Self-employed borrowers subject to greater scrutiny
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By Scott Sheldon  November 30, 2012 12:00 am

If there is one type of borrower in this credit market whose profile has been scrutinized the most by the financial markets, it’s the sole proprietor business.

Self-employed borrowers or sole proprietors used to be able to get stated income loans allowing them to provide no income verification. Because the paradigm has shifted so far, these individuals have a more challenging time qualifying for a mortgage than ever before.

Accountants, tax professionals and financial advisors would in most cases advocate self-employed individuals write off as much of their expenses as possible in order to show less income taxes. While this is quite favorable from an accounting standpoint, because there is less taxable income, it also reduces taxable income lenders need to offset mortgage payments. Self-employed individuals also have to go through several borrower traps during qualifying.

The biggest self-employed borrower traps every sole proprietor will go through when getting a mortgage are as follows:
• Not showing income on your schedule C: Showing little income on your schedule C reduces the amount of income you’ll need to offset your liability (new mortgage), or worse, taking a loss thereby showing negative income. In order to qualify to borrow mortgage money, take your annual income (your annual profit) for the last two years add them together. Then divide by 24, and that’s your income that will be used to offset the mortgage payment. The income will need to be at least 55 percent greater than the mortgage payment, assuming no other liabilities. If you know you need to show more income for loan qualifying, consider the house payment you think you can afford, then divide that number by 45 percent, and that will be the income you’ll need to average over the last two years.

• Not being self-employed for two years: This is not to say your loan will be denied if you will have less than two years of self-employed history. If you have less than 24 months, be prepared to document a net profit with both a current year-to-date profit and loss statement, as well as your most recent year’s self-employed income tax returns.

• Not being able to document large cash deposits: Any deposits going into your bank account have to be part of your regular income and will need to be documented as such.

• Not having a third-party business validation: This means either a business license to show you have a license to do business for however you’re conducting business or a CPA letter showing they have filed self-employed income tax returns for you for the last two years. Another option for showing your business is in existence by a third-party is making it searchable online.

• Using funds from a business account in a mortgage transaction: Are any fees being put into the transaction out-of-pocket? Are you putting down a down payment? If the funds for the transaction are coming from a business account, the mortgage company will assess your ability to use those funds as part of your regular cash flow. In other words, if your regular cash flow, income and business model is such it would make sense those funds would be plausible for use in the loan, you’ll be okay. However, if the business funds in the transaction do not support a way of how those funds were originally generated, you’ll need to provide a CPA letter showing the use of those funds do not impact the financial integrity of your sole proprietorship business.

• Other business liabilities: Debt obligations show up on your credit report the business pays, and you’ll need to support the fact the business actually does pay these debt obligations on a monthly basis. If these are business debts, but are paid for personally, these debts cannot be omitted and they will count against your borrowing ability.
 
Scott Sheldon is a local mortgage lender, with over six years of experience helping people purchase and refinance primary residences, second homes and investment properties. Visit him at www.sonomacountymortgages.com.

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