Los Angeles is filled with innovators and creatives, many of whom are self-employed. Being your own boss has a lot of advantages, but it also comes with a few logistical headaches. One issue is the extra legwork involved when applying for a mortgage loan. For the average person on salary, the process is usually pretty straight forward. But for those who are self-employed, it can take a lot more work to prove that your income and financial stability, especially if you have several income streams coming in from a variety of contract work.
If you’re self-employed, you should be prepared for the application process so you have a better chance of getting approved. Check out this basic guide so you can set yourself up for success.
The Criteria Every Applicant is Judged On
The point of applying for a mortgage is lenders want reassurance that you’ll be able to pay back the loan in a reliable and timely manner. The criteria they’ll use to judge your ability to do that will be the same criteria they use to judge someone who isn’t self-employed. What they look for can be broken down to the “Four C’s” which are:
- Capacity: Based on your current employment, employment history, and current debts you have to pay off, do you have the reliable income flow to comfortably cover a new monthly mortgage payment?
- Capital: Do have other readily available assets and investments you could sell for cash if you had to that could be used to cover your mortgage? Do you have savings that you could dip into? Basically, if something unexpected happened, like, say, a global pandemic, and you lost your job, would you still be able to cover your payments?
- Collateral: What is the value of the house that you’re pledging as security against the loan?
- Credit: Does your credit history show that you are someone who can be trusted to pay back a loan in a reliable manner?
Every applicant is judged on these criteria no matter what their job situation looks like. The difference is how an applicant proves that they meet the criteria.
Proving Your Capacity and Capital
No matter how you make your income or how you pay your debts, your credit history is objective. You have a score, and that’s that. Judging what collateral you’re working with will also be proven the same way as a person who’s on salary.
The main thing that a self-employed person will have to work harder to prove is your capacity and perhaps your capital. Proving your income will take additional documentation than someone on salary. Also, if your business is actually a valuable asset, it will take additional documentation to prove that as well.
The Application Process and Proving Income
The steps of the application process will be the same for a self-employed person. You’ll fill out an application either in person, online or over the phone. Usually, a loan officer or processor will take your information and submit it to an automated underwriting system. If the automated system approves you, then a human underwriter will step in to make sure that the answers you gave on the applications match the documentation you can provide. The automated system may say that they can’t make a decision or that you’re denied, and then the human underwriter will look at over your application to see if you qualify.
Usually, the documentation required to prove your income is a W-2. As a self-employed person, you don’t have that available, so you’ll have to provide other documentation to show that you’ve had consistent income and job security. They want to know that your work is profitable.
If you know that the profitable last year that you had wasn’t a fluke and you’re financially stable for the foreseeable future, that’s great. Some self-employed income loan programs calculate income over two year periods and will allow one year lookbacks which is great. The one year look back period programs have been tightened up during Covid-19 but they’re expected to be back soon. By the time you’re reading this, one year income analysis for self-employed borrowers will likely be available, so contact us for more info.
The Documentation You Might Need
Since as a self-employed person you won’t have a W-2, you will generally be asked for two years of tax returns and an unaudited year to date profits and loss statement for your business. As you can see, the added burden of documentation to prove your income isn’t too terrible and won’t be that difficult for you to come up with.
In fact, in the last few years lenders have loosened up even more, sometimes allowing applicants to only have to submit one year of their tax return. This is great for self-employed because one of the perks of working for yourself is that you have a much easier time writing off expenses associated with your business. However, the caveat to this is the more you write off, the less your taxable income it will appear that you have.
Obviously, the goal when applying for a mortgage is to show lenders that you have as much income as possible. You have to make the decision of whether you want to get all the write-offs you can or bite the bullet and write-off less so your taxable income is higher when you apply. If you only have to show one year of tax returns, then you only have to do one year of forgoing extra write-offs instead of two. One more caveat though is that COVID-19 has affected these ease of restrictions.
How COVID-19 Has Affected Mortgage Applications
The pandemic seems to have affected every aspect of our lives, and mortgages are no exception. Because COVID-19 has affected millions of people’s job security, many lenders who have agreed to accept one tax return are walking that back and are again asking for two.
It’s likely, though, that this is just for the time being. Once the uncertainty of people’s work levels out, it will hopefully return to requiring only one return.
There is one way the pandemic has actually created something positive: historically low mortgage rates. They’ve been holding steady under 3.3% for 30 year fixed-rate mortgages, and analysts predict they’ll stay that way or go even lower well into 2021.
And contrary to popular belief, if you’re self-employed, you’ll still be able to get those low rates. It’s a misconception that self-employed people automatically get stuck with higher rates. If you’re approved, you’ll get the same rates as anyone else.
Now, if you’re not approved, you still have some options, but those might require you to pay a higher rate.
A non-QM, or non-qualified mortgage, are mortgages that do not align with the Consumer Financial Protection Bureau’s (CFPB) guidelines. Non-QM mortgages still have protections in place for borrowers. The main difference here is the CFPB requires that applicants prove a steady income and non-QM mortgages do not.
To be approved for a non-QM, you have to prove that your credit is good, you have a low debt to income ratio, and you have assets at the ready.
This is the best option for people who are self-employed but have other money coming in that isn’t attached to your business income. For example, if you recently came into a big inheritance.
Though a non-QM loan could mean paying a higher interest rate than a QM loan, the rates aren’t the same across the board. It’s important to shop around so you can get the best rate possible. As Mortgage Brokers, that’s what we do for our clients on a daily basis. Since we’ve been doing this for a long time our experience helps us to be better shoppers than someone doing this once or only a handful of times over their lifetime
Get Some Help
Now you’re a little more aware of what you’re up against, you should start planning ahead before you apply. You can work with your accountant to see how you should handle write-offs for the next tax season.
Whether you’re applying for a QM or non-QM loan, you should always work with a mortgage professional. They have an insider’s perspective and can advise you on how to best present yourself to lenders and can help you find the best rate.
It’s Not As Bad You Think
Luckily, applying for a mortgage as a self-employed person isn’t nearly as big of a deal as people have made it out to be. It just takes a little extra documentation and maybe some sacrifices when it comes to your tax write-offs––but only for the tax years you need to qualify.
If you’re ready, email us or gives us a call at (323) 412-9060 and we can discuss the nuances of your situation and then get the process started. You’ll be on your way to owning a new home (and a brand new home office) in no time.