How to get a mortgage if you’re self-employed

By Amy Hoak, MarketWatch 

CHICAGO (MarketWatch) — It’s tougher for just about all mortgage borrowers to get a loan for a home purchase or refinance these days, but many self-employed business owners are really feeling the pinch.

Take Brett Yarmie, who tried getting a mortgage from about four lenders before finding one that would lend him money to buy a home in the Los Angeles area. That’s despite the fact that Yarmie has owned an automotive body shop for 30 years, and this is the third house he has bought.

“This [mortgage] was definitely the most challenging,” he said.

Banks are requiring more financial documentation from all buyers, but because of the variability in their income streams, the finances of self-employed borrowers tend to get a more thorough look. Personal tax returns, business tax returns and financial statements are considered in establishing the overall viability of a borrower, said Franco Terango, senior vice president and divisional executive at Bank of America Home Loans.

 Bad timing for business owners

“Lenders will use a two-year average to derive self-employed income,” said Karen Mayfield, national mortgage sales manager at Bank of the West. But if the most recent year’s income is the lower of the two, the lender may use that most recent year instead, she said.

And in a tough economy, many small-business owners aren’t posting their best numbers. “You have almost a perfect storm, in the sense that tougher underwriting guidelines resulting from the housing bust are coming around the same time that a lot of business owners have posted their worst years on record,” said Greg McBride, senior financial analyst for Bankrate.com.

Another rub: Small-business owners are typically knowledgeable about tax deductions and credits that will reduce the amount of income tax they need to pay, Mayfield said. But reducing the amount of taxable income on your tax returns means you’re showing the lender that you have less income to qualify for a loan as well.

All of the above is shutting self-employed borrowers out of the mortgage market to a greater extent, McBride said. That can hold true for refinancers and home buyers alike — unless they have loads of equity in their home or can pony up a large down payment.

But making a large down payment may not be a small-business owner’s preference, especially if he or she is simultaneously trying to keep a business above water.

There are ways self-employed borrowers can increase their chances of getting a home loan, however. Here are a few tips:

1. Look for lenders with experience

Rather than asking only for rate information, ask whether the lender has a history of working with self-employed borrowers, Mayfield said.

Borrowers should “focus more on finding a lender that will understand their situation,” she said. “There are many, many institutions and lenders out there. Some individual loan officers aren’t going to be able to think out of the box or come up with solutions that someone next door would be able to.”

2. Consider portfolio lenders

Portfolio lenders have more flexibility in originating loans because they don’t have to sell the loan to Freddie Mac or Fannie Mae. Instead, such lenders hold the loan on their books, and that makes a big difference in their ability to help self-employed borrowers, Terango said.

Many portfolio lenders will offer competitive pricing just as they would for standard, conforming mortgages, Mayfield said. The cost of the loan largely depends on the amount of risk the lender is taking on by approving and holding the mortgage.

Self-employed borrowers also may want to consider credit unions, many of which also keep a good portion of loans on their books, said Steve Rick, senior economist for the Credit Union National Association, a trade association for credit unions.

3. Boost income

Someone experienced with helping self-employed borrowers may be able to come up with other ways to make the mortgage work.

“We’ve had people do amended [tax] returns. We will look at a loan application again if they have sent in amended returns to the government,” Mayfield said. Sometimes by rethinking deductions and credits on income taxes, a borrower can increase his qualifying income. Of course, with this strategy, the borrower would also face a new tax bill.

Another possible solution: buying an immediate annuity.

With this insurance product, a person invests a lump sum and, in return, gets a guaranteed revenue stream. It’s important that the payments begin immediately so they can be counted as a consistent income stream, Mayfield said.

But keep in mind that an annuity comes with costs of its own, including the fact that you lose control over the money, and when you die your heirs typically don’t inherit the annuity. You should consult with an accountant or financial adviser before taking this route.

Amy Hoak is a MarketWatch reporter based in Chicago.