I hesitate to say it is more difficult to obtain financing for self employed individuals but unfortunately that can be the case. Not every self employed borrower is difficult-but there are a host of different rules and criteria that have to be met for the self employed person to be successful in their quest of a mortgage.
The first hurdle that has to be cleared is the self employed business owner must have filed tax returns on the business for two years. (There is an exception with one of our lenders that allows for one year if the borrower has a previous employment history in the business he now owns-but solid net profit has to be demonstrated in that one year in order to qualify.)
The second item on the list is the answer to this question: What was the average net profit over the past two years? This is important as many accountants instruct their clients to take as many expenses against the business as possible. That may make perfect sense tax wise, but that practice can make a mortgage loan impossible. For mortgage purposes what has to be computed is the net profit-sales, less all
expenses plus depreciation added back in and averaged over a two year period.
If for instance over the past two years a business has shown a loss-the owner will not be eligible for a mortgage based on his business income. Cash flow and sales are irrelevant-it's the bottom line that matters. So if you are thinking of getting a mortgage and you have shown losses for the past two years, you will need to get with your accountant and structure your tax returns to show enough profit to cover your consumer debt and a house payment for the next two years. Obviously, purchasing a home when one owns their own business requires planning.
But let's say the borrower, though self employed has a spouse who is a W2 employee and makes a good living. That's great-but if both parties file taxes together, the W2'd spouse has to have enough income to deduct the losses of the self employed husband or wife and still have enough income to qualify for the mortgage.
What if you decided to move from being a partnership to an LLC or S-Corportation? The new W2 income can be accepted, but if you are paying yourself bonuses or dividends again, they can't be counted without a two year history. In addition if the business returns show losses, then those loses have to be deducted from the W2 income.
Let's assume that the owner has been in business for two years or more and is showing enough profit to contemplate purchasing a home. Are the owner's bank accounts separated from his/her personal accounts? What about credit cards? Are the credit cards associated with the business paid out of a business bank account? Vehicles as well? My advice is keep business bank accounts, credit cards, and vehicles separated from all personal accounts. Otherwise you must put the business expense into personal expense which could run the debt ratio so high that mortgage financing is no longer possible.
It is also important to keep in mind that while money from a business account can be used in mortgage transaction, often you will need the services of your accountant to verify that using the money will cause no harm to the business. In addition, after the first quarter of a year you will be required to prepare a profit and loss statement for your mortgage lender so the underwriter can get a feel for how the business is doing year to date, and some loans require audited profit and loss statements which can run into significant money to prepare.
I have done many loans for self employed borrowers-but the rules are not the same. More preparation is involved and that is good to know before you have your heart set on buying a particular home.
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