What Self Employed Borrowers Need To Know About Refinancing
Written by Jason Nelson on November 6, 2018
Congratulations on being Self-Employed! You have the very best boss in the world – you. Setting your own schedule, picking when you want to work are all great ways to give you control and flexibility in your busy life.
Being self-employed, however, presents some challenges in the financial world. It’s not enough to just work for your money. You also have to keep accurate records of sales and expenses. But Expenses, Write-Offs and that horrible term – Debt to Income Ratio, is not the “kiss of death” you might think it is.
Most people wrongly believe that self employed borrowers can never get refinanced. Self-employed borrowers qualify for mortgages in almost the same way as a person on a salary or one that is paid hourly wages.
Averaging the Income
Just like salary or hourly employees, self employed borrowers must show two years work history. The difference is that it must be two years of self employment income. Unlike salary or hourly personnel, however, where the most recent pay stubs are used to calculate monthly income, self employed borrowers’ two years self-employment income is averaged over the 24 months to arrive at a monthly income. Let me stress that in most cases, the two previous years of Personal Federal Tax Returns including all schedules, and Corporate Tax Returns, if applicable, will be required to calculate that monthly average.
Lenders will examine the Net Income. Net Income is the income that is left after all the business expenses have been paid. If you expense everything that legitimately lowers your tax liability, it also lowers your Net Income.
The way that lenders examine your Net Income is far different than the way the IRS does – to your advantage. For example, if your Net Income over 2 years is $150,000 (after all expenses have been paid), and, your Schedule C (or Corporate tax return), shows $5,000 in depreciation, lenders will add those together to give you a net income of $155,000 for 24 months or $6458 per month – That’s the income that would be used to qualify for a mortgage.
There are other items that can be added back to your Net Income. Your mortgage lender can help you calculate the income accurately.
There are no differences in credit analysis from self-employed borrowers and salaried employees. Self-employed borrowers may have more inquiries on their credit because of the business. Too many inquiries indicate your attempt to buy on credit. That in itself makes you a higher risk to lenders. Careful use of credit is important for all borrowers regardless of employment status.
Make those minimum payments – PERIOD. If you have a minimum payment of $5.00, make that payment. Let’s face it, that $5.00 is certainly not going to make or break the creditor, but it will break you if you don’t make it. When you are approved for credit, you agree to monthly payments. Not making even the minimum monthly payment will negatively impact your credit and perhaps, prevent you from any financing for two years.
While planning your goals for your business, remember to plan for those financial and mortgage needs in your personal life as well. Arm yourself with knowledge about the process and your refinance will be as smooth as silk.