Q: Last year, my company closed and I lost my job. I am now a contract worker and I might actually gross more in 2011 than I did at my last job. (Of course, that’s gross pay and doesn’t include benefits.) But, I feel lucky given what else I see going on in my neighborhood.
I have a question about current mortgage lending practices: Is the desire for two to three years of tax return data for the self-employed just a knee-jerk reaction to the current climate? Or is there something in Dodd-Frank Act that specifically requires it?
My lender agreed to adjust our interest rate last year, but now that I want to get a whole new loan, I’m being told I need to show two years of self-employed tax returns, which I don’t have.
After a talk with my lender, who blamed Dodd-Frank, I suspect there are legal liabilities for lenders who fail to do due diligence on borrowers’ incomes and their solution is this policy of tax return data for the self-employed. What do you think?
A: I’m delighted to hear of a sort-of happy ending for someone who has lost his job during this very tough economy. Congratulations on the gains you’ve made as a self-employed individual.
Unfortunately, you’ve only been self-employed for maybe a year, and lenders have long required self-employed individuals (and those who own their companies) to provide at least two years of tax return data. This rule has been around for the last twenty years or so.
While Dodd-Frank is requiring lenders to be extremely cautious in their lending practices, this self-employed requirement goes beyond current politics. It’s how lenders have always checked out self-employment income. Any borrower during the last twenty years or so going for a conventional loan had to prove their income for at least two years. During the last seven years, some borrowers did not provide documentation but they were able to get away with that using some of the more unique loans that required little documentation and had lower underwriting standards. (These were known as “stated income” or “no-doc” loans.)
But now lenders are even more cautious, I wouldn’t be surprised if you’re asked for another year of tax returns and perhaps having a larger amount of cash on hand to cover unexpected issues with the home or your loan.
If you’ve been self-employed for less than 2 years, it’ll be really hard for you to get financing. You might want to wait until next year or you’ll have to find a lender willing to give you the loan but isn’t going to sell the loan on the secondary market or will require you to put down a significant amount of money relative to the value of the home.