The Self-Employed Loan Dilemma
Here is an article that I co-wrote with Pete Paredero, Senior Mortgage Consultant at Land Home Financial Services, Inc.
Remember the “stated” loan? It’s also called the “liar loan” or the “loan that crashed our housing market”. Actually the original intent of the loan was to help self-employed people whose tax returns took full advantage of tax write-offs and showed a bottom line lower than what would work for qualifying ratios for loan approval. Unfortunately it became so abused that W-2 wage earners where allowed to acquire a stated loan. When stated loans took this direction the stated loan became unreasonable and millions of under qualified borrowers received loans way over their ability to repay.
Today we have more and more people hanging their shingle as Companies keep making cuts and the job market remains fairly weak which is causing quite a dilemma. Stated loans have not come back and probably will not for a long long time (if ever). What should you know if you are starting your own business and will want to purchase or refinance a home? First of all, you will need to be in business for two years in order to qualify for a loan. Usually these are the hardest times for a start up business so be patient. If you are established in your business and want to refinance or purchase a home, you will need to sit down with your loan professional to review your taxes. If your debt to income ratios won’t work for current lending guidelines, your next step would be to visit with your professional tax preparer.
Recently I worked with a client who was in this very predicament. A meeting was held with me and Monika Hengesbach, Enrolled Agent, whom specializes in small businesses and their owners. We were able to work a plan that would help my clients toward their goal of home ownership.
Here are some helpful hints that Monika shared with me that can steer you in the right direction to loan approval:
Every tax season I get told the same thing, “I don’t want to pay too much in taxes, please help me.” However, if you could be “tax savvy” and report more income for the first two years so you can have more tax write-offs and save more money on taxes for the next 30 years, would you? Of course!
For taxpayers who do not itemize their deductions they are entitled to a standard deduction. For single filers, the standard deduction is $5,700 and for married filing jointly it is $11,400. Let’s say you purchased a $550,000 home, put down 20% and qualified for 4.375%, your itemized deduction would be $27,356. This number does not include all the other items you are now entitled to claim as deductions: State and Local taxes, gifts to charity, job expenses and certain miscellaneous deductions. As you can see, your deductions would be $21,656 more for single filers and $15,956 more for married filers. Talk about saving money on your taxes!
A few areas that can be looked at when managing your business and preparing your taxes are:
- Depreciate your fixed assets vs. writing them all off in year of purchase. Instead of taking 100% of the purchase price off in the year of purchase (Sec. 179) defer the payments over the life of the assets; 3, 5, 7, 10, 15, or 20 years.
- Contribute to a self-employed SEP. Contributions to a SEP are tax deductible and may be eligible for a tax credit of up to $500 per year for each of the first three years for the cost of starting the plan.
- Incorporate your business. Sole proprietors pay tax on their net income on whatever their personal rate is; they also pay self-employment tax of 15.3% on the net income. This is one of the reasons why I get asked “….help me”. You will pay the same 15.3% self-employment tax on your wages but not on your net income. Depending on the structure you choose, the net income can pass-through to you which will help with your income qualification for home ownership.