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Borrowers Can’t W2/Pay Themselves To Qualify; Complexity of Loan Process

A self-employed woman reviews her finances from her home office as she prepares for a mortgage pre-approval.

If the owner of a company pays himself $300,000 per year while the company itself is losing $300,000 per year, that owner effectively has no income.

I am oversimplifying this somewhat to illuminate a situation we see often.

Borrowers will tell us that they make $300,000 per year and “qualify easily,” but then when we dig into their tax returns we discover that they are paying themselves from a corporation that is losing money.

We see this with doctors, lawyers, consultants, and business owners relatively often.

They don’t understand that underwriters always dig into every borrower’s tax returns to look for these exact situations.

25% Ownership = Self-Employed

Underwriters also look into the ownership interests of every firm that is paying one of our borrowers.

If our borrower’s compensation or position within the firm is substantial, and if an employer is not a large or well-known corporation, borrowers must attest that they do not own more than 25% of the business paying them.

If borrowers do own more than 25% of the business, they are effectively “self-employed” and we have to dig into the business’s tax returns and attribute company losses and obligations to the borrower accordingly.

Self-employed or business-owning borrowers can of course pay themselves substantial salaries and still qualify, but their underlying businesses need to have enough profits to cover the full amount of the salaries (if we want to use the entire salary to qualify).

Complexity Of Loan Process – No Recipe; Can’t Chase Every Condition At Pre-Approval Stage

We sometimes have pre-approved borrowers who become extremely frustrated when we request additional conditions after they go into contract.

This is particularly the case with self-employed and jumbo borrowers.

Lenders do not chase every condition upfront at the pre-approval stage because such conditions are time-sensitive (and will expire) or because there is no need to spend the time chasing many conditions until a borrower is in contract.

In addition, sometimes updated documentation sparks additional conditions, and jumbo underwriters tend to dig into files much more carefully once a borrower is in contract (and then ask for what are seemingly inane conditions).

These additional conditions often involve IRS Tax Transcripts, letters of explanation for credit inquiries or large deposits, employment verifications, paper-trailing of escrow deposits, and updated statements.

These conditions rarely threaten a transaction, and are just part of the loan process.

Borrowers and agents alike often want certainty and a guarantee that there will be no more conditions – and this is often easy for us to do with conforming loans and clean files with wage-earners.

But self-employed and jumbo borrowers should always expect additional conditions (and “hoop-jumping”) after they’re in contract.

It is just a function of the regulations we are all subject to and the extreme risk of us not having a salable loan.

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Jay Voorhees
Founder/Broker | JVM Lending
(855) 855-4491 | DRE# 1197176, NMLS# 310167