Self-Employed Mortgage Loans

If you’re a business owner, real estate investor, or both, you've probably experienced inconvenient challenges when applying for self-employed mortgage loans during the past decade. It’s not an easy process. Mortgage market lending favors wage-earners receiving a W2 over business owners, entrepreneurs, or active real estate investors.

At First Capital Trust Deeds (FCTD), our clients are self-employed real estate professionals – builders, house flippers, landlords, land developers, and real estate agents/investors – along with business owners and entrepreneurs in medicine, law, entertainment, marketing, franchising and more. These borrowers usually come to FCTD for hard money loans for their latest project and over time, return for long-term financing on their primary or second homes, and investment properties. Self-employed real estate investors are our niche in the mortgage industry.

This article will cover what you need to know about self-employed mortgage loans, including:

• FCTD's Self-Employed & Investor Borrower Clients
• Most Common Challenges Self-Employed Borrowers Experience When Obtaining a Mortgage
• Self-Employed Mortgage Programs

FCTD's Self-Employed & Investor Borrower Clients

FCTD has originated mortgages for real estate investors since its founding in 2013, with an emphasis on hard money lending for investment projects. But, over the years, self-employed and real estate investor borrowers have additional financing needs for new projects, such as loans for their primary residence or vacation home.

Below is a sample of the self-employed and real estate investors that FCTD frequently works with to secure a variety of mortgage programs:

• Full-time house flippers
• Landlords with 50-100 rental properties
• Home builders
• Land developers
• Commercial real estate developers
• Conventional loan officers and realtors who are also active investors
• Attorneys
• Business owners
• Cannabis operators
• Crypto millionaires
• Doctors and dentists who develop real estate or have significant real estate investments
• General contractors with real estate investments
• Marketing entrepreneurs
• Retirees actively investing in equities, real estate, businesses, etc.

We’ve been fortunate over the past decade to work with so many borrowers with unique situations and backgrounds. Over the years, we've dealt with almost every situation imaginable. Our self-employed clients trust our ability to navigate the mortgage market and find financing solutions for situations that may require extra insight and attention.

Next, I’ll cover the most common challenges they face when applying for financing.

Most Common Challenges Self-Employed Borrowers Experience When Obtaining a Mortgage

Self-employed borrowers and real estate investors often encounter roadblocks to financing their primary residence, an investment property, or multiple investment properties.

Below are some of the most notable challenges FCTD has worked through with borrowers and lenders to obtain financing:

• Adjusted Gross Income (AGI) on Personal Income Taxes
  Many real estate investors and self-employed borrowers have significant tax deductions reducing their AGI far below their top line income. It’s not uncommon for a business owner with many investment properties to show $50,000 AGI – despite their business and properties generating $3-4 million in revenue.
• Positive Income One Year, Negative Income the Next
  A real estate investor with 5-6 rental properties who also flipped 3-4 high-end homes each year called me for financing on a new primary residence. All their cash was tied up in three finished fix-and-flips that were listed for sale on the market when they submitted an offer on a new primary home. The previous year’s and existing year-to-date (YTD) income through March was negligible. However, when the three flips sold, they’d clear over $1.2 million in profit from the sale and replenish all their working capital.
• Real Estate Rich, Cash Poor
  Finding one's income all tied up in real estate is more common than most people think. Every real estate investor who has a low-liquidity moment thinks they’re the only person who has ever had this problem. On the contrary, it’s par for the course and part of being in real estate — and why there are loans to help you get through the low stretch.
• Conventional Lenders Scrutinize Every Detail
  Owner-occupied loans, where we analyze personal income and document ability-to-repay (ATR), can be intrusive and seem to take forever. I’ve done numerous loans for self-employed borrowers and real estate investors, so I know what to look for prior to submitting the application to underwriting to help speed the process along.
• 10+ Financed Residential Properties
  There used to be a policy where investors could have only 10 financed residential properties. Fannie Mae and Freddie Mac had that rule for years, but there are ways around this using NonQM and bank portfolio lenders.
• Large Capital Gain Affects Loan Approval
  Investors and business owners may experience one-time capital gains from selling a business or property, and take the capital gain on their income taxes. It’s common for underwriters to disregard this income since it’s a one-time occurrence and can't be counted on in the future.
• Personally Guaranteeing Hard Money Loans
  Many hard money loans have a personal guaranty (PG) – even if the borrowing entity is an LLC. I worked with a home builder buying a new primary residence who had several hard money construction loans he’d personally guaranteed. The lender on the primary residence required the borrower to have six months of reserves for the hard money loans, which was nearly $300,000 in additional liquidity on top of the $50,000 in reserves for the new mortgage.
• Loss of Income – Large Tenant Vacated and Building Repurposed
  Sometimes a large commercial tenant moves out and the owner repurposes the building. The owner may face challenges qualifying for a residential mortgage without the steady income from the tenant.
• Selling a Property While the Buyer’s Financing is Delayed
  This happens all the time in real estate: you’re selling a property and the buyer’s financing is delayed. You might receive pressure from the seller of your new house, which leads to another level of stress.
• Acquiring a New Business in the Past Year
  FCTD had a manufacturer who acquired a business and deducted significant costs and expenses against his personal income taxes as a one-time loss. He also purchased a $2.5 million rental property in Newport Beach, but couldn’t qualify for bank financing due to the negative income.
• Income Derived from Cannabis Industry
  Lending to cannabis operators has been opening up ever so slowly. There are always additional challenges that need resolving when cannabis is the main income source.
• Numerous Entities (LLCs, Corps, Trusts, Etc.)
  Unwinding multiple entities can take time, especially when two generations of family members in real estate development and investment have numerous entities set up for tax purposes. The first step is to send all the entities to the title company to determine signing authority, and then to the underwriter.

Self-Employed Mortgage Programs

Mortgages for real estate investors come in a wide variety of programs from various lenders. As a mortgage broker, FCTD has access to many lenders, but we often place loans with a core group of 10-20 institutional and hard money lenders.

Below are the different types of lenders and programs we facilitate for self-employed borrowers and real estate investors:

Conforming Loans (Fannie Mae & Freddie Mac)

They’re called conforming loans because they must conform to Fannie and Freddie’s standards: loan amounts up to $726,200, or $1,089,300 in high-cost locations; 43% debt ratio against W2 or self-employed income; two months in reserves, and more.

Conforming loans are the most competitively priced loans on the market because they’re offered by nearly every traditional lender, who can sell them to the U.S. government-backed Fannie and Freddie.

If self-employed borrowers and real estate investors show enough income, a conforming loan is the best option. However, as I noted above, it’s not always possible due to the realities of being in business or a real estate investor.

Non-Qualified Mortgages (NonQM)

NonQM loans are a great resource for the self-employed and real estate investors. There are plenty of mortgage programs for real estate investors who lack easy-to-calculate income or whose tax deductions reduce their AGI to a very low number.

Let’s look at some of the most common NonQM loans.

Bank Statement Loans

I mostly use bank statement loans for business owners with significant deductions, solo practitioner attorneys, house flippers, and home builders with large deposits from sales.

Most of the bank statement loans I facilitate are 12-month business bank statement programs. The lender calculates the gross deposits minus the expense factor to come to the personal income.

Expense factors vary by industry. A home builder and house flipper would have an expense factor of 50-60%, whereas an attorney working from a home office would only have a 15% expense factor. A builder with $1 million of revenue would result in $400,000 in personal income – whereas an attorney with $1 million would have $850,000.

Asset Depletion Loans

Asset depletion loans have been around for five or six years, and are an important solution for investors who aren’t generating a monthly or quarterly income.

It works by the lender qualifying the borrower based on their FICO scores, Loan-To-Value (LTV), and their amount of liquid assets, whether in a bank or investment account.

NonQM lenders calculate asset depletion loans in two different ways:

1. Asset balance divided by 360 (months)
   Let’s use a $5 million house as an example.
   • $5,000,000/360 = $13,889/mo income
   • The lender gives the borrower $13,889/mo gross income.
   • Most lenders have a 43% maximum debt-to-income (DTI) ratio, which means the total of a borrower’s monthly expenses reflected on their credit report (mortgage, installment, and revolving debt) can be $5,972.22/mo.
2. Loan Amount Multiplied by 125%
   Let’s use a $500,000 mortgage as an example.
   • The borrower would need $625,000 in assets.
   • This assumes that the borrower doesn’t have any additional debt, including mortgages on investment properties or auto loans.
   • The most recent asset depletion I closed was for a real estate agent on their primary residence. They had to factor in the expense ratio for their rental property, plus two nearly-finished house flips that weren’t yet listed for sale.
   • This $600,000 mortgage would therefore require ~$875,000 in liquid assets.

Debt Service Coverage Ratio (DSCR Loans)

I originate many DSCR loans for investors with one or more residential rental properties. I mentioned above that Fannie and Freddie only allow 10 financed properties. NonQM lenders, however, allow a borrower to have 40-50 or more financed residential properties. Most NonQM lenders will limit their loan exposure to one borrower at 15 or 20 loans. When interest rates were really low in 2020-2021, we did 20 loans with one lender and 20 loans with another to spread out the exposure.

DSCR loans are underwritten using LTV, FICO score, and gross rental income against the carrying costs of the property (mortgage, taxes, insurance, HOA). NonQM lenders qualify based on personal income taxes, which benefits real estate investors with many properties who often have minimal or negative AGI on their personal income taxes.

W2 & Paystub Loans

I dealt with a situation where a traditional mortgage loan officer had 20 rental properties and was building two separate 11-unit apartments. They had a hard money loan on their primary residence, and the balloon payment was coming due. Because of tax deductions, their AGI was negative, disqualifying them from a jumbo mortgage.

NonQM lenders have W2 and paystub programs where the lender qualifies the borrower only on the two most recent paystubs and past two years’ W2s. They don’t require personal income tax returns, which in this case would have led to a quick loan denial.

Stated Income Loans

Some NonQM lenders offer stated income loans for primary residences and second homes. I see stated income loans mostly used for short-term bridge loans to buy a new home before the previous home sells, or for real estate investors with highly-fluctuating year-to-year income, depending on when projects sell.

Bank Portfolio Loans

Banks often offer portfolio loans to self-employed borrowers and real estate investors with hard-to-calculate or fluctuating year-to-year income. To obtain a mortgage, banks will often require the borrower to establish a depository relationship at the bank. A loan condition would be a minimum deposit amount with the bank for the life of the loan.

FCTD originated several bank portfolio loans for primary residences, second homes, and rental properties where borrowers had to open a deposit account after the loan was approved or from cash-out proceeds from the loan.

Most portfolio loans have 5, 7, or 10-year terms, which can either be interest-only or fully amortizing payments.

Hard Money Loans

From the start, FCTD’s primary focus has been hard money lending. We’ve originated over $2 billion in hard money loans, and our experience has made us a reliable partner to investors who use us time and again to find the right funding for their next project – or even a personal property. We work primarily with business owners and real estate investors, offering the following programs:

• Bridge loans
• Commercial loans
• Construction loans
• Cross-collateral blanket loans
• Fix & flip financing
• Owner occupied bridge loans
• Rental property loans
• Second mortgages

Conclusion

Self-employed business owners and real estate investors can find that their business decisions can impact their personal finances, sometimes landing them in the sticky spot of not qualifying for a traditional mortgage for their home or rental properties. The standards to meet a conforming loan can be out-of-reach for those with low-to-negative income on their W2’s, too many residential property loans, and a variety of other financial circumstances. The good news is that alternative financing options – from NonQM, bank portfolio or hard money loans – are all designed to help investors purchase personal property despite these obstacles.

Reach out to us today at FCTD to learn more about self-employed mortgage loans available to you.