Self Employed Mortgages
It is generally more difficult for self employed persons to obtain a mortgage loan to buy a house. This is because it is quite difficult to predict cash flow and profitability of a self employed person and therefore, loan guaranteeing income would be difficult to prove for the lender.
In addition to this difficulty, it has been found that the loans that have been granted with minimum or no documentation in 1980s, many of them were self employed persons, have shown significantly higher rates of default than those with standard documentation. This has made the lenders more cautious in dealing with self employed people.
The two major areas self employed people face problem for the processing of mortgage loan are regarding net income and documentation.
In the month of April, income tax deduction is a great advantage for self employed people. But, it would become a hindrance for granting a mortgage loan. This is because the tax payment directly reduces the person’s net income.
A self employed person who is presently paying a $1200 mortgage might not be eligible for even the half the present loan amount because of this tax deduction, even after a certain amount of deduction is written back for the purpose of the evaluation of the application.
The self employed person is required to provide more extensive documentation for a mortgage loan. This is because there is more scope for information provided to be cooked up.
Additional information that is required to be provided by a self employed person, besides the standard items that must be provided, might include copies of two years of filed income tax returns with all necessary schedules, an audited or professionally-prepared balance sheet for the previous two years, and a year-to-date profit and loss statement for sole proprietors. If the business is a corporation or partnership, signed copies of the previous two years’ federal business income tax returns (with all schedules), a year-to-date profit and loss statement, and a business credit report may be necessary.
Lenders generally calculate the income of self employed applicants by using the following formula: with the provided income tax returns, the applicant’s net income ( which is after considering all expenses but before deducting tax) for the last two years is computed.
Then year to date income (again, after considering all expenses but before deducting tax) for the current year is added to the total. Finally, this sum is divided by the total number of months involved to arrive at an average monthly income of the borrower.
This will give some idea to self employed persons regarding the procedure they should adopt to obtain a mortgage loan.
