Michaela Phillips, Guaranteed Rate, Inc.
Owning a home is part of the American dream, something that should be accessible to all. However, if you’re self-employed, securing a loan just became a little more difficult. This is because Freddie Mac recently tightened their guidelines for entrepreneurs.
Self-employed in America
Self-employment is fickle nationwide – the trend goes up and down – but it’s consistently very ubiquitous. According to the Pew Research Center, self-employed people represent 10 percent of the nation’s workforce. This amounts to approximately 146 million workers.
Mortgage loan constraints
If you own your own business, mortgage loan constraints can be an issue; banks balk at lending to those they deem high risk. This doesn’t mean it’s impossible, however. Lenders are cognizant of the need for new risk assessment models and are working to meet this demand.
As of now, a self-employed person qualifies for a mortgage the same way as a traditional worker: through down payment, credit history, and debt-to-income ratio. The difference lies in the documentation required; the self-employed must provide more.
Freddie Mac’s new guidelines
Previously, an entrepreneur could qualify for a loan by providing one year of tax returns for income verification. This was beneficial, particularly for people who owned businesses that weren’t profitable in their early days. But the rules have changed. According to Freddie Mac, the new guidelines include:
– The number of years of tax returns required will be based on the number of years the business has existed.
– For businesses in existence for at least five years, one year of business and personal returns are now required.
– For businesses operating less than five years, two years of business and personal returns are now required.
– Businesses must verify their years in existence with a CPA letter, a secretary of state filing, or other documentation.
What these guidelines mean for the self-employed
If your business has existed for five years or more, the above guidelines aren’t likely to change much; one year of tax returns are still required. However, if your business is young – under five years – these guidelines can hinder your ability to qualify for a loan.
As reported in the Houston Chronicle, the time it takes a business to become profitable is highly variable. Still, most self-employed entrepreneurs expect to make less than they did in their first year, break even in their second, and turn a small profit in their third.
For lending purposes, this is important: when submitting one year of taxes, a twelve-month average is used to calculate income. When using two years, a twenty-four-month average is used. This can alter your qualifying income if you made significantly less in the previous year. In other words, if you lost money last year, but made money this year, those losses bring down your recent profits and make you appear riskier through the eyes of the bank. This influences their decision-making and weighs heavily into whether you’ll qualify for a loan.
The good news is these guidelines haven’t gone into effect yet; the old guidelines apply to anyone closing on a mortgage before June 15, 2017.
Of course, this doesn’t mean home buying is off-limits for new business owners who miss the deadline.
By Michaela Phillips, Guaranteed Rate, Inc.
Michaela Phillips is the Vice President of Mortgage Lending at Guaranteed Rate, Inc. Contact Michaela at 303.579.5517, e-mail [email protected] or visit michaelaphillips.com. NMLS:312874.
