Self-employed and shopping for a mortgage — what’s the outlook?

Q: We’re a twoincome family. My spouse has a fulltime job with a local government while I’m self-employed. With interest rates so low, we want to buy a home but worry that nothing will be affordable without our self-employment income. Have lending rules for the self-employed gotten tougher as a result of the COVID-19 virus?

A: There has long been a confusing relationship between mortgage lenders and the self-employed.

Lenders want to make loans, the self-employed want financing, but underwriting those who work for themselves can be tricky.

Lurking in the background has been a longtime assumption. The idea that a paycheck is somehow steadier and more secure than the income reported on an IRS Schedule C. As the current economy shows, all income and employment must be carefully reviewed and verified in a crunch.

The usual expectation for the self-employed is that they have worked for at least two years to show two recent tax returns documenting their income. The lender asks for such paperwork because it must verify that the borrower can repay the loan. Tax returns can show a viable income and a demand for the applicant’s skills and services.

The two-year standard is a barrier for the newly self-employed where there has been a recent career change, or income has declined. However, if you go from employment to self-employment in the same field, and if your income holds up or improves, then you might be able to slide by with less than two years of selfemployment income.

Another point regarding underwriting standards for the self-employed is that they vary. Not all loan programs have the same rules. In the case of portfolio mortgages — loans the lender does not sell into the secondary market — the tests can be very different from the usual requirements. It makes sense for self-employed borrowers to ask lenders what paperwork and standards they require.

The COVID-19 economy has made lenders more cautious and with good reason: Millions of people with solid credit and long employment histories have suddenly lost their jobs. Many businesses have closed. If you’re a lender, you want to look beyond the usual standards to assure those self-employed borrowers have viable businesses and income.

You can see this with income verifications. For instance, Fannie Mae — a major loan buyer — has changed the standards lenders must meet to prove continuing income.

“Given the current economic climate associated with COVID-19 and its impact on employment and income,” says the company, “we recommend that lenders practice additional due diligence to ensure the most recent information is obtained. Lenders are strongly encouraged to help ensure any disruption to borrowers’ employment (or selfemployment) and/or income due to COVID-19 is not expected to negatively impact their ability to repay the loan. During these uncertain times, it is our goal to partner with you to help ensure sustainable homeownership for the borrower.

“As an example of additional due diligence for a self-employed borrower, lenders are encouraged to attempt to verify that the borrower’s business is operational closer to the note date rather than rely on our current Guide requirements (e.g., within 15 days instead of 120 days).”

None of this is a big deal. Lenders will be pickier in the COVID-19 era, but if you were checking loan applications at this time, you would do the same thing. For details and specifics, speak with loan officers and ask about requirements for the self-employed.