One of the more common mistakes business owners make when beginning the process of applying for a home mortgage loan is failing to recognize how their involvement in a LLC, sole proprietorship, or corporation can impact their status as a borrower. In the 20-plus years I've been working in the mortgage industry, not a year goes by where I'm not approached by someone who runs into this very common mortgage conundrum.
A Common Mistake
A homebuyer, during the mortgage application process, indicates that he or she is an employee of a company, earns an annual salary and collects a W2 each year around tax time. Unfortunately, the one thing this applicant fails to disclose is their stake in the corporation that is listed as his or her employer. This is where things can get a little complicated.
You Can't Hide Your Business From Lenders
In some cases, I've seen homebuyers who simply don't know they have to report their stake in a business. This is because they may not fully understand borrower guidelines. In other cases, I've seen homebuyers make this mistake based off some tax advice from their accountant.
Regardless of the reasoning, it's virtually impossible for homebuyers who own a stake in a business to hide it. Underwriters are very good at what they do and more often than not can discover a mortgage applicant's true financial status by employing some simple online investigative tools. Remember; it's their job to make sure they do their due diligence.
The reason this common mortgage conundrum occurs is because many business owners think that, because they earn a salary and collect a W2 each year, they are just like your average borrower. False. Depending upon their percentage of ownership in the business, this applicant is technically considered a self-employed borrower.
The Golden Rule for Business Owners
The general rule of thumb is as follows; if you own 25% or more of a voting stock of a business then you are technically classified as self employed, which as a result means you must provide a corporate tax return. That tax return, whether it shows profit or loss, can have a major impact on a home buyer's mortgage application.
How Profit/Loss Comes into Play
If a borrower who owns a stake in a business submits a corporate tax return that reflects a loss for that business in the previous tax year, that loss could reflect negatively on that person's individual salary reported as part of his or her mortgage application.
For instance, if an applicant owns 100% of the voting stock in his or her business and that business lost $10,000 last year, a mortgage broker will subtract that $10,000 from the borrower reported income. The amount changes according to the applicant's percentage of ownership in the business.
The same idea applies if the business' corporate tax return reflects a $10,000 profit. That $10,000 can now be added to the applicant's reported income. Likewise, if a homebuyer purposefully pays themselves a minimal salary (i.e. enough to keep the lights on at home) and that business makes $200,000 profit in the previous year--that money can also be applied to the homebuyer's reported annual income.
Your Business is Your Mortgage Broker's Business
It's in your best interest to be as transparent as possible about your financial situation when applying for a mortgage loan. Remember, the tools underwriters use to examine your financial history are sophisticated and don't miss much.
In some cases, the only solution to this common mortgage conundrum is patience. For example, if you're a homebuyer who is in a situation where the business you own a stake in reported a loss for the previous year, perhaps it's best to wait for applying for a mortgage until things start to turn around a bit. That could be next year, or the year after. But really what it ultimately comes down to is getting some solid and sound guidance from a mortgage broker and/or qualified tax accountant who you believe has your home buying interests in mind. With this type of teamwork, and potentially a little patience, home ownership is right around the corner.