Since the sub-prime mortgage crisis of 2008, it has been tough for self-employed workers to get a mortgage or even refinance their existing loans to take advantage of lower interest rates. The rules have just gotten tougher, but there are still options available.
Sweeping new regulations that went into affect January 10, 2014, have changed the way lenders scrutinize a borrowers ability to repay their mortgage loan. It is now the responsibility of the lender to dig deeper into a borrower’s finances. For self-employed borrowers, this means they will likely be required to provide two years of self-employed income history, profit and loss statements, and a detailed balance sheet for their business.
The new rules will require lenders to verify that the borrowers debt to income ratio does not exceed 43%. For self-employed workers, the total payments for all debts, including the mortgage, cannot exceed 43% of net income after deductions. For those who regularly deduct business expenses, this means that they may need to limit the deductions they take for two years to show higher net income if they want to apply for a qualified loan.
Under the new regulations, qualified loans cannot charge more than a 3% origination fee. They also cannot include features that were common prior to 2008 but are now considered high-risk, such as balloon payments, interest only or negative amortization schedules. Lenders that meet the new requirements are protected from liability should the loan ultimately fail.
For self-employed workers meeting the qualified mortgage requirements, there are several programs available.
- FHA Mortgages
- 3.5% down mortgages that allow family members to contribute toward closing cost and down payment.
- VA Mortgages
- 0.0% down payment mortgages available to active duty military, reservists, National Guard, and veterans who meet the VA’s service requirements.
- Fannie Mae and Freddie Mac Mortgages
- The two largest purchasers of conventional loans accounted for more than 75% of new home loans last year. Both of these government sponsored companies have announced they will only buy qualified mortgages or mortgages that are exempt, such as investor loans.
- Many different loan programs are available for qualified borrowers, including 10-10-80 (requiring 10% down) and conventional 20% down financing.
Banks and other lenders can still make loans outside of the new qualified mortgage rules, but they must show they made a good faith effort to verify the borrowers ability to repay the loan in order to avoid liability.
Mortgage industry analysts have estimated that 60% of current mortgages would not meet the new ability to repay rule mostly because the borrowers debt to income ratio is higher than 43%. As the effects of the new rule are gradually being realized, private money mortgage lenders seeking higher returns are looking at non-qualified mortgages as a potentially profitable business.
Here are two of the most common non-qualified mortgage programs available to self-employed workers.
- Reduced Documentation Loan Programs
- During the heady days leading up to the sub-prime mortgage crisis, stated income or no doc (short for documentation) loans were the mortgage product of choice for self-employed individuals. These loans were designed with self-employed people in mind. To qualify, borrowers provided bank statements showing their monthly income was sufficient to service the loan they were qualifying for. Abuse of no doc loans by borrowers who really could not afford the property they were buying was one of several factors that contributed to the crisis.
- Reduced documentation loan programs are still available for self-employed people, but with much tighter income reporting criteria, higher interest rates, larger down payments, and higher reserve requirements.
- Asset Based Mortgages
- If you have substantial liquid assets, such as a 401K account, stocks, bonds or large lump sums, from the sale of a business or inheritance, for example, you can also get a mortgage based on the value of those assets. To determine your income, the value of the asset is typically divided by 360. Fannie Mae and Freddie Mac have programs that require 30% down and a minimum FICO score of 620. Many private lenders also have asset based mortgage programs.
The Future of HARP
The Home Affordable Refinance Program (HARP) was set up in 2009 to help underwater (negative equity) home owners refinance their existing loans to lower their monthly payments and avoid foreclosure. The program was changed to include more mortgage holders in 2011. The new rules are commonly referred to as HARP 2.0. The changes, however, left out most self-employed people that used stated income, stated assets or both to qualify for a home loan.
In his 2012 State of the Union Address, President Barrack Obama alluded to further changes when he said that he planned to give “every responsible homeowner the chance to save about $3,000 a year on their mortgage”. In the banking industry, this new initiative is referred to as HARP 3.0. While it has not been passed to date, it is widely anticipated to include provisions to help more self-employed people refinance their homes.