Bank to Self-Employed: We Don’t Care about Your Income

by JT McGee

If you have never had a significant gig on the side, or owned your own business, you’re missing out. The banking industry has a huge, huge wrinkle – a gap – in providing loans to the self employed.

So let’s just say for the sake of discussion that you earn $72,000 this year pre-tax. Social Security and medicare take just over $11,000. Federal income taxes take $11,429. You’re in that lovely region where you get crushed by Social Security and Medicare – it’s a hell hole. All in, your net income will come to $49,555.

Man, that’s a freaking bite! Your effective tax rate is 15.9%, and with 15.3% on top, you’re paying an effective tax rate of 31.2%. But that’s not all. Nope.

Hey cool, you made $0

Take your tax returns to the bank and apply for a mortgage. No matter how much income you report on the top line, your bank won’t care.

You see, self-employment income is seen as incredibly risky for lenders. It should be. But whoever is controlling the policies at the risk management department must have a bone to pick with people who don’t walk in with a W-2.

Want to get a self-employed mortgage? Bankrate has your back.

Here’s what BankRate suggests:

  • 30% down – Are you freaking kidding me? Whereas you can snag an FHA loan with ease with 3.5% down, you self-employed folks need to have nearly 9 times as much invested in your home to get a good look from a banker.
  • Six months of savings – Okay. I think everyone should have this before buying a home, but if you’re self-employed, it isn’t a recommendation – it’s an order! Also, current costs are projected in perpetuity. If you have obscenely high current costs for a couple months (say, tuition), it’s built-in to your cash flow forever.
  • 720 credit score – Okay, duh.
  • A love for loan sharks – Self-employed loonie toons aren’t worthy of the advertised mortgage rate. Add on another .5-1% in risk premiums because, you know, the bank doesn’t think the above precautions ran deep enough.

I’m annoyed

Of the above precautions, the higher rate is what really grinds my gears. On an $85,000 home, you’re looking at a $420 monthly payment on the current rate for a 30-year fixed mortgage. Add a .5% risk premium, and now you’re talking $445. Okay – so $25 a month isn’t going to break the bank, but for a borrower with 30% down, it is annoying to inspire that much fear in the bank’s mind.

I’ve been shopping for that $85,000 home. It’s more than affordable, especially since I’m searching for multi-family units. The $85,000 property in particular is a duplex, one which my hours upon hours of late night research leave me to believe can be rented for $550 a month immediately. My thinking is simple: I can tolerate a lower quality home in my 20s if it means I can plow at least 50% of my take home pay into assets, not liabilities. (I think the tax code should allow me to deduct 100% of the mortgage interest, but I need to do more research here.)

I cannot fathom a scenario in which this purchase would not be cash flow accretive. I mean, I’d basically live for free, with maintenance being my only costs. Let’s just hope my future neighbors don’t take a bulldozer to half the home.

So, what’s the plan? Hmm..

I have options:

  • Give it a year and have W-2 income to report.
  • Play the banker’s game and pay out the rear for a stated income mortgage, hopefully refinancing at a later date with W-2.
  • Give real estate investing the cold shoulder and stick to the Pink Sheets.
  • Pay cash for a home, forgoing liquidity, leverage, and risk transfer, basically, all the beautiful bits of debt financing.

Right now I’m giving real estate and the mortgage industry the cold shoulder. I’ll revisit this at a later time, but I just had to vent about the state of the mortgage market. It’s great for W-2 earners, empty for the self-employed.

{ 13 comments… read them below or add one }

Bill July 6, 2013 at 14:30

The recommendations appear steep, but I don’t have any experience with stated income loans. You might have more luck at a credit union or the bank you keep your accounts.

I do know that FHA is available for business owners, but it’s complicated from what I hear. Best of luck.

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JT McGee July 10, 2013 at 12:29

I’ll definitely start at a local credit union where I keep my accounts and shop around from there. I’ll need the luck!

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krantcents July 6, 2013 at 15:42

I always suggest your first foray into the business/investment world is to rent out your first home/condo. It is a relatively easy choice since you already own the property and you have a low interest loan (mortgage). If you have any equity at all, you can usually have a nice positive cash flow.

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JT McGee July 10, 2013 at 12:29

Cash flow atop a $0 rent expense sounds like the best deal in the world. That’s why I’d love to buy a multi-unit.

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mochimac @ save. spend. splurge. July 6, 2013 at 17:06

I hear you.

I can’t even get basic loans as a self-employed person. All the more reason for me to hoard my cash when I do work, because I am not about to get any kind of help from anyone else, even if I am financially more than solvent for someone my age, and smart about not taking on things I can’t handle.

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JT McGee July 10, 2013 at 12:28

Responsibility can really bite you in the rear! Amazing, huh?

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Stephane July 8, 2013 at 23:22

It a little more difficult but it is possible. I am self employed and got my house mortgage 2007, a refi in 2009 and an investment property mortgage in 2012
The key is to have a few year of history on 1099. I also worked with brokers they tend to work with several lenders. For the investment property I used a credit union.
In all cases I got cimpetive rates

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JT McGee July 10, 2013 at 12:28

Asset sales have complicated the financials and made income more variable. I’ll give it another look in a few months.

Thanks for your anecdotes. Were you able to finance your properties with traditional down payments/LTV ratios?

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Stephane July 10, 2013 at 23:10

Yes, 20% down in all cases

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PK July 9, 2013 at 00:20

How does it change if you use W-2 and your 1099 income? “Hey, I make more on the 1099, but here’s my W-2”. Any luck with that strategy?

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JT McGee July 10, 2013 at 12:27

I’m sure that would be an added bonus, but hey, I don’t earn anything with a W-2. I suppose I could pay myself a W-2 salary, but that doesn’t get rid of any hoops to jump through.

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American Debt Project July 10, 2013 at 21:23

Usually it’s 2 years of W-2s that they want to see too. Let’s just get like 15 investors together and start buying cheap depressed properties somewhere.

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JT McGee July 10, 2013 at 21:58

Two down, thirteen to go!

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