Unique Challenges of the Self-employed Borrower
by Glenn Keller
Securing a mortgage for a real estate transaction can be challenging enough at times. However, being self-employed can introduce a set of factors that may affect your ability to borrow.
Because lenders define “self-employed” differently than the IRS or most of us would, it makes sense to spell out the characteristics at the outset of this article. Keep in mind that lenders are most concerned about a borrower’s ability to maintain a certain level of income and self-employed borrowers many times have the ability to modify their income based on certain factors within their control. People that fall into the category of self-employed include, but are not limited to:
- Business owners (typically those who own 25% or more of the company they work for)
- Independent contractors
- Sales reps that earn more than 25% of their income from commissions
- Independent Agents
- Franchisees
Others that have similar characteristics may also fall into the ranks of the self-employed category. Loan underwriters have the discretion to evaluate each case on its own merits. Why is this significant you might ask? The biggest point is in the documentation requirements. Normally, a borrower would provide two years W-2’s and 30 days’ pay stubs to prove income. However, a self-employed borrower will need to provide two-years’ personal tax returns (including all schedules) and possibly business tax returns along with a current income statement for the business. This is to ensure current income is ongoing and is in line with prior years’ income.
I will regularly get asked, “Why do I need to give you my tax returns? I get a W-2 from my company”. Well, the answer is that if you own 25% or more of your company, you are deemed to have the ability to change your income for any reason, and one reason may be to qualify for a loan.
Another problem that I see quite frequently is with fully commissioned sales reps where they earn a strong income on their W-2 but upon review of their tax returns, they reflect a significant amount of un-reimbursed business expenses. These are expenses that are borne by the borrower during the normal course of their business, but are not reimbursed by their employer. A few examples of this may be vehicle expenses, travel and entertainment or supplies. Underwriters will deduct the full amount of these expenses from the reported income and can kill the deal very quickly if it affects the ratios to a level that does not meet the loan’s program guidelines.
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