What Factors Impact Self-Employed Individuals On Mortgage Options?
Navigating mortgage options can be a daunting task for self-employed individuals, but insights from top mortgage professionals can make it simpler. Mortgage Brokers and Principal Brokers share their wisdom on what to consider when advising this unique group. Learn why the need for a line of credit is crucial and get the final word on why equity-based products might be your best bet. With six expert insights, this article provides a comprehensive look into the key factors you need to know.
- Consider Need for Line of Credit
- Analyze Tax Returns for Loan Options
- Include Accountant in Mortgage Discussions
- Evaluate Business Duration for Loan Approval
- Understand Business Ownership and Income Trends
- Suggest Equity-Based Products for Consistent Income
Consider Need for Line of Credit
When advising self-employed clients, a key factor I consider is whether they might need a line of credit, assuming they qualify. Cash flow fluctuations are common for self-employed individuals, and a line of credit can offer flexibility. It allows them to pay down extra on their mortgage or line of credit during peak earning months and access funds during slower periods. While a line of credit may not always be available for a purchase, especially if the down payment is limited, it's something I always discuss during refinance consultations.
Analyze Tax Returns for Loan Options
The key factor when advising self-employed individuals is their tax return.
Many self-employed borrowers have a lot of tax deductions, which could potentially disqualify them from traditional mortgage programs.
We have Non-QM programs, like bank-statement loans, for people with a lot of tax write-offs, but those programs are more expensive than traditional mortgage products.
We don't know which program is the best fit until the tax returns are analyzed.
Include Accountant in Mortgage Discussions
When advising self-employed individuals on mortgage options, it is critical that we also include their accountant in the conversation as we review income tax versus interest costs. Income taxes are not tax-deductible, whereas, for most self-employed persons, at least a portion of their mortgage interest is. Considering that most self-employed persons do all they can to reduce their income tax costs, it usually lowers their declared income, impacting their ability to qualify for A lender mortgage financing.
The trade-off for income tax savings is that we often need a B lender to qualify self-employed clients. B lenders do have slightly higher interest rates and fees with 20% equity or down payment; however, the fees and interest pale in comparison to the thousands of dollars in income taxes required to be paid to qualify with an A lender for the same amount of mortgage. With A lenders, most use an average of declared income over two years. If the taxes on $100K of income are 30%, that is $30K per year in taxes or $60K for those two years to qualify for a mortgage. On a $400K mortgage, the additional interest cost with a B lender compared to an A lender based on current 5-year rates is about $14K, with a portion of the additional cost also being tax-deductible. This means it would take 20+ years of the higher B lender interest to equal the cost of 2 years of income taxes.
Those income taxes saved could go towards the down payment or building wealth while still achieving homeownership, meaning the impact could be even more financially significant in the long term. This is why including the accountant of my self-employed clients is so critical to the overall process of mortgage qualifying.
Evaluate Business Duration for Loan Approval
One key factor to consider when advising self-employed individuals on mortgage options is how long they have been in business. Typically, we like to see someone who is self-employed have two years of employment under their belt. However, there are exceptions to all of these rules. I did a loan for a professional who was self-employed for two months, and we were able to get them approved because they were an employee of the company that they bought directly from the owner. I am doing a loan now where the borrower has been self-employed for 16 months. We are able to consider their income because they previously worked a W-2 job in the same industry. So as you can see, advising self-employed individuals on mortgage options will most likely be on a case-by-case basis.
Understand Business Ownership and Income Trends
There are a number of considerations when working with a self-employed borrower, such as their company's ownership type, percentage of ownership, size, and industry. Income is typically trended and averaged over two years. The mortgage industry is unduly conservative with self-employed borrowers. It's important that the loan advisor understand the layers involved here and when something like a Profit and Loss Statement matters more or matters less. Even more, it's important that the loan advisor have an excellent underwriting team that understands when some conventions should be disregarded.
Suggest Equity-Based Products for Consistent Income
When advising self-employed individuals who can't qualify with traditional lenders, one key factor we consider is their ability to provide consistent income documentation. Traditional lenders often require detailed proof of income, which can be difficult for self-employed clients with fluctuating earnings.
At Turnedaway.ca, for clients who can't meet these requirements, we suggest equity-based mortgage products as a short-term solution. However, we don't just stop there. We work closely with our clients to help them improve their income situation, so they're not stuck in an equity product forever. Our goal is to address both their immediate needs and support their long-term financial goals, helping them transition to better lending options as their financial situation stabilizes. This ensures they have flexibility now, while building toward future financial stability.