Evaluating the Self-Employed Borrower

Evaluating the Self-Employed Borrower

Lenders want to make sure the new monthly mortgage payments will be affordable. They do so by comparing gross monthly income with the new mortgage payment, including an amount for property taxes and insurance. The mortgage payment takes into consideration taxes and insurance along with an interest rate selected for the loan and the actual term of the loan.

If this total monthly payment will be $2,000 and gross monthly income is $6,000, the debt ratio is then 33. $2,000 represents 33 percent of $6,000. A secondary ratio then adds other monthly credit obligations such as a car payment or student loan payments. It’s relatively easy to arrive at these numbers by looking at a borrower’s monthly pay check which shows gross monthly income. But it’s not so easy sometimes when reviewing someone that is self-employed and doesn’t get a regular pay check on the 1st and 15th.

Self-employment income will vary from month to month. Someone might have a very good month and then the next month not so much. So, what does a lender do? To arrive at a gross monthly income amount for qualifying, lenders look at the last two years of tax returns, personal and business. Net business income, gross income less operating expenses, is added up over the last two years. In addition to income listed on the tax returns, lenders will also request a year-to-date profit and loss statement. This amount is added to the amounts gleaned from tax returns and averaged together to arrive at a qualifying amount. Lenders can also look at copies of bank statements which will reflect deposits resulting from business income.

Lenders want to see year to year amount be relatively similar. Wild swings from one year to the next can cause problems, especially so if last year’s tax returns showed much less income than the previous year. This can alert the underwriter the business may no longer be viable and require the borrowers to explain the drop in income. Finally, loan guidelines ask the borrowers be self-employed for at least two years.

The self-employed borrower can expect to provide more paperwork to the lender compared to someone who is not self-employed and underwritten a bit differently. However, if you’re self-employed, your loan officer can provide you with a list of needed documentation upfront to make sure loan application sails through.