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Self-employed and shopping for a mortgage? Here’s what to know!

July 30, 2013

Here’s What You Need to Know

Lenders have been much tougher on handing out mortgages in the last few years than they were in the past. But regardless of whether you’ve been very successful for a long time or you’re just getting started, lenders are more reluctant to grant mortgages to self-employed workers, whom they consider higher risk, than to those who earn a steady paycheck. This news is not meant to discourage you from pursuing self-employment. But knowing the rules can help you prepare for what you need to do to secure a mortgage.

 Ability-to-pay

Starting in January 2014, the Ability-to-Repay rule will go into effect. The rule was instituted by the Consumer Financial Protection Bureau (CFPB) as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Although the Ability-to-Repay rule is meant to help protect borrowers and the housing market from another housing crisis like the one in 2008, it will make mortgages harder to attain for self-employed workers. Basically, the Ability-to-Repay rule will put an end to no-documentation and low-documentation loans. Until the rule goes into effect, self-employed workers can rely upon three different loan options: full-documentation, low-documentation, and no-documentation loans.

 Full documentation

Most self-employed people don’t choose to provide full documentation for a mortgage, but if your documents prove that you are financially stable, then go for it. Here’s what you’ll have to give your mortgage lender: at least two years of tax returns that show your self-employment records, an active business license, a statement signed by your accountant, profit-and-loss statements, and balance sheets.

 Low documentation

With a low-documentation loan, you’d tell the lender how much you make with your self-employment status, but they wouldn’t have to verify it. They would just ask for clients’ names and a list of any other sources of income you have. You might still have to provide some IRS forms.

 No documentation

With a no-documentation loan, your lender wouldn’t check into any of your tax documentation. This is a good option for someone who has taken a loss or hasn’t made a lot of money in the past two years. The problem with low- or no-documentation loans is that they carry higher interest rates, usually somewhere between prime and subprime loans. The latter two types of loans go away next year when lenders will have to give out “qualified mortgages.” Qualified mortgages must have no interest-only periods; no negative amortization, which means the interest cannot exceed the amount of the loan; cannot exceed 30 years; cannot have balloon payments at the end of the loan, except in some rural areas; and cannot exceed 43 percent of the borrower’s monthly gross income. Borrowers have to show documentation that proves they can repay the loan. Those who are self-employed are often caught in a Catch-22. To pay less on taxes, they deduct business expenses, such as travel and equipment. But then lenders don’t see enough income to afford the mortgage payment.

6 steps for getting the mortgage

1. Provide whatever documentation your lender needs

2. Have an excellent credit score

3. Put a large down payment on your house, which lessens the amount of the loan

4. Have some cash reserves on hand — at least two months worth of mortgage payments in case of an emergency

5. Show your lender that you have a low debt-to-income ratio. Before you start shopping for a mortgage, pay off any other outstanding debts you have

6. Be ready to show your lender that you are well-established and successful in self-employment

 

Source: http://www.mtgcapital.com/homeblog/personal-finance/self-employed-and-shopping-for-a-mortgage/

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