Every year, more individuals become self-employed.
The increase in numbers has created a special category of mortgage
loans for self-employed borrowers. Loans for the self-employed have
existed for many years, but the recent revision of programs makes
the process easier for the self-employed borrower.
What do the self-employed face?
There are many issues that self-employed borrowers
must deal with in order to secure a loan. The primary problem is
that while they are trying to reduce tax liability through
minimizing current net income, loan underwriters are looking at that
net income as a basis of the borrower's earnings.
In general, the self-employed aren't any more or less
financial risk than employed borrowers. Yet, the application process
in which borrowers are reviewed by underwriters can often make a
self-employed borrower's financial position look bad. The
self-employed borrower should be prepared to fill out more paperwork
than is required for normal loan programs.
The documentation of the self-employed
The recent popularity of "no-doc" loans for the
self-employed has greatly increased the ability of the borrower to
obtain a loan. These loans carry a slightly higher interest rate,
but allow the borrower to not prove his or her income. The borrower
is given a loan without having to worry about their financial
records reflecting their business success or ability to repay the
Under normal Fannie Mae underwriting standards, a
borrower is self-employed if he or she owns more than 25% of a
business that makes an income. If the percentage of ownership is
below 25%, the borrower is considered an employee of the business.
If a self-employed borrower decides to go the
traditional, full documentation route, he or she must be able to
1. Two years of business tax returns. 2. Two years
of personal tax returns. 3. Credit references for a business
credit report. 4. A year-to-date profit and loss statement. 5.
A current business balance sheet.
The borrower can expect to be asked for other
financial documentation, including letters from accountants,
business and personal bank statements and other financial records.
Loan underwriters average the net income of the
business owner over the two years to establish an estimate of total
income. For example, a borrower with a net income of $50,000 in 2004
and $100,000 in 2005 is credited with an average income possibility
of $75,000 for 2006. This estimate is used regardless of proof that
2006 is on track to best 2005's income. If the averaged income meets
the program's standards, the borrower has a good chance of being
approved for the loan.
Many self-employed borrowers are not able to prove a
high enough averaged tax return income to qualify for the loan
program. Some businesses have a year that is off, due to many
different reasons. The averaging method allows this year to pull
down their regularly yearly business income. This is where a
no-income verification loan becomes important to the self-employed
The basics of no-income verification loans
No-income verification loans allow borrowers to secure
loans without having to prove their incomes. The borrower must be
self-employed for at least two years and able to provide proof of
sufficient assets. The borrower must also have excellent credit. The
borrower is able to either state their current income or leave the
income section blank. No verification is required of the income.
The interest rate on a no-income loan is usually
one-half a percentage point higher than normal loan rates. There is
typically a down payment of 20-25% required. While these loans
appear to be perfect for the self-employed, like any loan they come
There are several little details that can prevent the
approval of a no-income loan. Other details can hurt the borrower
down the road. Because the borrower is allowed to state any income
he or she wishes to disclose, the program is often abused by
borrowers. Two important changes were made to most self-employed
loan programs to prevent fraud.
The first enhanced requirement requires borrowers to
demonstrate that they have sufficient assets in relation to their
income. These asset requirements can be quite strict. Some programs
require a borrower to have at least 50% of their disclosed income in
provable assets, not counting the down payment money.
The second changed requirement involves a back-up
check with the Internal Revenue Service. Most no-income programs
require a borrower to sign a permission statement at closing that
allows the lender to obtain the borrower's tax returns from the IRS.
The application is then checked against the income returns for any
discrepancies. If misrepresentations are proven, the borrower could
be facing criminal action for fraud.
Applying for a no-income verification loan involves
some risk for the borrower. This risk is especially high if the
borrower overstates the personal and business income. In addition,
the business must be older than two-years to even qualify for a
New no-doc loans offer an alternative for
There is a new type of program, called the no-doc
loan. Any borrower, self-employed or otherwise, with good credit can
apply for a no-doc loan with a 25% down payment.
There is no income verification or analysis of the
business. The IRS tax returns will not be requested. The only assets
required for a no-doc loan is a down payment and closing costs. In
some instances, even the asset documentation requirement is waived.
For a mortgage, an appraisal must be performed on the property to
assess the value.
On a fixed-rate, no-doc mortgage, the interest rate is
approximately one-half a percentage point higher than on a
traditional fixed-rate loan. There are plenty of options to choose
from, including many types of adjustable-rate loans. A self-employed
borrower can use the loan to buy a home now, refinancing when their
personal and business financial records are sufficient enough to
secure a lower-rate, traditional loan.
With more choices of loan programs, self-employed
borrowers must be careful not to take on too much mortgage debt.
Without an underwriter placing a maximum loan amount on a mortgage,
the borrower must calculate a reasonable loan