As a small business owner, you have a few extra hoops to jump through when trying to get a mortgage approval. They aren’t impossible hurdles, though. As long as you know what to expect, you can prepare yourself.
Follow the steps below to properly prepare yourself and watch how easy it is to get the mortgage approval that you need.
How Much do you Own?
First, let’s start with your percentage of ownership. Are you the sole owner? If so, lenders will consider you self-employed and treat your mortgage guidelines as such. If you own the business with someone else, though, you need to know what percentage you owe. If it’s more than 25% of the company, then you are self-employed and must follow the guidelines below. If you owe less than 25% of the company, you aren’t considered self-employed and can follow the standard loan guidelines.
Provide All Income Documents
If you are self-employed, you must provide different income documents than the standard borrower. At the very least, lenders need all schedules of your personal income tax returns and a year-to-date Profit & Loss statement. If you use business income to qualify for the loan, lenders also need all schedules of your business tax returns.
Lenders use your tax returns to determine your income after expenses. This means any expenses you write off on your tax returns may count against you when looking for that mortgage approval. This is when it pays to prepare yourself ahead of time. Go over your tax returns and determine which expenses you can avoid writing off for the time being. While you’ll have a higher tax liability for a few years, it will help your case when you apply for a mortgage.
Lenders use your adjusted gross income because it reflects the costs you have for running a business. When you work for someone else, you don’t have those costs. As a self-employed borrower, you have more on your shoulders. Lenders need to make sure you can comfortably handle a mortgage payment on top of these responsibilities.
Dividing Up the Income
If you own a business with someone else, the lender will multiply the profit or loss by the percentage you own. For example, if you own a business 50/50 and your business had a profit of $1,000,000, you would get to use $500,000 as your income. If you own a side-business, say owning 25% of a business, you can add the profit or subtract the loss from your other income, even if it’s earned income from an employer.
Watch the Income Fluctuations
One of the biggest things to watch is how much income changes from year to year. If your income increases, you don’t have a lot to worry about. On the other hand, if your income decreased from one year to the next, you may have a few more hurdles to jump through.
Lenders look for reliability and consistency in your income. If you have a decrease in income, that doesn’t show either characteristic. It gives lenders something to worry about when looking at your income. They want to know that your business will succeed and that your income will remain steady moving forward. If your business did experience a decrease in income, be ready with an explanation. If it’s something the lender can accept, they may require a few compensating factors in order to give you a mortgage approval. If it’s a red flag, in their eyes, though, you may have to wait until you have more stable income.
Get Compensating Factors
The one thing any self-employed borrower can do is secure some compensating factors. In other words, you can offset the risk of your self-employment income with some of the following:
- Reserves – Liquid reserves, such as savings accounts, stocks, or bonds can help your case. Lenders compute your reserves based on the number of mortgage payments they cover. For example, if your mortgage payment would be $1,000 and you have $10,000 in liquid assets, you have 10 months of reserves. This gives lenders reassurance that you can pay your mortgage even in tough times.
- Low debt ratio – The fewer debts you have when you apply for a mortgage the better your chances of approval. Lenders want to know that you aren’t stretching yourself thin financially. They want to know that your housing payment can be easily afforded and that your total debt ratio doesn’t exceed 43% of your monthly income. The lower your debt ratio is, the better your chances of approval as a self-employed borrower.
- Good credit score – Your credit score is the first impression a lender has of your financial responsibility. A high credit score means you probably pay your bills on time and you don’t overextend your credit. A high credit score can help offset the risk lenders feel about your self-employment.
Self-employed borrowers have similar guidelines to employed borrowers with a few twists. If you want that approval, it’s best to get your affairs in order a year or two before you apply for the mortgage. This way you can maximize your qualifying factors and increase your chances of securing the loan.