THE MORTGAGE BROTHERS SHOW
Getting a Mortgage as a Self-employed Borrower
This week we discuss “What Self Employed Borrowers need to show us to get a mortgage.” Self employed folks are perhaps the hardest working borrowers we come across on a daily basis and unfortunately banks don’t cut them any slack when it comes to getting approved for a mortgage. These mortgages are the toughest and most time consuming loans out there but we don’t shy away from them.
- How many tax returns? One year versus two years Tax returns
- Schedule C versus Schedule E
- Single member LLC or multiple member LLC
- S Corp or C Corp
- Net income versus gross income
- Depreciation and depletion can be added back to income
*The following transcript has been edited for clarity.
Eddie Knoell — I’m Eddie Knoell.
Tom Knoell — I’m Tom Knoell.
Eddie — Welcome, everyone. This is the Mortgage Brothers Podcast and today we are talking about self-employed borrowers and what makes them different, how we underwrite them, where you can find the biggest deal, and what makes you different if you’re self-employed.
Tom — That’s right. Self-employed borrowers make up but how much of our applications?
Eddie — Probably about 30%.
Tom — Yeah, 30%. You all are some of the hardest working individuals out there. You’re very, very creative and very, very motivated. But when it comes to self-employed borrowers, we ask two questions when you call us about getting pre-qualified or how the process works. What are those questions, Ed?
Eddie — Yeah, we could ask, “Do you pay taxes?”
Tom — Right. We would say, “How big is your tax payment?” From that we can probably figure out everything that we need.
Eddie — That’s right. If you pay a lot of taxes, you’re probably in business and you can probably get a loan.
Tom — Right. We’ll ask, “What’s your net income, and how long have you been doing it?” So basically, two years. Two years is a very beautiful number. Every once in a while, you can get away with something less than that, but typically the self-employed borrower will be less stranded and frustrated if you go into a loan originator’s office, and the loan originator tells them that one year should be fine. Typically, it’s two.
Why don’t we jump into the big question about net income? I think taxes keep coming up because taxes is the one platform, it’s the one medium that all self-employed borrowers have to really prove to. The only entity that watches over them.
Eddie — That’s right. When it comes to documentation, when you have to prove to the underwriters and the bank, tax returns are the universal documentation we’re all going to go to.
Tom — That’s right. I think I had come up with this the other day. We were talking about this. It’s like the kid who walks into the house, maybe he wants to go outside and play, and his mom says, “Well, you got to do your homework.” He says, “I don’t have any homework, mom.”
So, he goes out and plays and lives life. And then, you know, a couple of days later, or maybe it’s that night, his dad comes to him and says, “Hey, you’ve got to do some chores around the house.” He says, “Oh, sorry, Dad.” I can’t. I have homework.” Then his mom and dad talk to each other.
The tax returns that are being submitted to the IRS talk are used in a way with how these loans are underwritten when it comes to Freddie and Fannie.
Eddie — Yeah, that’s right.
Tom — That’s important for people to understand. It’s not like they are, and they’re not totally connected, but they’re still living in the same kind of house, so to speak. It is the IRS. It’s the government. It’s the Fannie Mae and Freddie Mac. They’re all intertwined a little bit. And so, what you tell one of them on the expense side or on the income side is going to end up coming back to you when it comes time to get a loan.
Eddie — Yeah. You can’t have your cake and eat it, too.
Tom — That’s right.
Eddie — So when it comes to being self-employed you either pay low taxes, or you show a lot of money and can get financing.
Tom — Right.
Eddie — Yeah. So again, it all comes down to net income, folks. Most of you who are self-employed, some of you really know your taxes, and others just don’t.
I think that what will be helpful in this podcast is if you’re listening, you’re not going to see what we’re going to put up on the screen, but we’re going to try to put up on the screen a couple helpful little tax forms from 2018. That’s the latest tax return right now that we’re looking at.
We’re going to bring up these to just be helpful. If you don’t know where your numbers are, you could pull up your personal tax return, your 1040. What you’ll notice is on page one of your 1040, and folks, this is a different format. Remember, we’re not used to this format. It’s a small section on page one. It just has personal information. It has where you and your tax accountant sign. It’s page two where all the summary numbers go.
On line one, if you are a W2 employee of your business, you will have income on line one. So, yes, if you’re self-employed, you can be a W2 employee of your business. Of course, those of you who are listening will know that if you are an employee because you went through that whole setup process.
It’s line one. Again, it’s the same line even if you’re not self-employed and you’re a W2 wage earner. That income goes in the same spot, but the point is that’s where W2 income goes.
Now, line six is the next line I’m going to point out. That’s another highlight. That’s the net income that’s going to report over from a Schedule E or a Schedule C, and 95% of you who are self-employed are going to be filing your returns on a schedule C or your income has come through a Schedule E. Okay? But this line six is an important line. It’s where your net income comes, right across there. Okay? I want you to keep that in mind.
Now, if you get anything out of this podcast about the tax returns, it’s the 1040. Just look up page two. Okay? That’s the most important thing.
If you want to dig into your Schedule C, we’ll bring that up here and show you that when you’re looking at your Schedule C, that’s for sole proprietors. If you’re a 1099, just 1099, you get 1099s from all your jobs, you do work and you just get checks from them and then at the end of the year they 1099 you, that would be on a Schedule C. Okay?
It shows that. You add up all your checks. You have expenses, and it has the net income, and that goes right to line six of your 1040. Okay.
The Schedule C can be used for single member LLCs. And so, we see that a lot, and it works out. The Schedule C will work a lot like a sole proprietor, but again, Schedule C can handle the sole proprietor and a single member LLC.
The next thing. We’re almost done. The next form that’s really important is if you have an S corporation or an LLC.
Tom — Or a multi-member LLC.
Eddie — Yeah, or multi-member LLC. You’re going to have a K1 that will show up on page two of the Schedule E. Okay? It will have the business name. It will say whether you had a passive income or a non-passive loss. The K1 sections will be right there to show whether there was an income or loss.
Tom — And some of our self-employed borrowers can be quite sophisticated and complicated where they’ve got multiple K1s. They could have five or six, several of which they’re 100% owners of, and others, they’re just a partial number or partial owner. One of the key numbers we work with is 25%. If you are 25% or more owner of that particular company, we will typically always require and request the business returns.
Eddie — And the K1s, everyone, K1s will actually show the ownership percentage you have of the business. Remember, the K1 is a form that really is generated from the net income from a business tax return. If you have a K1 that means there’s a business tax return somewhere.
Now in this podcast, we’re not going to get into the business tax returns. What we just want to say is that if the business tax return is going to have net income, or if it will have the gross receipts and then a net income, that net income turns into a K1. They’d give K1s out to all the owners. I think that’s probably enough to cover for that.
Yeah, I think at the end of the day, your income is going to report to the 1040 form. Okay? The page two of the 1040, and it’s the net income.
Tom — And then, also I’ll throw this out, too. We started it with this saying two years is kind of the magical length, being in business. That’s the minimum. If you can get to that three, four, or the five-year mark that helps.
One of the big things you look for is that the income is not declining by more than 10%. If the income does decline more than 10%, there’s a little more underwriting that has to happen. If we have a five-year period, we can kind of explain. “Well, that was when the Great Recession was. You were in the real estate market, so we can kind of piece things together.”
Eddie — Yeah, and some people have a year that was just unusual, like an anomaly. They’ll have $100,000 of income, and all of a sudden, boom, $200,000, and then it goes back down to $100,000. Just because it declines from $200,000 to $100,000 that’s okay if we can show the history, and that the average income.
Tom — Right, as long as it was an anomaly. Also, not only for income mode, but for expenses, you could have a borrower that has one year where they just went and bought trailers and trucks and all kinds of different equipment and got hit really hard with a ton of expenses, but if we’ve got a long enough year or multiple years that we can look at, we can say, “Oh, okay. Well, the likelihood of that level of expenses coming again is not high.”
Eddie — Right.
Tom — All right. Did we forget anything?
Eddie — We probably did, but I think it was good enough to leave everybody with that. Be sure to e-mail us. Call us with questions. I think we pride ourselves for being really good with self-employed borrowers.
Tom — Eddie, how about this? If you’re like a self-employed athlete and you make good money, the only thing we’re going to ask is that you have a contract, and that the contract needs to be good for, what is it, two or three years? I think it’s actually a two or three-year contract.
Eddie — We’ve run into some baseball players where they’re temporary, but anyway, yeah… If you’re a player, that’s a whole other thing.
Tom — Right, but if you happen to be one. All right. Well, thank you, folks.
Eddie — All right. Everyone have a good week.
Tom — All right. Take care. Let’s go home.
Eddie — Hey, guys, thanks for listening to the Mortgage Brothers Show. Please let us know if you have any questions you would like us to answer on this podcast. You can e-mail your questions to email@example.com, or yours truly at firstname.lastname@example.org.
Be sure to ask us for a free quote on your next mortgage. Tom and I will personally work with you and help you through the whole process.
Signature Home Loans, LLC does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors before engaging in any transaction. Signature Home Loans, NMLS 1007154, MLS number 210917 and 1618695, equal housing lender.