Self-employed borrowers face new scrutiny from Fannie, Freddie

Good showings on past tax returns may not overcome COVID-19 triggered weak financials.

Who cares if it is April, May or December when you make the big bucks from your business and stash the cash in your bank account?  When it came to qualifying for a mortgage, the bottom line always was did your tax returns show you produced enough income to qualify for that loan you were eyeing.

Not so much anymore.

When Congress enacted Dodd-Frank back in 2010, one of the requirements was your ability to repay the mortgage. The recession triggered by COVID-19 added a new wrinkle to the mortgage qualifying equation. On top of the most recent year or two of tax return income scrutiny, now deposits and interim profits are all the rage.

Nearly one in 10 U.S. workers is self-employed, according to the U.S. Bureau of Labor Statistics. If you own 25% or more of a business, you are by mortgage definition, sell-employed. Examples are mom and pop retailers and restaurant owners, repair services and small manufacturers. Less obvious examples are entertainers and actors, Realtors, court reporters and commission-only salespeople who are paid on a 1099, not a W-2.

Just how many of those self-employed borrowers saw slowdowns of their incomes or worse-their income abruptly coming to a halt as a consequence of mass layoffs and shelter-in-place orders?

Starting Thursday, June 11, Fannie Mae and Freddie Mac are mandating additional standards to scrutinize self-employed borrowers to determine if the borrower’s income is stable and there is a reasonable expectation it will remain stable.

Here is a sampling of additional factors lenders are scrutinizing:

  1. Either an audited or unaudited year-to-date profit and loss statement reporting business revenue, expenses and net income through the month preceding the loan application date. They will also want to see the most recent two months of business bank statements.
  2. Evidence that your business is still running, such as a valid business license, recent vendor invoices, a functional website, someone answering the phone or showing up in a Google search.
  3. The stability of that industry you’re in during the pandemic. Do you own a nail salon? Or, do you own a security guard company that may be booming?

Other factors include:

  1. Does your year-to-date profit and loss statement square up to last years’ income tax statement? Let’s say your 2019 tax returns indicated $8,000 average monthly income. But your year-to-date income this year fell to $5,000 per month. Your lender is likely to use $5,000 per month as your mortgage qualifying income. If your business income is seasonal and you can show strong, clear, verifiable evidence of orders that are about to close, your lender may use the $8,000 of monthly income.
  2. Payroll Protection Plan (PPP) and/or any similar COVID-19 programs or grants will not be considered as business assets.
  3. Co-borrowers such as spouses who are furloughed or collecting unemployment cannot have their income counted until they are back to work.
  4. If you have rental property income and that income is needed to help you to qualify overall, your lender may require proof of ongoing payments by your tenants.

Some lenders raised the bar well before F& F’s new self-employment mandates. I just completed an Irvine rental property refinance for one of my self-employed clients. Even though he was able to knock the rate and payment down from 4.625% to 3.75%, he was worn down by the extra scrutiny.

“I’m glad I did the refinance,” he said. “But if I had known what was involved, I probably would not have done it.”

Before you invest your valuable time to purchase or refinance, provide clear and detailed data about your business expenses, income, cash flow and the like. Explain exactly why you believe the outlook is good for your business. Give the detailed ammunition needed to convince your lender to just say “yes”.


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Jeff Lazerson - Mortgage Columnist since 2011