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 an “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.
This column is written weekly by Peter Boutell, Mortgage
Consultant at Santa Cruz Home Finance.
You may reach him at (831) 425-1250 or email him at
Peter@SantaCruzHomeFinance.com.
View his past columns at www.PeterBoutell.com
