The United States housing market is on fire. Pending home sales increased over 24% from August 2019 to August 2020. They were also up nearly 9% in July. One reason that demand is so high is due to the record-low mortgage rates. The average rate for a 30-year mortgage fell below 2.90%.With borrowing costs so low, Americans are jumping at the opportunity to buy or refinance. Self-employed workers are equally eager to take advantage of these rates. Read on for a comprehensive guide to self-employed mortgage loans. Learn how to interpret income qualification requirements and get your mortgage.
Before issuing a mortgage, lenders want to verify the borrower’s income. Typically, they use a person’s annual W-2 statement provided by an employer. This is a simple approach, however, it is not one available to the self-employed person. There are 16 million self-employed workers in the United States. These individuals and families deserve equal access to homeownership. It is incumbent on lenders to develop a fair income verification process for the self-employed. Instead of the W-2, a self-employed person relies on a Profit and Loss (P&L) statement for income verification. They will also provide copies of their tax returns as well.
Before we dive into the self-employed mortgage requirements, let’s discuss P&L statements a little more. It is important to understand what data the lender is looking for.At the top-level, a P&L statement is a summary of a business entity's revenue and expenses. It shows a lender how much revenue a self-employed person is generating. With the inclusion of expenses, there is a clear understanding of the net income that the worker is bringing home. P&L statements are typically prepared on a quarterly or annual basis. For a self-employed worker or small business, an annual statement is more likely. Lenders are going to request P&L statements dating back to the start of the year. The rationale for this is to verify a steady stream of income.
Employment verification is also more challenging with a self-employed worker. Typically, the loan processor reaches out directly to an employer. The employer then issues a letter or other written verification to confirm the person’s status. Employment verification is different with a self-employed person. Instead, the loan processor will turn to other professionals and state organizations to verify employment. They may request a letter from your certified personal accountant (CPA). Written correspondence from a professional organization will suffice if you belong to one. The lender may also look for a state license or insurance coverage. They may even reach out to current clients to verify that you are working for them.
Lenders may get weary if you do not have a long employment history. There is less risk involved when a person has been earning consistent revenue for a long period of time. The underwriting standards vary based on the lender and what type of loan it is. In general, you should be able to demonstrate income from the same source for 12 to 24 months minimum.
The debt-to-income (DTI) ratio is a calculation performed by lenders. Each lender and underwriter is different, but there is often a fixed threshold that a borrower cannot exceed. The lender wants to ensure that the borrower is not taking on too much debt to pay their mortgage. The more debt that an individual has, the more risk they pose to default on the loan. All types of debt are considered including credit cards, student loans, medical, and more. The calculation of the DTI ratio is another reason why the P&L statement is so important. The lender cannot calculate the ratio without a reliable income figure.
It is important that you understand the difference between audited and unaudited P&L statements. An audited P&L statement is reviewed by a Certified Public Accountant (CPA).Clearly, an unaudited version is not reviewed by a professional third-party. As a result, it carries less weight but could still be accepted by some lenders with supplemental documentation. An audited P&L statement will help the underwriting of your mortgage. Remember, the employment verification process requires a third-party to confirm your status. An audited P&L statement by a CPA serves this purpose. Also, an audited P&L statement provides lenders with a professional opinion on your finances. The audit verifies that consistent and accurate accounting practices were used. This professional judgment reassures the lender and tells them that you are less likely to default on a mortgage loan.
Like a traditional employee, the lender is going to review your credit score. The lender wants to ensure that you are not overutilizing credit. In addition, they want to verify that you make timely payments on other loans and financing vehicles. Your credit score informs the lender about your overall creditworthiness. However, there are some implications to your P&L statement. You should ensure that all business expenses are properly classified and recorded on your P&L statement. It is important not to mix personal and business finances. There are negative consequences for charging business expenses to personal cards. It gives the impression to the lender that your personal expenses are greater than they truly are. Also, these expenses drive up your personal credit card utilization. This could affect your creditworthiness and the ability to secure a mortgage.
Unfortunately, many prospective buyers do not apply for mortgages. They are under the false impression that self-employed workers cannot verify their income without a W-2.However, there are millions of self-employed workers throughout the United States. Lenders would be doing themselves a disservice by not adapting their procedures for the self-employed. You can demonstrate your income with a P&L statement. An audited version carries even more weight. An independent review by a CPA is also a mechanism to verify your employment status. If you are interested in applying for a self-employed mortgage, contact us today to speak with a local licensed mortgage loan officer.
You can reduce you Debt-to-Income ratio if your business pays for debts that report on your credit. Be sure to talk to your local mortgage broker about getting the most out of your business expenses.