(Editor’s note: Information in this article is subject to change as the GSEs continue to update requirements.)
BLOG VIEW: According to Pew Research, about 16 million Americans are self-employed in the United States. This means about 10% of jobs in the U.S. are people working for themselves and owning their own businesses. With such a high number of self-employed workers, lenders can expect to work with at least one self-employed borrower during their career.
Each type of borrower requires some individualized attention, and self-employed borrowers are certainly no exception. A self-employed borrower is someone that owns 25% or more of a business and that business will be a source of the income used to repay the mortgage loan. Due to the nature of their income, there are quite a few different steps to take to ensure the borrower qualifies for the loan and is using appropriate funds. For agency or qualified mortgage (QM) loans, lenders must gather unique information from self-employed borrowers and communicate that effectively so that both lenders and borrowers are able to keep the process running smoothly.
When dipping your toe in the self-employed borrower pool, it is important to have an open dialogue about their financial history. Let them know that they must be transparent about incomes and financial history. Simply providing a tax return won’t always be enough for lenders to understand the borrower’s unique situation. Getting context from the borrower will help lenders identify any spots in the mortgage lending process that may need some extra attention.
It also is important that lenders clearly communicate what they need from borrowers so there aren’t any delays in the process. For agency or QM loans, lenders will need a full set of both personal and business tax returns with schedules, worksheets and statements. Often times, borrowers will not provide comprehensive information, likely only providing a tax return, which may lead to snags down the road. Lenders should be very clear about all the required information and documentation they’ll need from the borrower in order to create a seamless and positive experience.
There are a couple of tips that lenders should keep in mind as they work with borrowers who own their own businesses. The first is to analyze if the business is solvent and profitable.
It also is important for lenders to know that there is no one line on the tax return they can look at in order to approve someone for a loan. They must be able to understand the whole return, including adjustments and more, in order to discern what the actual qualified income is that they can use. There will be quite a few numbers on the return that are meaningful, and lenders should be able to not only identify them, but understand them as well.
The COVID-19 pandemic also has introduced a few more intricacies into the process of working with self-employed borrowers. It is now more important than ever to assess the business by asking questions like: Is it stable? What is its potential cash flow? Was the business financially strong pre-pandemic and is it financially strong now? What is the product or service? Is it seasonal? Is the business open right now? Is it essential in the current environment? Lenders must really dig in and determine that the borrower’s personal income derived from this business will feasibly be enough to support a given loan.
Also, Fannie and Freddie recently announced that lenders will no longer just look at historical income over the past two years, but borrowers also will need an audited profit and loss statement (P&L), or one that can be backed up with business asset statements
Timing for the verification of the existence of the business has been cut down from 120 days prior to close to just 20 days now to prove the business is open and operating.
There always have been concerns about accessing business funds for personal mortgages, even before the pandemic, but this concern has increased recently. With many businesses now approved for Paycheck Protection Program (PPP) loans, it is increasingly important to verify that any business assets used for down payments or closing costs are not from PPP funds, as they are only meant to be allocated for payroll purposes. Additionally, lenders must verify that the withdrawal of those funds will not have a negative impact on the business.
Working with self-employed borrowers can present different challenges, especially in today’s environment, but that should not discourage lenders. It is important to be prepared to communicate clearly and set expectations for what is needed from the self-employed borrower, while also knowing what is expected of the lender. When communication is clear and expectations are set, lenders no longer need to view self-employed borrowers as a challenge, but an opportunity.
Marykay Scully is the director of customer education at Genworth Mortgage Insurance, leading the development of the company’s customer education curriculum.