The Smarter Mortgage Series

Helping homeowners make smarter financial decisions, one mortgage question at a time.

Every Realtor knows one.

Every CPA has several.

Every lender talks with them almost every day.

The self-employed borrower.

One of the hardest conversations I have starts with a sentence I’ve heard hundreds of times:

“Doug, my business made great money last year. Why am I only qualifying for a fraction of what I actually earned?”

The answer usually surprises people.

Mortgage lenders don’t qualify you based on what was deposited into your bank account.

We qualify you based largely on the income reported on your tax returns and then calculate qualifying income according to mortgage guidelines.

That is why tax planning and mortgage planning should work together.

Before We Begin

One important disclaimer.

I am not a CPA, and nothing in this article should be considered tax, legal, or accounting advice.

Your CPA’s job is to help you legally minimize your taxes.

My job is to help you understand how your reported income may affect your mortgage options.

If buying a home is part of your future, one of the smartest things you can do is have your CPA and your lender communicate before your tax return is filed.

A little planning today may create more opportunities tomorrow.

The Myth

“If I qualify for a tax deduction, I should always take it.”

Sometimes that is the right answer.

Sometimes it is not.

The real question is not whether a deduction is legal.

The real question is:

“What are my financial goals over the next one to two years?”

If purchasing a home is one of those goals, your tax strategy and your mortgage strategy should complement each other.

Understanding Qualifying Income

One of the biggest misconceptions among self-employed borrowers is confusing business revenue, cash flow, and qualifying income.

Imagine your business brings in $300,000 during the year.

Throughout the year, your business pays for:

• Equipment
• Advertising
• Insurance
• Office expenses
• Professional services
• Vehicle costs
• Payroll
• Rent
• Other ordinary business expenses

By the time your tax return is complete, the income reported as profit may be significantly lower than the total amount your business collected.

That does not mean your business was unsuccessful.

It simply means you operated a business with legitimate expenses.

For mortgage purposes, lenders generally begin by reviewing the income reported on your tax returns and then apply underwriting guidelines to determine qualifying income.

Fortunately, the review does not stop there.

Not Every Business Is Taxed the Same

Every business is unique, and the way your income is reviewed depends in part on how your business is structured.

Sole Proprietor

Income is generally reviewed from your business tax return and evaluated according to mortgage guidelines.

S Corporation

Income may include both W-2 wages and ownership income. Underwriters often review both when determining qualifying income.

Partnership

Ownership income and business financials may both play a role depending on the situation.

Corporation

Corporate ownership structures often require additional analysis because the business and the owner are separate legal entities.

No matter how your business is organized, the goal is the same:

Determine stable, recurring income that is likely to continue.

What Can Sometimes Be Added Back?

This is where many borrowers are pleasantly surprised.

Certain deductions that reduce your taxable income may not reduce your qualifying income in the same way.

Depending on the loan program and underwriting guidelines, examples may include:

• Depreciation
• Amortization
• Certain depletion expenses
• Certain documented one-time business expenses

Every loan program has different guidelines, so no two situations are exactly alike.

One-Time Expenses Versus Recurring Expenses

One of the questions I hear most often is:

“I wrote off $5,000 in office supplies. Can’t you just add that back?”

Unfortunately, it is not that simple.

Office supplies are generally considered ordinary and necessary business expenses. Because those expenses are expected to occur year after year, underwriting guidelines typically treat them as recurring operating expenses rather than one-time events.

Now imagine your business purchased a specialized piece of equipment that is expected to last many years, or your company experienced a large, documented, nonrecurring expense.

Those situations may be evaluated differently depending on the loan program and underwriting guidelines.

Every file is unique, which is why reviewing your complete financial picture is so important.

Consistency Matters

Mortgage underwriting is not only about how much income you earn.

It is also about whether that income appears stable and likely to continue.

A business reporting consistent earnings year after year often presents a different picture than one with significant swings in profitability.

Lenders understand that businesses experience good years and challenging years, but consistency helps paint a clearer picture of long-term financial stability.

The Goal Is Not To Pay More Taxes

Let me be clear.

I am not suggesting anyone pay more taxes than they legally owe.

The goal is not to increase your tax bill.

The goal is to understand how today’s tax decisions may affect tomorrow’s borrowing power.

Planning with both your CPA and your lender allows you to make informed decisions instead of discovering surprises after your tax return has already been filed.

Planning Timeline

Buying Within the Next 30 Days

Your financing options will generally be based on the tax returns that have already been filed.

There may still be excellent solutions available, but your planning opportunities are more limited.

Buying Within the Next 6 to 12 Months

Now is an excellent time to begin the conversation.

• Meet with your lender.
• Talk with your CPA.
• Discuss your goals before your next tax return is prepared.

Buying One to Two Years From Now

You have time to develop a strategy.

That may include:

• Improving your credit
• Saving additional assets
• Evaluating different loan programs
• Discussing future tax planning with your trusted advisors

New Business Owners

Many traditional mortgage programs require an established history of self-employment.

If you recently started your business, don’t assume homeownership is out of reach.

Depending on your previous employment, the type of business you own, and the loan program, there may still be options worth exploring.

This is another reason why planning ahead is so valuable.

What If Your Tax Returns Don’t Tell the Whole Story?

Some business owners have healthy cash flow while reporting relatively low taxable income.

That does not necessarily mean homeownership is out of reach.

Alternative financing options may be available, including bank statement loan programs designed for certain self-employed borrowers.

Rather than relying primarily on taxable income, these programs may evaluate business or personal bank deposits to help demonstrate your ability to repay the loan.

Bank statement loans are not “easy loans.”

They simply evaluate income differently.

For the right borrower, they can be an outstanding solution.

Every program has different qualification requirements, so it is worth having the conversation before assuming you do not qualify.

Frequently Asked Questions

Does writing off business expenses hurt my ability to qualify?

Sometimes. It depends on the type of expense, your income, the loan program, and current underwriting guidelines.

Should I pay more taxes just to qualify for a mortgage?

Not necessarily.

The better approach is to have your CPA and lender work together before your tax return is filed so you understand the tradeoffs.

Can I qualify without using tax returns?

Possibly.

Certain alternative documentation programs, including bank statement loans, may be available for eligible borrowers.

What if my business income has increased recently?

Every situation is different.

If your business is growing, discuss your circumstances with your lender. There may be financing options available that fit your situation.

Planning Beats Guessing

One of the best conversations I have with self-employed clients happens before they file their tax return.

That gives us the opportunity to discuss:

• Their homeownership goals
• Their expected purchase timeline
• Different financing options
• Whether traditional or alternative loan programs may be appropriate
• Questions they may want to discuss with their CPA

That conversation often creates more options than waiting until after the return has already been filed.

My Philosophy

My job is not to tell you how to prepare your taxes.

My job is not to convince you to pay more taxes.

My job is to help you understand how your financial decisions today may affect your mortgage options tomorrow.

The earlier we have that conversation, the more opportunities we may have to help you achieve your goals.

A CPA’s Perspective

Coming Soon

I believe the best financial decisions happen when your lender and your CPA work together.

I’ve invited a local CPA to contribute to this article because I believe homeowners and business owners deserve both perspectives before making important financial decisions.

Questions for Our CPA

• What is the biggest misconception business owners have about taxes and qualifying for a mortgage?
• If someone plans to buy a home within the next 12 to 24 months, when should they begin discussing those plans with their CPA?
• How do you balance minimizing taxes while helping clients prepare for future financing?
• Are there deductions business owners frequently misunderstand when it comes to mortgage qualification?
• What advice would you give someone before filing their tax return if they hope to purchase a home soon?
• When should a CPA recommend that a client speak with their mortgage lender?
• How do you explain the difference between taxable income and cash flow?
• What is one thing every self-employed borrower should know before applying for a mortgage?

Stay tuned. I’ll publish the CPA’s answers in next week’s follow-up article so you can benefit from both a lender’s and a CPA’s perspective.

Final Thoughts

The best mortgage strategy often begins long before you ever fill out a loan application.

It begins with a conversation.

A conversation with your lender.

A conversation with your CPA.

A conversation about where you want to be one, three, or even five years from now.

Buying a home is not just about qualifying today.

It is about creating a financial plan that supports your long-term goals.

Because my job isn’t to sell you the lowest interest rate.

My job is to help you make the best financial decision for your situation.

Have Questions?

Whether you own a small business, receive 1099 income, operate a corporation, or simply want to understand how your business income may affect your mortgage options, I’d be happy to help.

Doug Caldwell
Executive Loan Officer
Rocket Mortgage
NMLS #1697500

925-421-7280

dougisyourlender.com