Homeownership down among self-employed, but that’s not the whole story
According to the Urban Institute, “At all income levels, mortgage use and homeownership rates declined more for self-employed households than for salaried households between 2001 and 2016.” There are many reasons for this, but there is also good news for self-employed home buyers. If you’re one of them, you have options in 2019.
The news is not bad
Self-employed home buyers often worry about their ability to qualify for mortgage financing. However, as someone who last held a full-time job in 1972, all I can say is: relax. I’ve never been turned down for a mortgage. And I can assure you, I’m not on any list of the wealthiest Americans.
To me there has never been a better time for the self-employed to obtain real estate financing. That’s not just an idle observation. There are several reasons to support such thinking.
No tax return needed
Since 2010 the mortgage industry has operated under rules laid out by the Dodd-Frank Act. The law runs 849 pages and the juicy part for the self-employed reads like this:
A lender “making a residential mortgage loan shall verify amounts of income or assets that such creditor relies on to determine repayment ability, including expected income or assets, by reviewing the consumer’s Internal Revenue Service Form W–2, tax returns, payroll receipts, financial institution records, or other third-party documents that provide reasonably reliable evidence of the consumer’s income or assets.”
The rules mean lenders can look at far more than pay stubs and W-2s when checking borrower income. This is great news for the self-employed, because we simply don’t have such documents. However, we have tax returns and bank records. They’re surely anyone’s definition of “reasonably reliable evidence” to show our income and assets.
The real challenge is finding mortgage lenders willing to put in the extra work for those with this kind of documentation. And with lending business tapering off, and a huge pool of self-employed applicants, it’s getting easier — a lot easier.
The gig economy is exploding
It used to be that the definition of “work” pretty much meant a nine-to-five job. That wasn’t true in the past and it’s not true now. Look around. We are surrounded by the self-employed. Your lawyer, accountant, plumber, electrician, and computer repair pro have long been part of the gig economy.
“Climbing the corporate ladder is no longer the American dream,” says FreshBooks in its latest Self-Employment Report. Over the last few years a significant mindset shift has taken place, and with it has emerged a workforce which values flexibility over stability.”
With downsizing, rightsizing, automation, and the job exports to places far away corporate employment is no longer so stable. More of us have to be self-employed because traditional jobs are a vanishing species. According to Sen. Mark Warner (D-VA), 30 percent of the labor force – 42 million workers – are now part of the gig economy.
The fact that so many people are self-employed has created a new reality for lenders: either adapt to the gig economy or lose a lot of business. Lenders, as you might expect, are adapting.
The paperwork shuffle
There’s no reason why self-employed home buyers should not be able to get real estate financing. The trick is to overcome the two big worries feared by lenders.
According to Fannie Mae, 95 percent of all lenders “think it is difficult to use gig economy income to approve mortgage applications with today’s lending practices. Top barriers include unpredictability and instability of gig economy income, investor requirements, and underwriting criteria standardization.”
“There is wide recognition that self-employed people find it more difficult to get approved for a mortgage than people who receive a regular paycheck,” said the Urban Institute. “The self-employed can be more difficult to underwrite in part because they, unlike salaried workers, experience greater income volatility and lack pay stubs or W-2 wage statements that make it easy for lenders to verify and document income.”
Less caution, more common sense
Part of the problem is that lenders have a need to be super-cautious when originating mortgages. A lender who violates program rules, even accidentally, can sometimes be forced to buy back loans from investors. Also, there can be big fines when incorrectly originating FHA- and VA-insured mortgages.
Sen. Warner and Sen. Mike Rounds (R-SD) introduced legislation in 2018 that if passed would allow lenders to accept a wide variety of paperwork for all types of loans. Under the proposed Self-Employed Mortgage Access Act, limits on the use of IRS Form 1040 Schedule C for sole proprietorships, IRS Form 1040 Schedule F for farming, IRS Form 1065 Schedule K-1 for partnerships and IRS Form 1120-S for S Corporations would be eased or eliminated.
Since the Warner and Rounds legislation did not pass in 2018 it will have to be re-introduced in the next Congress.
Mortgages for self-employed home buyers
Even without the new legislation there are plenty of borrowing options available today for self-employed home buyers.
Bank statement mortgages
Lenders – and credit scoring services – have begun to increasingly look at bank statements as an index of borrower income and financial stability. In 2019 new scoring models from Fair Isaac (UltraFICO) and Experian (Experian Boost) will ask consumers for permission to track bank account activity. Fair Isaac estimates that “seven out of 10 consumers who exhibit responsible financial behavior in their checking and savings accounts could improve their score” with the new approach.
Lenders who accept bank statements will likely want all statements for the past 12 to 24 months. In a growing number of cases with your approval they will be able to get such documents electronically from banks.
Most mortgages are originated by lenders and then sold to investors through the secondary market. However, there are some lenders – so-called portfolio lenders – who keep some of their loans. Because such mortgages are not being sold to investors they do not have to meet investor or program requirements. Instead, they have to meet bank standards. Bank standards are often much more open to the self-employed. If you have a personal or business account with a local bank be sure to ask about portfolio mortgages.
Two-years of self-employment
Many mortgage programs require two years of self-employment. However, you have to look very carefully at how that “two years” are defined. If you’ve had a career in computer programming and now want to do auto repair the two-year standard will likely apply. However, if you’re moving from corporate accounting to your own practice one year of self-employment may be acceptable.
Lenders are very happy to look at tax returns and that’s good for the self-employed. Why? First, because you have them. Second, they can raise your qualifying income. For instance, lenders can add depreciation back to your income. Lenders can “gross-up” untaxed income such as military allowances and child support to increase qualifying income.
For details and specifics speak with lenders. Let them check tax returns and other paperwork to get the best sense of your borrowing ability. In today’s gig economy you’re likely to well with most lenders.