By Brad Walker, CEO and Co-founder of Income&
Owning a home is part of the American dream, and mortgage lenders are motivated to do everything possible to make sure Americans of all ethnic, educational and professional backgrounds qualify for a mortgage. That said, the current system for determining who qualifies for a home mortgage is not perfect.
Mortgage lenders are highly constrained by regulations, especially since the financial crisis, and have to stick to certain criteria in determining creditworthiness if they want to participate in the federal mortgage system (Fannie Mae, Freddie Mac, FHA and so forth). This means that lenders can’t just rewrite their lending standards, and have to justify making a loan by confirming objective criteria demonstrating the creditworthiness of the borrower.
The key issue here, of course, is that not all borrowers are alike. Although many mortgage applicants today are still traditional W-2 employees who work directly for an employer, the number of “gig economy” contract workers has been increasingly steadily for years, and this is trend is very likely to continue.
Mortgage lenders have been working hard to develop new risk assessment models for the growing number of self-employed mortgage applicants today, and some progress has definitely been made.
Management of these firms are leading the charge to make their business processes more flexible, with the goal of offering a loan to anyone who can demonstrate the cash flow to be able to repay what they borrow over a reasonable loan term.
Note that smaller fintech firms are breaking new ground with innovations in several segments of the financial industry, including mortgage lending. Bigger players have been buying up these innovators or else snagging talent to develop their own products aimed at the expanding pool of gig economy workers.
Tips for Qualifying for a Mortgage in 2017
Like anything else in life, you need to put your best foot forward when you are applying for a mortgage. Whether you are a traditional W-2 employee or an independent contractor in the modern gig economy, you can take steps to make yourself a more attractive borrower.
In most cases, the down payment, debt-to-income, and credit requirements to qualify for a mortgage are virtually the same for W-2 borrowers and the self-employed. The difference is that the self-employed typically have a significantly higher documentation burden.
Employed applicants generally just have to provide W-2 forms to prove income, but self-employed borrowers are often required to produce two years of tax returns, including all schedules.
This means that debts and credit record are especially important for W-2 workers. You can’t change the numbers on your W-2 (although you should tell your lender if you just got a raise as they will usually increase your income in their assessment formula), but you can take steps to improve your credit score (and your chances of qualifying for mortgage).
Keep in mind that even though it’s more income, having a second job on the side as a contractor can actually make it more difficult to qualify for a mortgage. Some experts suggest you might be better off not even listing the income from the second job unless you need the income to get into an acceptable debt-to-income ratio.
Self-employed gig economy workers
Even if you can come up with two or three years of complete tax returns, gig economy workers often still have a problem qualifying for a mortgage based solely on returns. That’s because self-employed filers frequently write off expenses that W-2 employees do not (cannot). Therefore, your net income after the write-offs is much lower than it would be without the write-offs.
This lower net income makes it hard to qualify for a mortgage as you often do not meet lenders’ preferred debt-to-income ratio. The preferred range for a debt-to-income ratio today is around 36-43 percent.
If you are considering buying a home in the next couple of years, it may be a good idea to talk to a tax professional to discuss alternative strategies relating to various tax write offs given the potential for sabotaging your debt-to-income ratio.
Another strategy is to set up your contracting work as a business, and pay yourself as a W-2 employee instead of taking your income from the profits of the business.
A number of smaller mortgage lenders are developing new credit risk models and rolling out programs designed to assist self-employed individuals in qualifying for a mortgage. These companies are considering a number of new factors in their underwriting models. Some new factors used in these models include social media behavioral analysis, spending history, and assessing the “reputation” of the borrower.
Last but not least, an increasing number of lenders are now looking to see if self-employed borrowers have significant cash reserves, and look more positively at borrowers with at least a couple of months’ worth of expenses sitting in a savings account.