YOUR INCOME WILL DETERMINE WHETHER YOU WILL QUALIFY FOR A LOAN OR NOT

THE SELF-EMPLOYED BORROWER

After the mortgage loan meltdown of 2008, the government stepped in to make sure that if you were interested in buying a home or refinancing your present mortgage you were going to have to prove that you could in fact make enough income in a year to afford the payments. Two years of tax returns became the essential element of proof.

There is a stark difference between proving your income as an employee and proving your income as a self-employed borrower.  

Oftentimes self-employed people are put in a dilemma when purchasing a home or refinancing their current mortgage. This is because most self-employed people have legal deductions that they claim, thereby lowering their net income, and consequently their tax burden. Their annual income throughout the year is sometimes far greater than the net amount that they show on their income taxes.

Since for the purpose of getting a loan, the income of a self-employed person is determined by their income after deductions, they sometimes will be rejected when applying for a loan, because of a key element in the loan approval process, known as the debt to income ratio. 

Lenders want to be sure that you are spending less than 45% of your income on your basic monthly payment. This payment includes your principal and interest on the loan, your property taxes and homeowner's insurance. For example if you have $2,000 worth of total monthly payments and earn $60,000 per year ($5,000 per month) your debt to income ratio would be 40%. However if after tax deductions your net income is reduced to $45,000, or $3,750 per month, then your debt to income ratio would be 53% and your loan could be rejected.

Furthermore, if the amount of their total monthly debt is greater than 50% of the net income that is declared on the 1040 tax return, they could also be rejected for a loan. More specifically, if you are spending more than 50% of your income after adding car payments, credit card payments, or other installment debt you could also be declared ineligible.

In the old days lenders would allow a borrower in good standing to state their income higher than their net income on their tax return and closer to their gross income, closer to the amount of money they earned during the year before deductions. However, this is no longer the case.

If you want to buy a home or refinance your present mortgage you must show a net income that is sufficient enough to qualify you. This means that your net income must meet the requirement of 45% debt to income on your principal, interest, taxes and insurance payment combined; and 50% total debt to income after including any other debt that might show up on your credit report. Consequently you could end up paying more in taxes that year, or even for 2 years as lenders will insist on taking an average of 2 years of tax returns.

If your tax return in 2010 showed a net income of $36,000 or $3,000 per month and you have determined in order to buy the home of your dreams you will need $4,000 per month to qualify, you will have to be sure to show an income of $60,000 for the next year, or $5,000 per month, the average of the two years will be $4,000 per month and you will be eligible. 

The good news is that if you work with a qualified mortgage loan officer, they can assist you in just how much you will need to declare in income in order to qualify for a loan. What generally happens is that although you generally take all of the possible deductions from your business income, you do not declare them all, so that your net income is sufficient enough to qualify for the loan you are seeking.