In Part One, we went over who is considered self-employed and what sorts of documentation might be required. For this article, we will discuss qualifications and down payments.
How Will You Be Qualified
For lenders, it is all about how the loan will be repaid. For salaried individuals, that question is pretty easy. Here is my monthly salary, and here is how long I’ve had the job. Things are a little trickier for the self-employed.
A business makes profits to pay the owner based on a simple concept – gross income minus total business expenses. What is left is gross profit. To determine the business owner’s credit worthiness, lenders will look at tax documentations as well as the financial statements of the company. Take a minute, go back to Part One and look at the list of documents typically requested.
The underwriters will look at the business’ growth, considering if it is steady or erratic. They will consider the type of business and if there is good growth potential in the field. Finally, the experience of the owner, including how long he or she has been doing this sort of work, will come into play.
As every self-employed person knows, life can be a financial roller coaster. To deal with this, underwriters will average the last 24 to 36 months to develop your “qualifying income.” Even so, there can be bumps that might look worse than they actually are. Here is where you need a great loan officer.
Working with your loan officer, develop a narrative to go along with the documents. This is your opportunity to point out things like a new piece of business equipment or a change in clients that created a bump in income or expenses that is not likely to repeat. It’s OK to be a little creative here, but be careful you are never deceitful.
What About Tax Deductions?
When you are self-employed, there are plenty of tax deduction opportunities. Whether it is depreciating a large asset or deducting automobile mileage, these are the bread and butter of the self-employed. They can also have an unexpected impact on your mortgage application. If the lender is using your tax documents to determine your earning capacity, every tax deduction you take lowers what they see as income available to pay the mortgage.
Here is where a knowledgeable loan officer comes through. There are some tax deductions that can actually be added back to increase your qualifying income. Don’t forget to drill down on this issue in the narrative mentioned above. Let the underwriters know what is really going on.
There are many different loan programs that balance the down payment and interest rate. Higher down payments may qualify for lower interest rates and vice versa. Once again, having the right loan officer is critical. Evaluate your personal situation to prioritize holding on to cash through a low down payment or keeping monthly expenses with a low interest rate. Be frank with your loan officer so that he or she can present the best program for your specific situation.
The Bottom Line
Successful business owners understand that it is all about the net, the bottom line. Understand how you will be qualified so you can present the best possible picture. Use communication to help the underwriter understand tax and business situations. Finally, seek the balance of interest rate and down payment that will work for you in the long run.