Qualifying for a mortgage involves: an acceptable credit score, sufficient assets and stable income. These are to show you can support a mortgage payment, plus other liabilities. You must have a balance of all three to successfully qualify for financing. The following is what you must know when trying to qualify with “paper losses” on tax returns.
There are two types of mortgages. W-2 wage earners and self-employed individuals. Sometimes you can do both, but most of the time it is one or the other. A W-2 wage earner is someone that has no interest in the company in any capacity, does not have control over their income and subsequently has more stable income. Lenders are also usually able to qualify a W-2 wage earner more easily. That’s not to say if you are self-employed you can’t secure financing, but being a W-2 individual does make it easier. Self-employed individuals are either soul-proprietors or have ownership interest in some sort of business entity.
Here is where things can get tricky:
Rental Income Losses – On almost every mortgage loan application this can come back to bite the borrower. This is because rental losses, usually represent more expenses going out than there is revenue to cover the property. Lenders use a special Fannie Mae formula, which in most instances, next to losses look even worse. This is because the expenses are added back into the mortgage payment, then deducted from it over a 24-month period.
It is important to note: When purchasing a rental for the first time, some lenders will use an exception basis. The exception they are going to use is 75% of the projected market rentals. This is to help offset the mortgage payment as long as you are specifically purchasing a rental property.
Schedule C – This is a biggie. No one wants to pay an excessive amount of taxes, especially self-employed individuals. You may be aware; taxation is higher for self-employed individuals. So it goes without saying: every accountant wants to be a hero by saving you money when helping with your tax returns. They are doing this, but at the expense of your refinancing or buying a home. Writing off all your expenses, or worse, showing negative income means the lender literally has negative income to offset a proposed mortgage payment. Even if you own a home already, have excellent credit and have an impeccable payment history, it does not matter. The income on paper is what lenders look at. For short, CCI, which is Cash, Credit and Income.
Entity Losses – The following scenario is a common one where a borrower pays themselves a W-2 wage along with a paystub, at the expense of bleeding the company dry. This will become problematic, because there almost certainly will be lower income figures. The same income figures the borrower is trying to qualify with. It does not work. Consult your tax professional.
In short any negative income being reported on personal and/or corporate tax returns, will hurt your chances of qualifying for financing. As a result, one of these may be an offset, but they are not limited to the following:
Waiting until the following year – Depending on the severity of how much income loss there is, you may need to do a two-in-one. This means showing two years of income in one year. This is to offset the two year averaging lenders use when calculating your income.
Changing loan programs – This could be an array of different things, but it may mean going from a Conventional mortgage to a FHA mortgage for example.
Investigating more – You might need to put more money down to purchase a home than you otherwise thought. You would do this if your income is lower than what your purchase price expectations are.
Paying off debt – Depending on your financial scenario, paying off consumer obligations is always a smart and healthy approach. Even if it requires some of your cash. Getting rid of a credit card at 11% with a payment at $200 a month may help.
What should you do if you know you want to qualify for financing and you currently have tax returns that contain losses? First and foremost, consult with your tax professional. Learn what your options are directly from the source. Once armed with those options, talk to a lender skilled enough to help you understand how much financial power you may have in the marketplace.
Scott Sheldon is a local mortgage lender, with a decade of experience helping consumers purchase and refinance primary homes second homes and investment properties. Learn more at www.sonomacountymortgages.com.