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Self-employed borrowers are treated differently

Being self-employed certainly has its advantages as well as its disadvantages but when it comes to obtaining a mortgage, self-employed individuals will find that mortgage industry rules are more favorable towards those who are working for others. The income used to qualify a self-employed borrower must be taken from the most recent federal tax return (Schedule C net profit); whereas, an employee may use the income from the most recent raise. To qualify with the income from one year of tax returns, the borrower must have been in business for at least five years. If self-employed less than five years, income will be averaged over two years of the most recent tax returns.

Cash that sits in a business account of a self-employed borrower that is expected to be used to cover the down payment or closing costs for a home purchase may or may not be acceptable to the underwriter. The reasoning (correct or not) is that the business may be hurt by a depletion of business funds. If business funds are to be used, a CPA letter stating the business will not be hurt by removing funds from a business account may be required. Unfortunately, for liability reasons some CPAs are not willing to write that letter and with that in mind, money not needed to keep the business healthy should be transferred into personal accounts several months before applying for a mortgage.

Some self-employed business owners may be inclined to overstate their deductions in order to minimize their income tax liabilities; however, since the mortgage industry uses the business’s “net profit” as stated on the federal tax returns, the more deductions claimed, the lower the net profit. Since the mortgage industry uses the self-employed borrower’s net profit to determine a borrower’s home purchasing power, more deductions mean lower net profit which, in turn, mean lower purchasing power.

Borrowers who own 25 percent or more of a partnership, LLC or corporation must also provide the partnership returns and/or corporate returns. For example, a borrower may consider himself an employee if he is working for a corporation but if he or she owns 25 percent or more of that corporation, the mortgage industry will treat the borrower the same as a self-employed borrower.

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