Self-Employed Looking for Credit… What Do Loan Originators/Underwriters Look For?
So, you are self-employed and need a loan on some real estate.
Want more articles like this?
Create an account today to get BiggerPocket's best blog articles delivered to your inboxSign up for free
What exactly do you need?
As a bank underwriter, I underwrite a lot of these kind of loans, so in this post I will share what you need to know to qualify for a loan as a self-employed borrower.
In this post I'm going to go over some very BASIC underwriting on how I analyze a self-employed person (Part I of this post) for a business loan and how mortgage underwriters analyze your business (part II of this post).
PLEASE NOTE – there have been books written about this subject, months of training materials, so if you think I’ve left something out or disagree with me, please don’t go Nazi on me in the comments.
Let’s get started!
I don’t want to put you to sleep talking about tax-returns so let’s just use a real-life example of the President of the United States of America! This is his Schedule C of his 2008 tax return. Note: Schedule C is a part of your individual return. If you are the 100% owner of the LLC you can also file the companies return as a Schedule C. This is a very common way to file a tax-return.
First off we look at line Line 9 and 7. This gives us a quick snap-shot of the borrower and how big his business is. In the case-of the President’s 2008 tax return I can see that since he has 100% gross margins – this is simply a Royalty based business.
Then we look at expenses. What expenses were non-cash like depreciation (line 13) that need to be excluded. Also, to get a handle on his debt service we need to exclude interest expense (line 16a & 16b).
Excluding these expenses and double-checking any extra expenses in the footnotes like amortization (another non-cash expense) we now have the cash-flow of the business.
The reason 2-3 years and interim financial statements are required are because we want to see not just a one-year snap-shot of the business but what are the trends in the business? Trends that we are looking at are revenue trends, gross margin trends, cash-flow trends, leverage trends, etc…
Below is part II on how mortgage underwriters underwrite self-employed business owners.
Self Employment – What Do You Need?
Simply put: two years being self employed for a conventional loan.
They will need two years of tax returns (2012/2013) filed with the IRS to calculate income. They’ll probably average it over 24 months if you started early in the year, and maybe ask for 2014 profit and loss.
Self Employment and Business Entities
The LLP.. is this your business… or just what you hold property in?
Do any of the mortgages show up on personal credit or are they commercial loans, or loans not in your name?
You’d also need to provide two years of Form 1065s if you own more than 25%, and throw in the k1’s for that.
Self Employment and Your Cash
A tip: if the cash you have is in the business account… I may not accept it.
I assume you need it for the business to pay your suppliers, so I’m not going to allow you to use it to buy a property and then watch your business (which is paying us back) suffer or become insolvent.
Additionally, most lenders will ask for a business license for the past two years you’ve been in business. Either that or a letter from your tax preparer/CPA certifying that you’ve filed as self employed.
What About Mortgages?
The mortgage from your LLP probably won’t show up on your credit report (or does it?). If it doesn’t, no one would ask about it.
A commercial mortgage would actually show on the 8825 of the 1065. The issue that most often comes up, however, is that most people take out residential mortgages in their name and then transfer title into the LLC for liability coverage legally.
The debt obligation is still written to their personal names and therefore shows on their credit – which alters the ability to qualify for future loans.
We actually don’t typically ask for the 8825 of the 1065 though, as most states have commercial verification websites. We do that plus a 411 listing together for our verification of self employment. Verification through a CPA obviously is also acceptable.
Additional Self Employment Loan Tips
Additionally, you might want to also have two months of clean statements (post separation) to give the lender. Otherwise you might be sourcing deposits- ie. income from clients.
Finally, if you own less than 25% it’s passive income not self employment as defined by Fannie/Freddie/FHA. Therefore, we need 2 years of form 1040 and 2012 k1 to show % ownership, but no business return.
Questions? Leave your questions or comments below and I’ll do my best to help!
Photo Credit: epSos.de