As a self-employed borrower, how do you get a mortgage loan these days? It’s not as easy as it used to be. The process is different. The documentation is different. Even the way the mortgage market defines “self-employed” is different. So what do you do?
The first step for any self-employed borrower is to provide your mortgage loan officer with your federal tax documents for the last two years, including your W-2 forms. If you are unable to locate a copy, your lender can have you sign a 4506-T form for the IRS. This document releases a line-item transcript of your tax return to your lender, providing third-party verification of the reported income.
If you are a small-business owner, your income might be documented in your federal return on a Schedule C form, summarizing any income and expenses associated with the business. If your income can be verified using Schedule C, that situation is often the simplest for a lender to determine a borrower’s ability to make a monthly mortgage payment because all the information is contained within your federal return.
Other types of self-employment necessitate business tax forms such as the 1120S or 1065. If your tax situation requires these types of forms, it is likely that you have a certified public accountant or another tax professional who can provide the appropriate tax returns to your lender on your behalf.
As a self-employed borrower, you need to understand that income that does not appear on your W-2 will be analyzed in greater detail than a borrower who earns typical wages. You will need to have been self-employed for a reasonable time period, which typically requires a two-year self-employment history.
Your lender might also request any K-1 forms that flow into the Schedule E, or the complete business return for all your businesses to analyze the following: income stability, type and nature of business, demand for service, financial strength and ability to generate sufficient income to make monthly mortgage payments.
For many self-employed individuals, income can be variable and seasonal in nature, so lenders often need a more current year-to-date profit and loss statement or balance sheet for any business entities. Filing for a tax extension, for example, could create financing delays that you need to take into consideration.
But how is self-employment defined in today’s mortgage lending environment? If an individual has a 25 percent or greater ownership interest in a business, they are considered self-employed.
For example, if you own a rental property management company with your siblings and have reported income or loss from that entity that results in a K-1 form showing 33 percent ownership, you are self-employed. But if the K-1 form you received from, for instance, buying into a local restaurant or craft beer company shows a 5 percent ownership interest, you are not self-employed.
Confused? Here is a simple piece of advice to make it all easier: A little tax planning can go a long way. If buying a home or refinancing your mortgage is in the cards for you this year, share that information with your accountant before filing your 2014 tax return. Your accountant might be working to reduce your tax liability by a few hundred dollars — but those tax savings could influence your ability to qualify for a mortgage, which has much greater financial implications.
Planning ahead for this new mortgage process will make a significant difference in getting you the loan you need.
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