Lenders have responded to the housing crisis by becoming particularly reluctant to lend to non-W-2, non-“cookie-cutter” borrowers, giving self-employed individuals a particularly troublesome lending experience.
Those who report their income on 1099s must be prepared to prove their earnings are stable, consistent and increasing. To obtain a mortgage, the self-employed must:
- prepare for a detailed presentation of their income by presenting the lender with income tax returns from the last three years;
- provide evidence substantiating year-to-date income — e.g., profit and loss statements and monthly bank statements on businesses, securities activity and income property;
- highlight clients with whom they’ve had long and consistent contracts, along with charts or spreadsheets on their monthly income and expenses for the past couple of years;
- maintain cash reserves and be able to document the source of deposits – e.g., an inheritance or simply accumulated wealth and earnings from their occupation;
- pay off all credit cards and other short-term debt by carrying no balance beyond current monthly charges; and
- be prepared to offer an explanation for any income fluctuations and flows of money.
The self-employed will have more luck with local community banks and credit unions since those smaller lenders will take the time to process a mortgage application and have personnel who can make discretionary decisions. It is also important to make sure the lender understands a freelancer’s tax return.
first tuesday take: Lenders panic when a self-employed homebuyer applies for purchase-assist financing because there is more room for fraud and they must spend more time analyzing and processing the application. Before they will approve a mortgage loan application for any buyer, lenders require assurance the buyer has the capacity to make their mortgage payments.
Documenting the income and wealth and then analyzing the risk of default by a self-employed buyer is a more extensive process than that of scrutinizing the finances of a traditionally-employed individual.
Only buyers seeking financing who can demonstrate the certainty of their income, document the extent of their accumulated wealth and are capable of putting down a minimum 20% to 30% down payment are qualified to receive mortgage financing. Although Californians are not yet used to the practice of verifying income due to the flagrant popularity of the liar loans that sparked this jobless Lesser Depression, lenders are handling self-employed homebuyers properly by resurrecting the fundamentals for their management of mortgage money — an artificial commodity which by necessity is regulated. [For more information regarding real estate fundamentals including the 20% down payment principle, see the June 2011 first tuesday article, The 20% solution: personal savings rates and homeownership.]
Lenders are born to lend — it’s their business — but they (and the secondary mortgage market) require the risk of default to be fully analyzed before doing so, even if now compelled by regulations.
Buyer’s brokers and agents must correct their mindset to reflect that mortgage lenders will finance a purchase by a self-employed buyer. When they counsel their buyers about the financing they need, brokers can help their buyers expect extensive questioning and documentation by the lender. A patient self-employed buyer who can fully document his income and wealth — and chooses a community-based lender — will likely have a successful future borrowing and buying.
Re: “When income is freelance” from the NY Times