. For a fully documented loan, two years of federal tax returns would satisfy this requirement. If the loan is a;EZ Qualifier loan, in which income documentation is not required, it can become a challenge to prove the length of self employment.
A software programmer working out of her house may not need a business license, a yellow page ad or even a business card. If tax returns have been filed, a letter from the borrower's accountant stating the length of self employment should be adequate.
The way the lender calculates the borrower’s income puts the borrower at a distinct disadvantage. The lender will average the borrower's & net profit, as reported on line 31 on the Schedule "C" from the last two years of federal tax returns. For the self employed borrower applying for a job this year, only the tax returns from 2001 and 2002 would be reviewed. If the business is growing and 2002 was a great year but 2001 was a poor year, using the average income would penalize the borrower.
If the borrower were applying for a mortgage in the eleventh month of 2003, underwriters would still average the income from the 2001 and 2002 tax returns. That is, no credit will be given for the good 10 months during 2003 until the federal tax returns have been filed for 2003.
The “EZ Qualifier” loan was originally created to help the self employed borrower overcome the strict guidelines as outlined above. Because this type of loan does not require any income documentation, the borrower can conscientiously use the income earned in the most recent month, quarter or year.
This type of financing carries interest rates that are slightly higher than the best rates but if this difference allows the borrower to buy a home now, rather than wait, it is well worth it.