Being self-employed has several advantages, but getting a quick-and-easy home loan no longer makes the list.
It used to be — before the mortgage-industry meltdown two years ago — that self-employed people were able to obtain loans based on "stated income." This meant the mortgage broker or loan officer would simply ask the applicant how much income they earned per year (in some cases with no further questions asked, no documentation required), and a loan would be drawn up.
"If you had a high enough FICO score, some money and you could verify you're working, we could do that loan," says Kathy Sanders, operations manager at North Pacific Financial Corp. in Medford.
"There were even some where all you needed was a credit score," says Sanders. "They no longer have those loans."
The problems with this honor-based system seem pretty obvious now; after all, it was this sort of corner-cutting that led to tens of thousands of people getting into home loans that were way beyond their ability to repay.
These days, as anyone who has applied for a home loan knows, new heights of hoop-jumping are required. This is especially true for the self-employed. Here are a few tips from Sanders on what to expect and how to be prepared.
Establish your business.
"The lenders require that you're self-employed in the same line of business for two years consecutively," says Sanders. To avoid more paperwork, strongly consider waiting to convert the structure of your business (to a limited liability company, etc.) until after the loan is approved.
Keep your income on the incline.
"We're looking for a 24-month income average to get a true history of it," explains Sanders. "If it fluctuates up and down and up and down, or if one year was good and this year is slow, I'm seriously going to look at your declining income because that's what you're making now. Will it be enough to support the mortgage in the future if it doesn't go up?"
Tell the truth to the tax man.
"Report to the IRS what you truly make because we can only use what you report to the IRS, and we're now required to verify with the IRS," says Sanders.
Skip the write-offs.
Claim all the income you can for two solid years. "If you're looking to buy a home, but you want to write off all your income because you don't want to pay Uncle Sam, it's not going to work," warns Sanders.
Claim a few bonuses from the IRS
It's not all bad news for the self-employed: Tax deductions claimed for equipment depreciation and the costs of working from home can both be added back to the total income.
Put business expenses to work for you
Never pay for business expenses with cash, says Sanders. "It's a paper-trail nightmare." Pay for everything through a business bank account. "If we can verify, and I get 12 months of canceled checks or statements, I don't have to hit you for the expenses," she says. Online accounting is the most efficient and preferred method of accounting. "It shows it all right there, and it's very easy and can be a huge benefit for qualifying reasons."
Make an appointment
Even though their hoops are higher and sometimes narrower, self-employed people are still eligible for all sorts of conventional and government loans. To find out what might fit with your profile, call a trusted — preferably local — mortgage banker, mortgage broker or finance company and make an appointment. They'll probably ask you to bring in two years' worth of tax returns, six months of income reports and pay stubs and a few other pieces of simple paperwork.
Then take a deep breath and prepare to start jumping through those hoops.