David Brannan, 44, is co-founder of a software company that’s been in business since 1989. He and his wife have owned their home for 18 years and are in the process of buying a new, custom-built home. Brannan has an excellent credit score.
So he was stunned last week when CitiMortgage, which just a week earlier had said everything was in good shape, sent a letter saying his mortgage application had been rejected. It suggested he consider credit counseling.
Brannan called Citi, which told him his income for the past two years wasn’t enough for the size of the loan. He says Citi refused to include profit distributions from his company that account for more than half his income. (CitiMortgage declined to discuss Brannan’s application. But spokesman Mark Rodgers says the company will restructure or decline a preapproved loan if it can’t sufficiently verify information from a borrower.)
Brannan belongs to a group that’s become a kind of drive-by victim of the mortgage industry crisis: the millions of Americans who are self-employed.
Changing Marketplace
Some lenders that specialized in home loans to self-employed workers and small-business owners have gone out of business. And many lenders that still offer such loans have tightened their standards, making it harder for self-employed borrowers to qualify for a loan.
Self-employed borrowers can usually still get a mortgage, says Bill McNamee, president of Pinnacle Home Mortgage. But “The rates they’re paying a lot of times are higher, because [lenders] have decided the risk level is higher.”
Most self-employed people can’t provide the types of documents that lenders typically rely on for proof of income, such as W-2s and pay stubs. To address that problem, the mortgage industry created “stated-income” loans, which don’t require as much documentation.
During the real estate boom, though, some borrowers used stated-income loans to inflate their incomes, enabling them to qualify for mortgages they couldn’t otherwise afford, says Marc Savitt, president of the National Association of Mortgage Brokers. The increased scrutiny of these loans, Savitt says, “is part of the shakeout” of the subprime collapse.
New Rules
Here’s what self-employed borrowers need to qualify for a mortgage in this new environment:
More documentation. Along with two years of tax returns, self-employed borrowers might be asked to provide a profit-and-loss statement, bank statements and proof that they’ve been in business for at least two years.
In the past, self-employed borrowers could provide a letter from their accountant, verifying that they’d been in business for at least two years, says mortgage broker Lisa Alley.
But now, Alley says, many lenders require further verification, such as a business license.
Gathering all that information takes time. Self-employed workers who are considering buying or refinancing in the next few months should “start working on getting your paperwork and financial house in order,” says Gene Tricozzi, a mortgage broker at Northern Funding.
Fewer tax deductions. Shane Backer, a broker in New York, says one of his clients, a self-employed taxi driver, is having a hard time getting a loan to refinance his home mortgage, even though he earns about $85,000 a year. The problem: The taxi driver claimed a lot of tax deductions on his tax return last year, and his business shows a loss.
Self-employed taxpayers are eligible for a long list of tax deductions and write-offs. They can deduct the cost of computers and other equipment, home-office costs and transportation, among other things. From a tax standpoint, it makes sense to claim as many as the law allows. But it can also make it harder to get a mortgage, Savitt points out, because deductions reduce the amount of income on a self-employed borrower’s tax return.
Savitt says self-employed workers who plan to buy a home in the next year or two might want to forgo some deductions. “Make sure you can show as much income as possible,” he says.
Larger down payments. With the market for stated-income loans shrinking, lenders that still offer them are demanding more cash on the table. Stated-income loans that accept zero down payment have pretty much disappeared, Tricozzi says.
He says he’s still finding loans for self-employed borrowers who can put down 10 percent of the value. A few lenders, he says, are offering loans with a 5 percent down payment — but only to self-employed borrowers with higher-than-average credit scores.