The Washington PostDemocracy Dies in Darkness

How buyers with uneven income can qualify for a home mortgage

Getting a mortgage can be troublesome for the millions of people who are self-employed, independent contractors, gig workers or who depend on commissions and bonuses for most of their income. (Charles Krupa/AP)

While finding a home they can afford is a major challenge for prospective buyers in 2021, qualifying for a loan can also be an obstacle.

The general requirements for a loan approval include a credit score of 640 or higher for most lenders, a debt-to-income ratio (which compares your monthly gross income and the minimum payment on recurring debt) of 43 percent or lower, and proof of your assets and income. That last item — income — can be troublesome for the millions of people who are self-employed, independent contractors, gig workers or who depend on commissions and bonuses for most of their income.

We asked Tabitha Mazzara, director of operations at Mortgage Bank of California, which is based in Manhattan Beach, Calif., for advice for mortgage applicants without standard W-2 income. She responded via email.

What obstacles are faced by self-employed/entrepreneurs/people with commission-based income when they want to buy or refinance a home? Why do they face more difficulty than traditional buyers?

Mazzara: Most self-employed people and business owners write off a good amount of what they make simply because they can. But writing off so much in taxes reduces what they can count as income when applying for a home loan, so it is harder for them to qualify for a traditional mortgage loan. If they decide to pay the taxes on their true income, the amount they will owe in taxes will take a big chunk out of their savings for a down payment. So they are in a “Catch-22.” To complicate matters, lenders for the most part require two years of income — which some borrowers cannot provide.

What solutions are available to these borrowers?

More than one-third of consumers found errors in their credit reports, investigation finds

Mazzara: The Mortgage Bank of California [and some other financial institutions] qualify self-employed people, business owners, entrepreneurs, investors and freelancers who have alternative forms of income. They may come to us with bank statements, 1099 or a Debt Service Coverage Ratio (DSCR) for rental income or assets they can use. We rely on their true cash flow as an income qualifier rather than a tax return that can be manipulated. For 1099s, we use the gross income from the 1099 rather than the net. DSCR is great for people who have Airbnb or Vrbo properties or for real estate investors, because they can use their rental income as a means of qualification.

How can these borrowers best position themselves for a loan approval? Is there a specific amount of time that they need to be earning money in nontraditional ways before that income can be used to qualify them for a loan?

Mazzara: They can qualify as long as they have been self-employed with income on 1099 forms for two years. Other factors such as good credit and down payment also factor into qualification eligibility. The industry as a whole looks for a minimum of two years of stability in self-employment.

Do borrowers with erratic income pay higher interest rates for a loan? Can they offset this at all with a bigger down payment, lower debt-to-income ratio or higher credit score?

Mazzara: The broader mortgage industry may view applicants with uneven income flows as erratic. But since we look at a 12- or 24-month snapshot, we really don’t view them as erratic. Rates for non-qualified mortgage (non-QM) loans, which are loans that don’t meet the guidelines established for qualified mortgages by the Consumer Financial Protection Bureau, can be slightly higher than your conventional loans that are backed by the government. But it has to do with risk. We are not using tax returns or verifiable income; we are using cash flow. Borrowers can offset a higher rate with a larger down payment, however most of our clients typically do not look at an interest rate as the determining factor. They see it as an opportunity cost. It’s about liquidity and what they can do to earn more money rather than put capital into their home to save a couple of dollars on their mortgage.

Do you anticipate more loan programs to open to these nontraditional borrowers as the economy changes?

Mazzara: Loan programs for nontraditional borrowers are constantly being reviewed and enhanced. What we have noticed is the performance of these loans are better than your traditional conventional loans. As the mortgage servicers who deal in non-QM loans establish positive performance trends, non-QM loan programs will continue to expand.

Read more in Real Estate:

Is the red-hot housing market starting to cool?

Tips for home buyers: How to offset rising mortgage rates

Newly built condos for under $400,000 in Southeast D.C.