Tips for Qualifying Self-Employed Borrowers
By Tanya Rutledge | June 23, 2016
While independent contractors enjoy a host of benefits that come with self-employment – including opportunities for taking tax deductions against their income – they can sometimes worry they’ll face unique challenges when it comes to financing a home.
Daphne Bear, a Fannie Mae credit risk analyst in underwriting and pricing, says being self-employed doesn’t have to complicate the loan application process. “Sometimes borrowers get nervous because they think that if you are self-employed, it’s harder to qualify for a loan,” she says. “Our policy doesn’t intend to make it harder for a self-employed borrower to qualify.”
Chris Moore, branch manager of Benchmark Mortgage in Plano, TX, says the biggest challenge for most independent contractors when it comes to qualifying for a loan stems from taking tax deductions that count against their income.
“They are able to take quite a few deductions to reduce their tax liability,” he says. “The challenge is in many cases they deduct so many expenses that they show very little documented income.”
But Bear said it’s important to remember that Fannie Mae allows lenders to add non-cash expenses that have been deducted back into a borrower’s income for the purposes of qualifying for a loan. Those expenses may include depreciation and depletion on business-related items. A one-time expense such as a casualty loss may also be added back in.
“So at the end of the day, a lender can look at actual income, not just taxable income,” she says.
Behind the Numbers
Documenting income is the biggest piece of the puzzle in qualifying a self-employed applicant for a home loan.
To qualify for a mortgage, Moore says, self-employed applicants typically have to present two years of tax returns. Their income is the average from those two years. In some cases, he says, lenders will accept a tax return from just one year.
Indeed, Bear points out, Fannie Mae recently updated its underwriting eligibility policy. Although the standard requirement is to provide two years of tax returns, Fannie Mae will accept only the most recent year’s tax return in certain cases where the borrower is deemed to carry a lower credit risk.
She says some sole proprietors believe they also have to present other business documentation – such as a profit and loss statement. However, tax returns are the only documentation they need. And that eases the burden on entrepreneurs who are seeking to purchase a home.
“Sole proprietors shouldn’t think they have to change anything they do in terms of their financial reporting in anticipation of buying a home,” she says. “At the end of the day, the important thing is that they can buy a house and pay their mortgage payment.”
Tanya Rutledge is a freelance writer based in Dallas who specializes in real estate and finance topics. She has been covering business news for outlets in Texas and California since the mid-1990s.