Get Approved: 5 Tips for Small Business Owners for Mortgage Approval
Photo by rawpixel on Unsplash
Before the financial crisis of 2007-2008, mortgage lenders and banks were more lenient than it was today. During and after the Great Recession, the lending standards of the financial institutions become stricter making millions of borrowers including the self-employed lost their homes to foreclosure.
To avoid any foreclosure, home buyers need to understand the importance of pre-qualification and why it becomes stricter. Pre-qualification both protects the lender and the borrower. The lender protects himself from the risk of defaulting while the borrower lessens the possibility to foreclosure.
In order to make the process easier for the small business owners, this article listed five tips on how to get easy approval for a mortgage. Read on.
Identify Business Structure and Show Proof of Income
Lenders need to see if you’re business is consistently earning. If you are applying for a mortgage, provide documents that prove your income. According to Larry Finkelberg, co-founder and vice president of sales and business development at AmeriHome Lending in Rockville, MD, declaring the income and business expenses is one of the biggest challenges of business owners.
Small business owners need to demonstrate that he has been in the business for at least two years. Additionally, he needs to provide professional and business licenses.
Lenders require some documents from the borrowers based on the business structure. It will help them assess whether the borrower’s income and business could afford the payments. It is important to note that business structure can significantly affect his chance of getting pre-qualified for a mortgage.
If the business owner has a business partner or is into business with multiple owners, he should have the permission of the other partner or partners before he can access and hand any documents.
Be Prepared with the Documents
Here are the documents that the lenders require regardless of the type of business:
*2 years of personal tax returns(copies of the Form 1040, a complete list of 1099 Forms, W-2 Forms if he pays for himself)
*2 years of business tax returns which includes K-1 Forms, 1120 Forms for Corporations and/or 1120S Forms for Partnerships and S Corporations
*Profit and loss statements, Balance Sheet, Bank Statements
*CPA letters that indicates the applicant as the owner(if applicable)
*If the applicant is only receiving income several times a year, an explanation letter is required.
Though document requirements will vary from lending institutions, the paperwork compiled by your bookkeeper will give underwriters the confidence that the information presented was accurate.
The underwriting in the credit union mortgage is very conservative because they are heavily regulated. According to Rick Wargo, the general counsel of the Pennsylvania Credit Union Association, the credit union did business exactly different from the rest of the industry. Therefore, an applicant can expect to be required to put down the 20 percent standard down payment and at least three years of returns.
The major factor that a lender takes into consideration is the income after the business expenses have been deducted. It can result in lower loan amounts or worst rejection. Say, if you are self-employed and has reported a $70,000 in revenue last year and wrote off $45,000 as your business expense, the lender will only consider the net amount after deductions have been made.
So for a $70,000 revenue with $45,000 expense, the lender will only consider $25,000 annual income or $2,083 per month as real income.
Depending on the type of loan products that the borrower avails, some lending institutions allow small business owners to show only a year of personal and business tax returns. Moreover, if a part-time self-employed professionals get pre-qualified, they need not show proof of income based on the W-2 form.
Explain Income Fluctuations
Financial stability of the applicant also has a significant impact on the pre-qualification. Even if the business is earning good, the borrower will have a higher chance of approval if he can clearly explain the dips and income fluctuations.
Say, if a small business owner combined income for two years is $150,000, $100,000 on the first year and $50,000 on the second year. Still it can have a chance to be rejected. Though the income will give an average of $6,250 per month, the lender might conclude existence of one or more factors that could lead to business failure.
Make Bigger Down Payments
If a small business owner can make a bigger down payment compared to the required amount of the lender, he is likely to get pre-qualified. Not to mention that it could result in a lower loan amount and monthly payments.
Other than the down payment, lenders also take into consideration the credit score, debt-to-income ratio and loan-to-value ratio.
Credit score or credit rating is a three-digit number that reflects the likelihood of you to pay your credits. The higher credit score, the lower the risks for the lenders. Debt-to-income is the ratio that compares the debt payments to his overall income.
A higher DTI shows that a borrower has too much debt for the amount of income he has. On the other hand, borrowers with a lower DTI are more likely to manage monthly debt payments.
If you think you do not qualify to get pre-qualified, consider co-signing with a family member or relatives with reliable and stable income.
Though you have the sole responsibility to make the right decisions, it is still best to seek advice from the experts. Get yourself a mortgage broker. Like accountants who can help you with the documents, brokers can provide professional help by giving advice and reliable information and can even negotiate on your behalf.
Getting yourself a mortgage broker offers a lot of advantage. If a broker has broader experience and a more extensive network, you can have a better opportunity to obtain a loan at the interest rates that best suits you.
Note that communication and understanding of the mortgage process are critical. If you fail to submit the loan documents, it could create problems and might not let you get pre-qualified. By knowing the rules and requirements of the mortgage and adhering to them, you will have a greater chance to get a loan to purchase your dream house.