Sure, it’s great being your own boss. No employees to oversee or pay and no dress code. You set your own hours and don’t have to deal with prickly clients if you don’t want to. Everything seems fine and dandy, all hunky and dory, right?
Then you try to qualify for a home loan.
For the growing legions of the self-employed, the same federal law enacted to protect the public and the economy from another housing crisis and economic meltdown is preventing many sole-employee business owners from qualifying for a conventional home loan. It’s especially difficult for businesses less than two years old and those showing little or no profit come tax time.
“Some business owners have a profitable business and cash flow but on paper run at a loss for tax purposes,” said Greg McBride, the Palm Beach Gardens-based chief financial analyst for bankrate.com. “It’s nearly impossible for recent startups to get a loan unless there are other income streams or the business owner still has a day job.”
The 2010 Dodd-Frank Act, which overhauled the nation’s financial regulatory system and is slated for likely termination under the Trump Administration, tightened the mortgage approval process. Self-employed applicants can no longer show check stubs or bank statements as proof of income. Still fresh off the Great Recession and robo-signing, traditional lending institutions are scrutinizing business and personal tax returns more closely. Line 37, the adjusted gross income on the 1040, is the bottom line for most banks and typically disqualifies those in business for themselves from low-interest conventional loans, VA, USDA and FHA mortgages.
“CPAs can be very creative in claiming deductions for small business owners,” said John Salter, a relationship manager at PNC Bank in Boynton Beach. “They get taxes down as much as possible, which is great for tax time but a challenge when these business owners try to get a mortgage.”
Nationally, more Americans are their own bosses. Some 15 million workers, according to the Bureau of Labor Statistics, have stepped out of corporate America and are working for themselves. Between 2012 and 2013, Florida led the nation with 63,000 individuals joining the ranks of the self-employed. Census data, which will be updated in May, shows self-employed individuals account for the majority of all U.S. businesses.
Realtors, ironically, are among the self-employed who often don’t qualify for a mortgage. So, too, are attorneys, entrepreneurs and the growing ranks of freelance and contract workers. It’s also difficult for these solo professionals just getting started in their careers.
Florida has over 1.8 million self-employed workers, with professional services — particularly jobs in real estate and rentals — accounting for the most. The state also leads the country with the most mortgage failures, according to NerdWallet, a personal finance website which allows users to compare products available at various banks and insurance companies. Nearly one in five mortgage applications — 17.1 percent — get turned down, it discovered during its inaugural Home Buyer Reality Report.
Angie Fritz Nichols, broker associate for The Nichols
Team at Jones & Co. Realty in Fort Myers, encounters self-employed would-be homebuyers “all the time. There are lenders out there who can get it done if the buyer has been self-employed for two years with enough claimed income to qualify for the loan.”
For those who can’t show enough income, rectifying the situation isn’t going to happen overnight. In most cases, banks will ask for two years of tax returns. Tim Manni, a mortgage expert at NerdWallet, suggests business owners reduce their deductions and start taking a salary, which means paying more taxes.
“It’s definitely possible to target a conventional loan, but it’s going to take time and research longer than a traditional salary position,” he said. “You might have to write off less in those two years. Mortgage companies are going to look at line 7 to 22 on the 1040 and 23 to 37 for adjusted gross income. Debt levels are another thing.”
The bottom line, said Victoria Prast, vice president of mortgage operations for Achieva Credit Union, is how much of a financial risk the potential borrower poses.
“At the end of the day it’s about qualifying someone for something they can definitely afford,” she said. “They have to have the ability to repay. There are regulations on lending that weren’t there before and we have to show we’re making good business decisions.”
As a member-owned institution, Ms. Prast said the 80-year-old Pinellas Parkbased credit union with offices throughout Southwest Florida, has more flexibility than a traditional bank.
“We follow a more common-sense approach,” she said. “Members feel we are looking at their particular situation and not asking for it to fit into a box. We can look beyond the bottom line and the current profit and loss, but it does have to make sense.”
Ms. Prast and other experts also advise self-employed business owners to separate business and personal expenses. Paying for a business expense with a personal account can affect personal debt-to-income ratio, another key factor in qualifying for a home loan. Lenders look for a ratio of 36 percent or less when dividing monthly debt obligations by pretax income. Achieva also considers how much a member is paying for rent compared to a monthly mortgage.
All lending institutions will factor in home-related expenses, including monthly mortgages, taxes, insurance and homeowners’ association fees and other debts like credit cards and personal, school and car loans.
For the self-employed, Mr. Manni suggests keeping tax write-offs low to attain a 36 to 43 percent ratio. “Having a really strong credit score, coming to the table with a large down payment and providing ample financial documentation will help your cause,” he said.
Also, be prepared to be Googled, said Mr. Manni, noting a potential lender searched online for a former colleague, a self-employed freelance writer, “to see who she worked for and if it was consistent. It was kind of shocking to her.”
She did get approved.
“The bottom line is income,” Mr. Manni said. “Ten years from now a bank wants to be able to protect its loan. You have to show you have money now and in the future.”
Formerly the Pinellas County Teachers Union, Achieva has grown with the acquisition of other credit unions and opened offices in Cape Coral, Estero and Port Charlotte. By carefully vetting its mortgage holders, Achieva survived the housing crisis with less than 1 percent of its mortgages in default. Nationally, 90-day delinquency rates and foreclosure initiation procedures reached an all-time high of 25 percent in May 2008.
Paying the price
There is another option for the self-employed who want to buy a home sooner rather than later. Google “self-employed home loans” and more than 1.6 million results pop up, including shouty responses and advertisements guaranteeing approval.
One of the top, Home 1st Lending, rings right to Ruth Macellari, who runs the Naples branch. She’s worked with attorneys, Realtors and lawn-care company owners locally and statewide. Depending on the dreaded line 37 on their tax return, she can qualify them for a conventional loan.
Home 1st Lending offers a portfolio of mortgage products, including a nontraditional loan that forgoes the tax return for 24 months of personal or business tax statements. But there are downsides, including higher interest rates — based on credit score and down payment amount — and a one-time 2.75-percent fee due at closing. Unlike a conventional loan, private mortgage insurance isn’t a requirement for anyone putting less than 20 percent down.
“I do seven to eight of these a month,” said Ms. Macellari. “Only a few lenders do this.”
It’s a matter of weighing the cost benefits — pay higher interest or additional business taxes.
For example, monthly mortgage payments with a 20 percent down payment on a $250,000 loan at today’s 3.75 percent interest rates would run about $954 with no PMI. Expect to pay about $1,200 a month for a 6-percent home loan through Home 1st Lending.
“It is more but you’re getting a loan,” Ms. Macellari said. “You can always refinance out at any time.” ¦