For several years before the mortgage meltdown, small business owners only needed to show minimal paperwork that ‘proved’ the income they stated as theirs and the revenue that their business generated. In fact, it seemed back then that simply having a pulse qualified you for a mortgage. Even those whose income and business revenue did not truly support payments on a mortgage got one if they went to the right mortgage broker or bank.
“Before the housing meltdown, borrowers became accustomed to providing less documentation, which ultimately led to inflation of both income and assets for the purposes of purchasing homes,” says Don Frutchey, senior loan officer at Atlantic Coast Mortgage in McLean, VA.
That meant the self-employed, like many borrowers, ended up with more home than they could afford. And during the Great Recession, when many of their businesses faltered or outright failed, they lost their homes.
However, like much of the banking industry since the mortgage meltdown, the process for obtaining a mortgage for all consumers has changed dramatically. Laws have been enacted to protect consumers from mortgages they can’t repay. The laws that help prevent mortgage fraud and reduce foreclosures come with new requirements that the self-employed provide more and verifiable documentation.
“Just about every facet of mortgage lending is stricter, more closely reviewed,” explains Larry Finkelberg, co-founder and vice president of sales and business development at AmeriHome Lending in Rockville, MD. Since January 2014, like their employed counterparts, small business owners have had to be in a strong financial situation and show “ability to repay” to their mortgage lenders in order to obtain “qualified loans.” Mortgage brokers and lenders that don’t prove ability to repay for mortgage applicants can face fines and other sanctions. Underwriting for direct lenders has become very strict as well.
Small business owners, Finkelberg says, can expect to provide two or three years of verified personal income tax returns, business tax returns and balance sheets to prove they have the income to support mortgage payments. Depending on the source of your mortgage funds, your business financials may have to be audited as well.
Finkelberg also says that stated income mortgage loans are gone and are now illegal in some states. Frutchey and Finkelberg both agree that small business owners now have to show full eligibility for qualified mortgage loans that meet the new legal standard.
“The challenge for many business owners is the way they declare income and business expenses,” says Finkelberg, who is also the chairman of the board of the Rockville Chamber of Commerce. “Many want to protect their business revenue from income and other taxes,” which is legitimate but often reduces their adjusted gross income. That can affect their capacity to show “ability to repay.” Also, because federal law now requires that debt-to-income ratio be verified, any debts being paid by a business, like a car loan, should be removed from the business owner’s debt-to-income ratio.
A mortgage broker might give you access to mortgage loans from a variety of sources, but that may not be true if you go to a more traditional lending institution, like a bank or credit union. In fact, you can expect even stricter underwriting requirements because they’re the direct lender.
“Credit union mortgage underwriting is very conservative because credit unions are heavily regulated,” says Rick Wargo, general counsel of the Pennsylvania Credit Union Association. “The credit unions never did business in the same way as the rest of the industry,” he adds. Therefore, you can expect to put down the standard 20% down payment for your mortgage and show at least three years of returns.
In addition to business documents, you will need to provide the same supplementary documentation as other consumers. This is another reason it’s important for you to keep good records. “Smart business owners get out in front of this process early by consulting with a qualified mortgage broker or lender a few years before they plan to buy,” says Finkelberg. Doing this will help you be prepared when you begin applying for mortgage loans; you won’t lack proper documentation, the required down payment, assets and/or collateral, and a strong enough credit score, among other requirements.
Finally, small business owners who are looking for a mortgage broker or lender should go to one who understands the unique needs of self-employed borrowers. That’s because, just as for employed consumers, “Communication and understanding of the process are critical. If you don't submit loan documents properly, it could create problems that are hard to fix,” explains Finkelberg.
By knowing the new rules and meeting all of the requirements for a post-housing meltdown mortgage loan, even as a small business owner, you should have few difficulties with obtaining financing for your next residence.