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Self Employed MortgageThere is a lot of conflicting advice out there regarding mortgages for the self employed. It really comes down to common sense. A mortgage lender lends you money based on your income, and the probability that your income will remain the same or better after closing. They just secure the mortgage with your home to protect themselves against the possibility of you defaulting on the loan. With this in mind, let's explore financing for the self employed.When am I considered self employed in terms of a mortgage?The rules are clear: if you get income from a business, whether it is W-2 or 1099 income, you are considered self employed if you own 25% or more of the business that is paying your income.Does being self employed count against me when I apply for a mortgage?In the first paragraph we talked about a lender lending you money based on the stability of your income. Statistics say that the majority of businesses will fail in the first two years of their existence. (ref. US Bureau of Labor Statistics).Lenders know this. They therefore have a requirement that you be self-employed for a minimum of two years before you can be considered for financing. Not only that, but if you are doing a full documentation loan, they will want to see tax returns and business licenses for those two years. Since the first two years of self employment is the hardest, you can see how this makes it difficult for you to get financing. Here is another challenge. Having a business gives you the opportunity to have tax write offs that are not available to the wage earner. Since cash flow is always an issue, and Uncle Sam wants you to succeed, most businesses write everything off they are allowed by law on the books in order to show the lowest possible income that will be exposed to taxes. This is a two edged sword. You now show a very low income and pay less taxes, but come mortgage time you have to convince the lender that you have the ability to make payments on the mortgage. Since they will be looking at your tax returns on a full documentation loan, most business owners will not have enough income to document to qualify for a mortgage (if you are doing good tax planning that should be the case). Don't be discouraged however, there are multiple ways you can still get financing. Lenders know that you are taking full deductions, and therefore created a self employed mortgage to get around the issue. It is called a stated income mortgage. You simply state your income on the loan application, but you don't have to prove that is what you are actually making. This does not give you license to claim whatever income you want however. The original intent of a stated income mortgage is to let you state what you were actually getting, but you could not prove you were getting it because your tax returns tell a different story. Many mortgage brokers and unsuspecting borrowers use this loophole to make sure the borrower qualifies for the loan by stating sufficient income, when in fact they don't really make the income that is being stated. This is very dangerous and a big mistake. If the loan officer does it without the buyer fully understanding what they are getting into, they could be setting the borrower up for an obligation that is too big to handle. If the loan goes into foreclosure, the lender will go back to the original application and go over it with a fine tooth comb. If they find that the income that was stated was much higher than it should have been, it could open you up to charges for misrepresenting your financial situation. Are there mortgages available if I have been self employed for less than two years?As a matter of fact, yes there are. It is called a no doc loan. It means don't tell and don't ask. You fill out a loan application, but you do not state or document any income, or any asset, or any employment, whether self employed or not. You could be making $2,000 a year and apply to buy a million dollar home. Since you don't have to disclose income, assets or employment, this is certainly possible. Sounds unbelievable doesn't it? Not really though, because the lender have ways to protect themselves on a no doc loan.The first requirement is that you have excellent credit, typically a score of 680 or better is required, and on investment or high end properties, a score of 720 or higher could be required. Statistically your probability of default with a high credit score is very low, and therefore the lender is trusting your judgment that you can handle the loan based on your track record of responsible management of money. Secondly, you will not be able to get 100% financing. 95% is the max (except for a few niche lenders). The reason being that should everything go wrong, the lender has a little room to recover their losses. This 95% is typically an 80/15 loan so that they can spread the risk between different divisions. Thirdly, the interest rate will be much higher. Since the lender is taking all the risk, they need to be compensated for the risk they are taking, and they reflect it in the intest rate. Documentation, credit, max loan and rate impact combinationsTo illustrate how the different documentation levels of a self employed mortgage influence the other variables, we created this illustrative matrix for an owner occupied home:
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