Self-employed borrowers can have a difficult time applying for home loans these days in San Diego (and all of California for that matter). The issue really comes down to income calculation. Self-employed borrowers many times have years that are up and down for income or they may have years with lots of write-offs not showing much income. W-2 salaried employers generally have an easier time obtaining a home loan because their income is steadier and they do not have as many write-offs. But the good news is there are many solutions for self-employed borrowers to obtain a home loan today.
First let’s determine how a lender calculates income for a self-employed borrower:
- The most important documents in a calculating a self-employed borrower’s income is their last two years federal tax returns.
- The lender will take the NET taxable income (after all write-offs) off a borrowers tax return and average the last two years NET income to determine a borrowers income for loan qualification.
- If the income is declining from one year to the next, the lender will just take the recent year and not do an average. If the income has risen from one year to the next, the lender will do an average.
- There are write-offs that can be added back to a borrower’s income. Depreciation is the most common tax deduction that can be added back. And there are other items that can be added back depending on the loan type; conventional, FHA, VA. For conventional home loans, generally the deduction for business use of home can also be added back and some other write-offs as well.
- If the borrower’s income declines by a very large amount from one year to the next, the lender may decline the loan due to severe declining income.
- If a borrower files an extension on their tax returns, the lender will not require that years returns until October 15th of that year. So for example if a borrower is applying for a loan in 2014, the lender would normally require the borrower’s 2012 and 2013 federal tax returns to determine their income. However if a borrower files an extension, up until Oct 15th the borrower could use their 2011 and 2012 returns to qualify.
S Corporations and C Corporations
- If a borrower operates as an S Corp or C Corp, the lender will determine the borrower’s income by what flows through to their personal returns. All pages of last two years S or C Corp returns will be required as well as all pages of personal returns.
Borrower just moved from a W-2 job to being self-employed of a 1099 contractor
- In this case a borrower will need to be self-employed for two years in order to apply for a loan
- However I will offer some solutions around this below. I will explain some options for borrowers where only one year of tax returns is required.
Next I want to talk about some of the options out there for self-employed borrowers having difficulty getting approved for a home loan.
Using only the most recent years tax return
A great option for borrowers who may have not shown much income the previous year is the option to use only one year of tax returns to apply for a loan. This is very possible for a borrower who has 20% down payment using a conventional or jumbo loan. This option is not possible for borrowers applying for less than 20% down conventional, FHA or VA home loans. With a conventional home loan, the borrower is run though the desktop underwriter (DU) automated underwriting system. And if the DU system comes back with a response only requiring one year’s tax returns, then the borrower is in luck and the lender will only need their most recent year filed return to determine income.
No income verification loans or “stated income” loans
A no income verification loan (NIV) is a loan where a borrower does not have to list their income on a loan application and the lender will not ask for any tax returns. The lender will be evaluating the borrower solely on the basis of their credit score and cash reserve assets in the bank. These home loans are now available again in San Diego and across the state of California, and are available even up to loan amounts in the millions. The lender will usually require at least 20-30% down payment on these loans.
Stated income loans are home loans where a borrower will list their income on the loan application and the stated income will be used to approve the borrower for a home loan. Like NIV loans, no tax returns or income documentation is required on these loans.
So for a self-employed borrower who does not want to have to provide their last two years tax returns, stated income and NIV home loans can be a viable option for purchase or refinancing options.
FHA, VA and other low down home loans
As mentioned above, any low down payment home loans (often used by first time home buyers) will require full last two years of tax returns for a borrower to qualify. FHA loans only require 3.5% down and allow for very high debt-to-income requirements so they can be excellent options for self-employed even showing limited income.
Adding a co-borrower to qualify
Another option for a self-employed borrower who does not have sufficient income from their tax returns to qualify is to find a co-borrower. A co-borrower does not have to live in the property. Both FHA and conventional home loans allow for a “non-occupant” co-borrower to go on the home loan to help a borrower meet the debt-to-income ratio requirements to qualify for a home loan.
So I hope that helps you better understand the options for qualifying for a home loan being a self-employed borrower in San Diego or anywhere in California. Don’t hesitate to call or email me if you have any questions at all about qualifying for a home loan in California.