Mortgage Pitfalls for Self-Employed
Have the revenues from your business been solid over the past two years? Great! Well that’s not good enough to get a mortgage. Here are two main reasons:
- If you have been maximizing expenses in order to minimize your taxes payable, remember that it is the net (after expense) income from your business that is used by a lender to calculate your qualifying ratios
- If your projected income in the current year is lower than the income reported in your tax returns over the past two years, a conventional lender may decline your loan request outright
The Federal National Mortgage Association (Fannie Mae) publishes self-employment income guidelines for lenders. To qualify for a mortgage, your self-employed net income should be stable, predictable and “likely to continue”. While having guaranteed, contractual income is not a requirement, lenders carefully analyze the financial strength of your business, your sources of income, and the economic outlook for your industry.
Some suggestions to maximize loan approval probability:
- Understand how the lender calculates your debt-to-income (DTI) ratio – especially if your most recent tax return shows declining net income
- Produce a current year Profit and Loss Statement (P&L) showing year-to-date actual figures along with realistic projections for the remainder of the year
- Show that your company distributes less income than it earns (to demonstrate growing cash reserves)
- Ensure the new mortgage payment (for which you are applying) is in line with or lower than your current rent or the mortgage payment on your existing loan.
Here’s the Point: Make sure you produce a solid Letter of Explanation (LOE) to your lender that will support the continuity of earnings from your business.