Several times a year I have to tell a self-employed individual that they can’t qualify for a mortgage because their taxable income is just a little bit low to accomplish their goal of getting a mortgage.
Under the Dodd-Frank financial reform bill, lenders must document an ability to repay a loan before granting it. This means, for most, showing an actual taxable income that is adequate to meet the loan payment and all other monthly obligations and meet debt-to-income ratios.
In the case of a W-2 wage earner, we start with the gross income before taxes. In the case of a self-employed individual, we work off the adjusted gross income, which is the bottom line of page on a 1040 form. Typically we might have to average two years income, but in some cases one year will suffice.
Self-employed people are allowed a number of legitimate and generous deductions such as mileage, business use of a home office, and the ability to expense off in one year items such as new computers or office equipment. Some entrepreneurs take their work so seriously that it seems like, with every trip to the grocery store, they are scouting out new opportunities along the way and writing off the mileage.
Some self-employed people don’t make enough gross income to qualify for a loan, but many make the gross but max out every possible deduction and show very little taxable income. That may be good news when you have to write a check in April, but not so good when you come in to get a mortgage loan. While a lender is allowed to add back some deductions such as depreciation and part of home office expenses, we can’t undo what has been declared in most categories of deductions. We also can’t count the client who paid in cash that the busy entrepreneur forgot about when he was calculating his taxes.
In some cases, the borrower’s income is so low that, even if they had not taken every deduction, it’s impossible to qualify for much of anything. But many times I’ve seen applicants who were literally a dollar a month short to get the loan they want. In that case, we might have to reduce the loan amount slightly to make it work.
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Other times, though, the applicant might be a few hundred dollars shy of what is needed. In those instances, I can almost always look at the deductions and find one that, had it been lower, would have gotten to a yes on the loan approval.
While a borrower cannot declare they made more gross income than they actually did to qualify for a loan, there is no law that says one has to claim every possible tax deduction. If a borrower had decided not to write off a cell phone or max out mileage deductions, then he might pay a little more in tax but might also qualify for a mortgage loan.
So if you are self-employed and planning to get a mortgage loan in 2017 or 2018, you need to put an extra step in your tax planning. Not only should you discuss your numbers with your CPA, but also discuss them with a mortgage lender to see where you would need to end up income-wise to get the loan amount you would be looking for.
Chris Neuswanger is a mortgage loan originator with Macro Financial Group in Avon and may be reached at 970-748-0342. He welcomes mortgage-related inquiries from readers. His blog and web site is http://www.mtnmortgageguy.com
