Before the mortgage crisis and credit crunch of 2008, it was very easy to obtain a mortgage, even if you were an entrepreneur or self-employed. In many cases, self-employed individuals could obtain a mortgage without the requirement of proving their income using tax returns, financial statements, and bank statements. Instead, the mortgage lender/banker would just take the “word” of the entrepreneur on what their revenues or profits were.
Of course, without checks and balances in place, individuals were able to over-state their income, get approved for mortgages they couldn’t afford, and get the house of their dreams.
A New Climate
Today, getting approved for a mortgage, no matter if you are self-employed or on W-2 working for someone else, is much harder and complex. Many self-employed individuals find it almost impossible to get approved for a mortgage today. Gone are the days where your “word was bond”, as Al Pacino’s character Tony Montana would say in the 1983 cult classic Scarface. Today, to get a self-employed mortgage, you are going to have to bring to the table:
- Two years of operational history
- Documentation showing upcoming work
- Incorporation, DBA, and other business entity paperwork
- Two years of personal and business tax returns
- Two years of bank statements
- Two years of CPA prepared financial statements (Profit & Loss statements and Balance Sheets)
- Verified business license
- Professional client references
- Bond insurance (depending on your industry)
- Letter from CPA verifying the business existence
How Do I Know if I am “Self-Employed”?
Most mortgage lenders will consider you self-employed if you have a 25% or greater interest in a business. You can be incorporated as a LLC or corporation or operate as a sole proprietor, but the rules would still be the same in terms of that 25% ownership rule.
If you are applying in 2017, you should be showing the years of 2015 and 2016 in terms of verification of income. If 2016 is showing a lower revenue amount than 2015, you might be automatically declined, especially if said revenue is a drop of more than 30%. Also, if you have been in business for less than 2 years, you might also be automatically declined as you don’t have a long enough of a track record to show your income, revenues, and profit levels.
Finally, your personal credit score will come into play. Higher credit scores mean you’ll have a better chance at getting a lower APR from a lender. Even if your rate is only a fraction of a percentage point lower because of a higher score, over the course of a 30-year mortgage that can really add up.
Bad credit can also disqualify you from qualifying for a mortgage. In general, if your score is in the mid-to-high 700s, you’re in good shape. Scores under 640 are in danger of getting denied. Based on different scoring models, to be in the “safe zone” of qualifying for a mortgage, your FICO Score should be at least 670 and your Vantage Score should be at least 700. If you fall below these ranges, your lower scores might harm your chances of approval.
Tax Deductions and Getting a Mortgage
During tax season, our CPAs encourage us as small business owners to write-off everything humanly possible to slash our tax liability. However, this “slashing” procedure turns into a double-edged sword, because on one end you are slashing your tax liability, but on the other hand, you are slashing your net income down to levels to where it will be even harder to get approved for a self-employed mortgage.
Other calculations such as Debt-to-Income ratio come into play and with a “slashed income”, this calculation ratio could be one of the main reasons your self-employed mortgage application moves over to the declined pile, rather than into the approved pile.
This article was originally written on May 4, 2017 and updated on May 21, 2020.