In underwriting a home loan, generally the income from a borrower who is an employee (that is paid regularly and who receives a W-2 at the end of each year), is whatever monthly income the employee is making at the time of the loan – including recent raises. JMAC’s brokers know that borrowers who are self-employed, however, often feel as though they are being discriminated against when it comes to qualifying for a mortgage. And rightfully so: income used to qualify for a mortgage for a self-employed borrower must be averaged over a 12 – 24 month period.
For sole proprietors, the income that is used to qualify the borrower must come from the bottom line on Schedule C of the federal tax returns. It is called “Net Profit” and is divided by 12 to come up with the monthly qualifying income. The net profit is what is left after the taxpayer deducts all of his expenses from his or her gross income. The more deductions the taxpayer claims, the lower the net profit and the lower the income tax liability; however, it also reduces the purchasing power of the borrower. Our brokers know that a borrower can’t have one set of books for a loan and another set for taxes.
Since many lenders want to average the self-employed borrower’s income over the last two years of federal tax returns, any increase in profits realized by the borrower from one year to the next is diluted when the sum of two years of net profits must be divided by 24. To top it off, when a self-employed borrower’s income drops significantly from one year to the next, it is the income on the most recent tax returns that is used to qualify the borrower and an explanation as to why their income is dropping is required.
Our brokers explain to borrowers that cash that sits in a business account of a self-employed borrower will generally not be accepted as cash that can be used to cover the down payment or closing costs for a home purchase. Generally borrowers who own 25 percent or more of a partnership, LLC, or corporation must also provide the partnership returns and/or corporate returns for two years – like a self-employed borrower.
There are, however, some programs that are better for self-employed borrowers, and that can be explained by your JMAC AE. Give them a call!