The Underwriting Process Sucks for Self Employed HomeBuyers

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  • The Underwriting Process Sucks for Self Employed HomeBuyers

Yes, you can absolutely get a home loan if you’re self employed. You do not have to be a W-2 worker. That being said, don’t let anyone fool you; it’s not fun nor is it particularly easy for many.

You’re going to have to provide more paperwork and jump through more hoops than a W2 worker. Period. It’s doable, but you better have your stuff together.

The example used below is from trying to obtain an FHA loan as a self employed borrower in NYC from a mortgage broker.

Every situation is different and you may have a harder, or easier time, qualifying for a mortgage. This is only so that you have a rough idea of what to expect during the underwriting process.

The Basics

You are potentially eligible for the same loans that people with W-2 income (meaning they get a paycheck from their employer) are eligible for: FHA, conventional, VA, USDA loans.

  • You should ideally be in business for at least two years
  • Credit: Aim for at least a 620 mortgage credit score.
  • Debt to Income Ratio: Below 50%.
  • Property: For FHA loans, the property should pass health and safety standards according to FHA guidelines.
showing more money more problems for self emplyed paying high taxes

The Conundrum for Self Employed Borrowers

We’re specifically discussing the guidelines for FHA loans because they are easier to qualify, particularly for self employed borrowers. This is mostly because self employed people tend to focus on reducing their tax liability by deducting alot of business expenses.

This ends up reducing our qualifying income, which is not good when we’re trying to convince a lender that we make enough money to qualify for a home loan.

You see how the two goals are diametrically opposed to each other? If you show a lot of taxable income, your taxes will be high, but if you don’t show enough, you won’t qualify for a home loan.

Pick your poison: Do you want a low tax bill or do you want to qualify for a home loan? It’s really hard to do both.

The Hard Part – Income Documentation

This is the hardest part and is where most people get tripped up so you let’s take a minute to unpack this.

First off, you and your CPA better be tight. You will be relying on them so you should have a good working relationship. They can make or break your deal.

black cpa

How Lenders view Your Income

Mortgage lenders are very conservative and they will plan for the worst case scenario.

Has your income increased this year or has it decreased? It has increased this year vs last year? Guess what, lenders will take the average income for the business for the past two years.

Example: 2021 income: 70K. 2022 income: 60K. They will document your income as 65K.

Has your income decreased this year vs last year? Ok, then lenders will take an average of the past 12 months.

Type of Business – Income Stability

Lenders will be all up in your business, see what we did there 🙂

Is the business income relatively stable or are there large fluctuations? Is it seasonal? What industry is it in?

They want to know whether this is a legitimate business and if it will continue or die off and fail like most small businesses normally do. To be fair, can’t blame them. Usually asking to borrow a large sum of money and most businesses eventually fail.

black cpa collaboration

CPA Collaboration

You got with a CPA who has been amazing at saving you on taxes, huh? They set up an S Corp for you? They advised you to deduct travel, business, home office etc…expenses?

Ok, well just know that your CPA better keep that same energy when it comes to helping you obtain this home loan.

  • Tax Returns: You will most likely have to provide both your business returns and your personal tax returns.
  • Profit and loss statements, which could include a Schedule C, Form 1120S or K-1, depending on your business structure
  • Cash Reserves/ CPA Letter: We had to obtain a letter from our CPA stating that withdrawing money from the business to cover the down payment and closing costs wouldn’t adversely affect the business.
  • They also had to state how long they had been doing our taxes.
  • Deductions: The only real items that a lender will add back to your income are for the deduction you took for your home office, and the “depreciation” deduction you took. Meals? travel? Equipment? Nope. These are considered ongoing expense and are deducted from your income.

Income Documentation – Your Part

  • Profit and Loss Statements: Do you have a bookkeeper or are you doing this yourself? Either way, you better have a legitimate Income Statement for the past two years.
  • Balance Statement: Do you know how to put one together? Accounts Receivable, Payable? Assets? If not there are plenty of free templates available online.
  • Bank Statements: Really hope you have a separate personal and business bank account. You will need to provide the past two months’ statements. The income you’re stating on these P&L statements should be similar to what is showing on your bank statements.

If you don’t think you can provide all of this documentation, you can look into bank statement loans that require less paperwork, but given that you will pay a much higher interest rate, it probably isn’t the best option.

The good news is that all of this is very doable and if you make it to the other side, you’ll obtain a mortgage commitment and likely become a homeowner.

Update (10/5/23):

Fannie Mae just released new guidelines that may help self employed borrowers out. This is still breaking news so lenders are still digesting this massive document but the changes appear to be for conventional loans, not FHA loans.

Instead of having to show 24 months of income, and therefore incurring high taxes over 2 years, you may be able to only show 12 months of income. This means that you will only have to potentially incur a high tax bill for 1 year, not 2 years.

We’ll keep you updated as we learn more information.