Being your own boss comes with multiple pros and cons. One of the common cons business owners have to deal with is securing a mortgage. Things are quite different from the standard mortgage, and all this because of the financial crisis in 2008.
Before the crisis hit, all a borrower with a great credit had to do to qualify for a mortgage was to declare assets and income. This was known as a SISA loan. However, this was short-lived.
For a W-2 employee, securing a mortgage is easy. You only need to present your tax returns (two years’ worth), paycheck stubs for two months and a bank statement.
The Good News
Over 14 million self-employed borrowers will benefit from new guidelines issued by Fannie Mae the most outstanding highlight being the reduction in documentation showing income tax returns to a single year down from two years, although this applies only to specific cases.
In addition, Fannie Mae also announced a new method to calculate income for borrowers who may have little-to-no income history. However, the biggest change is in how to calculate your cash flow. This is simply the amount of money coming in and going out of your account.
Banks will use this factor to determine whether you can meet mortgage payments. In short, they’ll be on the lookout for cash distributions the business owner can make. Back in the day, self-employed borrowers could only use the money equal to their income from the business.
Today, you don’t need a ton of paperwork to impress lenders because they don’t require you to furnish them with documentation proving you have access to cash.
The Process Involved
Take a look at the documentation you’ll need to get a mortgage as an entrepreneur. It’s all about preparation to own both a business and a home.
1. Employment Verification
In the conventional 9 to 5 jobs, a simple call is enough to verify your employment status. If the company’s manager confirms that you still work there, you’ll have the green light.
However, as an entrepreneur, you’re the manager. Therefore, verifying the authenticity of your employment may be difficult. As such, you’ll need to furnish the lender with the necessary documents that prove you’re employed.
Here are some of the documents you’ll need:
- A letter from a CPA, an enrolled agent, or a tax preparer
- A bond insurance statement, 2 or more years
- Proof that you’re a member of a professional organization for at least 2 years
- Current business or state license in your area of profession
- Employer’s Liability Insurance and Worker’s Comp records
- Doing Business As ( DBA)issued 2 or more years ago
What Lenders Will Want to See
Lenders will primarily want to establish how long you’ve been in business. Anything over 2 years will be advantageous to you. To them, this is an indication of an established business, one that knows the market dynamics and understands the profession.
If your business is under 2 years old, getting a mortgage will be an uphill task. It’ll be even more difficult because you must prove to them that the business is standing on its own two feet and that it has the potential of producing income now and in the future.
2. Proving Your Income
Stating that you earn an income is not proof enough. You’ll need to provide the lender with copies of your bookkeeping records, as well as tax documentation and documents verifying your employment. Take a look at the documents you’ll need to provide when applying for a mortgage:
- Records of business tax returns, at least 2 years
- Records of personal tax returns (if asked)
Similar to employed people, just right loans lenders will also want to see a stable income. This means the income shouldn’t show a decline of over 25% in the past years.
Keep in mind, receipts or gross revenue don’t qualify as income. You’ll need IRS taxed income to qualify. Also, there are certain restrictions when it comes to business account funds, but that will depend on the type of mortgage product. To get more insight on the best way forward, consider consulting a home loan expert.
3. Asset Separation
One of the biggest mistakes small business owners make is mixing their personal assets and finances with those of the business. When you apply for a mortgage, you’ll need to prove your assets.
In this scenario, the best way forward is to make sure you separate the funds you’ll use in settlement fees and down payment from your business assets by putting the former in a personal savings account. This way, the process will be smooth.
Also, if you plan on using business assets to close, make sure you save the records and receipts to show the deposits. Closing costs can pile up quite fast, therefore, don’t forget to factor that in your budget.
Make sure all your taxes for the current year are paid to the IRS before making a mortgage application. Owing taxes to the government can present huge obstacles during the mortgage application process.
Additional Tips When Applying for a Mortgage
Making a home purchase is a great move, and this needs serious thought because of the magnitude of the investment. Therefore, it’s only prudent that you tread with caution to avoid complications. As an entrepreneur, your main focus should be on how the lenders will perceive your income.
For instance, start by getting rid of deductions you might write off. At that moment, this may not sound like the perfect idea, however, you’ll be relieved down the road that you took that step after submitting the necessary documents to the lender.
You also want to take a look at your credit score. According to a report by Zillow, employed people have higher credit scores compared to self-employed people. This means the chances of getting a mortgage with favorable terms for a self-employed person are less.To avoid this, make sure your credit utilization is below 30%. Also, make sure you pay all bills on time and in full. These two factors have a significant impact on your score. Improving them means a higher score and in turn better loan terms. As an entrepreneur, the road to home ownership comes with additional roadblocks. However, each roadblock is to ensure that you meet the necessary terms set out for a business owner. It’ll also show that you can afford the mortgage. With the tips outlined here, your journey to home ownership should be smooth.