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Self Employed Mortgage Rules for Newly Self Employed Borrowers & Gig Workers

Obtaining a Mortgage As a Self Employed Person

Self-employment: The New Normal

Across the United States annual healthcare spending per capita is $9,403 - nearly double what is spent in other developed markets. Rising health care costs have caused many large established companies to either outsource or hire contractors, while downsizing their core workforce. Google hires more contractors than full time employees. Verizon offered 44,000 employees voluntary severance packages.

The Gig Economy Gives Rise to Self-employment

Tech-enabled startups have created marketplaces for taxi drivers, short-term home rentals, and many online services like graphic design, copy writing, web design, programming and Internet marketing. The freelance market ranges from high-end consultants all the way down to $5 gigs on Fiverr or micro-work tasks priced in the pennies on Amazon Mechanical Turk. Companies like Uber and Lyft have filed paperwork to go public and bankers estimate the valuations of these companies ranging from $10's of billion to as high as $120 billion. Other startups like Airbnb are also valued in the $10's of billions.

As of 2015, 10.1% of all United States workers were self employed.

Self-employment continues to be an important source of jobs in the United States. In 2015, 15.0 million people, or 10.1 percent of total U.S. employment, were self-employed, including those who had incorporated their businesses and those who had not. Of all the self-employed, 9.5 million, or about 6 in 10, were unincorporated; the remaining 5.5 million were incorporated. People who are self-employed typically incorporate their businesses in order to receive traditional benefits of the corporate structure, including limited liability, tax considerations, and enhanced opportunity to raise capital through the sale of stocks and bonds.

The self-employment rate had fallen from a high of 12.1% in 1994 to 10.1% in 2015, but the rise of the gig economy along with corporate cost cutting have drastically grown the share of nontraditional workers in America. In 2018 accounting software company FreshBooks estimated there would be a total of 42 million self-employed workers across the United States in 2020. The COVID-19 crisis accelerated the work from home movement while mass layoffs and business closures led to record new business formation. The Economic Innovation Group stated the initial plunge in new business activity in the wake of the COVID-19 crisis has been more than compensated for by elevated rates of "high-propensity" business applications which are likely to become active employers.

“Even though the burst of filings has begun to taper off, 34,790 applications were submitted by likely employers last week, representing a substantial jump of 47 percent over the same week in 2019. The gap in new business filings that opened up during the initial stages of the pandemic has been more than compensated for by the past few months of unusually high application numbers.”

EIG on September 4, 2020

Many employees prefer to work at home as a means of gaining additional flexibility & avoiding other employment-related frustrations like high rents near their employer's location, long commutes, rush hour traffic, an angry boss & other office politics.

Go to Work.

Understanding How Self Employment Impacts the Mortgage Application Process

Historically self-employed people were somewhat locked out of the mortgage market, however on August 28, 2018 Senator Mark Warner introduced a bill to help make it easier for self-employed people to gain access to funding.

Today, U.S. Sens. Mark R. Warner (D-VA) and Mike Rounds (R-SD), both members of the Senate Banking Committee, introduced legislation that would help expand access to mortgages for the self-employed, gig workers, and other creditworthy individuals with non-traditional forms of income while protecting consumers. The Self-Employed Mortgage Access Act would help creditworthy borrowers with non-traditional forms of income by allowing lenders to verify an applicant’s income using additional forms of documentation other than the W-2.

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Unless a loan is eligible for sale to the government-sponsored enterprises (GSEs) or insurance by government agencies, QM loans require lenders to satisfy the rigid requirements of the CFPB’s Appendix Q guidelines. These guidelines often results in a less precise calculation of income for borrowers with non-W-2 income sources, such as rental income, retirement income, or income from self-employment. The effect is creditworthy individuals relying on non-traditional income, who represent up to 42 million Americans, or 30 percent of the labor force, are unduly constrained in their ability to obtain a mortgage.

The legislation would expand the types of documentation that self-employed individuals could submit to demonstrate they are a credit worthy borrower and banks could use to keep a loan in qualifying mortgage status. Those types of documentation include the IRS Form 1040 Schedule C for sole proprietorships, the IRS Form 1040 Schedule F for farming, the IRS Form 1065 Schedule K-1 for partnerships and the IRS Form 1120-S for S Corporations.

As a self-employed individual, you will enjoy many freedoms and opportunities. The ability to create your own schedule, open up compensation potential and work on projects that truly energize you have encouraged many to pursue the path of self-employment.

However, when it comes time to get a mortgage, being self-employed may introduce some additional considerations. Lenders may want to see more, or different things from someone who is on their own compared to someone who has a steady job within a more traditional company framework.

This is not meant to sway the self-employed from seeking a mortgage. Instead, this article is meant to help identify what lenders might be seeking from a self-employed mortgage applicant, so as such, you can enter the marketplace better prepared.

For your convenience, here is a rate table listing current rates from local lenders.

Mortgage Basics

The basic requirements for a mortgage are not all going to be affected by your place of employment. To be clear: lenders will definitely be concerned with your work history and its likely future – but there are other basic aspects of the mortgage that are also going to be weighed into your eligibility. These will include:

1

The amount you are seeking: mortgages will of course vary in amounts, though they are trending higher recently. Data suggests that home prices have risen 48% in the past six years, while wages grew at only 14% for the same period. Where you choose to buy your home also matters, as well-developed urban areas, especially on the coasts like Boston or San Francisco, are rising in value at an even more rapid clip. The FHA states that the average home price in 2018 is about $312,900.

 

2

Your current credit score: your credit score should be in the mid-600s or better to help you qualify for your loan. While you may be able to qualify with a lower FICO (FHA loans go as low as 580, or even lower) a lower FICO will increase your necessary down payments and could incur other qualification problems with your lender. Improving your credit score always helps you in borrowing scenarios.

 

3

Down payment: coupled with the amount you are seeking, the amount you have to put down will matter a lot in how your mortgage plays out for you. There are going to be options for low down payments, and sometimes even a zero-down payment – but these offers should be investigated further, for the lender will typically make that money up somewhere else by charging other fees and/or a higher rate of interest on the loan. The larger your down payment can be, generally, the better the terms you arrange can also be, and you can lower your monthly payments and loan duration. The VA loan enables veterans to obtain government-insured funding with no down payment. USDA loans also have low down-payment requirements.

 

4

Cash reserves: because with a mortgage you are trying to prove your creditworthiness to the lender, having ample cash reserves can help your processing and make your application more attractive. While not a necessity, your cash reserves will be reviewed.

 

5

Debt-to-income (DTI) ratio: {existing monthly debt payments + monthly home payments inclusive of taxes & insurance / current monthly income = back end DTI} Your DTI is an important measure to further prove your creditworthiness and the level of risk the lender has with you. Most lenders like to see a back end DTI of less than 43%, with 36% considered a comfortable market position to shop mortgages competitively. As like a credit score, working on lowering your DTI ratio is always a smart move as a borrower. Some lenders also look at the front end DTI ratio, which measures the home related expenses versus your monthly income {monthly home payments inclusive of taxes & insurance / current monthly income = front end DTI}.

 

As you can see from the list above, the mortgage lender is seeking a financial stability and dependability from its applicants. So how does this actually play out for the self-employed?

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How It Actually Works

When looking for a mortgage, borrowers are going to be reviewing banks and credit unions for potential options. While the qualifying criteria will be similar, it pays to shop around for your best offers.

At Bank of America, a service representative stated that they will not be seeking a different DTI, or any additional information from the self-employed mortgage applicant: “It matters really only in terms of employment verification and supplying pay stubs, but otherwise we look at all applicants equally.”

“I didn’t find much in the way of answers, until I applied online,” stated Martin Lamers, a self-employed business owner from the Atlanta area who refinanced his mortgage in early 2018. He stated that most banks and credit unions offer a little information online and in-store, but really, want you to complete an application before they start telling you more detail. “Everyone had an online application, so I weighed a few out and decided on one to try.”

Though active with a corporate bank account for more than a decade, Lamers chose a local credit union for his mortgage. “They offered lower rates than most places, and there was a sense of stability I felt with them, that I didn’t find in the banks.”

Once the web application was processed, a credit union representative contacted Lamers to further the negotiations. He was given a list of items to collect/complete for them to continue and complete the approval process, and it was exactly as follows:

  • Most recent YTD Paystubs to cover 30+ days
  • Most recent 2 years’ W2s, for each borrower whose income is used to qualify
  • RETIRED BORROWERS: 1 most recent monthly Pension statement, SSA Awards Letter, 1099Rs & 1099SSAs
  • IF SELF-EMPLOYED or BORROWERS using COMMISSION/BONUS INCOME to qualify: 2 Years most recent FILED Personal & Business Tax Returns, with all W2s, 1099s, & K1s, & a copy of your business license &/or current state registration, and most recent YTD Paystubs, if applicable
  • 1 most recent monthly Mortgage &/or Home Equity Loan Statement
  • Mortgage &/or Home Equity Loan NOTES -from the closing documents of your current mortgage(s) &/or Home Equity Loan(s)
  • 1 most recent complete Bank / Retirement Account Statement(s) (need all numbered pages including junk, miscellaneous and reconciliation pages; no “screenshots or account histories” please)
  • Most recent City/County Property Tax Bill, Current Homeowner’s Insurance Declarations Page, and HOA Dues Bill/Invoice (for your Current Primary Residence)
  • Most recent Warranty Deed or Quit-Claim Deed (for your Current Primary Residence)
  • Signed/Dated/Completed Disclosures – you can retrieve online at your Application Status Page
  • Current & Valid Driver’s License for all borrowers & persons on title to subject property
  • Other items that could apply: Credit Card Statements, Signed/Dated Letters of Explanation for Credit Inquiries or Delinquencies, Employment/Income Inconsistencies, Address Discrepancies, Documentation for Source of Funds to Close, Updated Bank Statements, Intent to Retain Current Property for rental/future sale, etc…, Finalized Bankruptcy &/or Divorce Documents, additional years’ W2’s/1099’s/Tax Returns, or more/other…

“I was very well prepared, and had all of my documentation in order,” Lamers states. “I had to have one of their people do my appraisal, which was fine, but not who I would have chosen otherwise. But then their underwriters took a few weeks to approve me and were struggling because I was an S-corp LLC, which made them want to look at my P/L statements a little more closely.”

Lamers said he used Quickbooks and an online payroll service, and that they were key tools for him to prove his creditworthiness.

“I had a pretty stable income for over three years, but my Quickbooks Profit and Loss statement and its other outputs helped me show my business was strong and dependable. The outputs were easy, as my bookkeeping was up-to-date. The payroll service had all the tax info stored to download. I think I would have really struggled without them.”

Lamers financed a 30-year mortgage at agreeable terms, and said the process was not really affected by his self-employment until it got into the underwriting.

“It seemed to me, that given my FICO was incredibly high (over 800), I had a very comfortable income and savings, and my home was appraised for a fair market value that I should have qualified a bit more quickly than it happened. I don’t know exactly why it took them as long as it did – I simply kept supplying any documents they asked for along the way.”

Overall, the process took him almost two months, which is a few weeks longer than the typical 4-6 weeks a mortgage generally needs. However, he said he was happy with his terms, and despite the slow process, it all worked out well.

Making It Easy

The key to making a mortgage process easier, is to be prepared with all the necessary documentation that will prove your creditworthiness. If you are self-employed, it simply means adding a few extra things to your collection.

Quickbooks, or a reasonable bookkeeping alternative is a smart and simple way to help you prove your business’ worth and its weekly flows. They will be able to export profit-and-loss statements, billing and more – all valuable things to help prove stability to creditors.

I Love My Job.

A payroll service can also help the self-employed. Payroll services can allow an individual to stay on top of tax payments as well as all payroll issues – crucial items to be able to report to a potential lender.

Using third-party tools not only helps you export this data quickly and efficiently, it also presents your efforts in a more professional manner than a simple spread sheet would do. In a real and an implied sense, you are taking your business seriously.

Note also, that a self-employed applicant needs to be ready with 2-years-worth of personal and business tax returns, including all W2s, 1099s and K-1s filed. Essentially, you need all the records of the past two years to be ready to share with your lender.

Ultimately, obtaining a mortgage as a self-employed individual is not a great hurdle to cross – it just requires a little more attention.  However, with the right approach and a few more details provided to the lender, any budding entrepreneur can enjoy a competitive and secure mortgage.

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