Q: We run our own business, and even though we have pretty good cash flow to pay our bills, our income tax return shows very little taxable profit. This makes it difficult for us to qualify for loans.
We have heard of "No-Doc" or "No Income Verifier" loans for people like us who have trouble showing enough income to qualify for a mortgage. Can you give us some information about those loans and how they work?
G.H., Snohomish
A: Many small business owners have money coming in, but their tax returns show little net profit.
Now before I go any further, let me clarify that I believe it is illegal, immoral and unethical not to properly report all earned income on your federal tax returns. I do not condone or recommend that anyone should deliberately lie or under-report their income on their income tax returns.
In fact, I often tell my clients to claim fewer deductions and declare more income on their tax returns. That’s because if you can fully document your income, you will get the best mortgage interest rates available.
If your documentable income is not sufficient to qualify for the mortgage loan amount you desire, you have two choices. You can get either a "stated income loan" or a "no income ratio" loan.
As its name implies, on a stated income loan you simply state the amount of money you make on the loan application but you are not required to supply any documentation to support that number. Now, do not misunderstand. This does not give you permission to lie and make up unrealistic income numbers.
It is intended for business owners who have actual usable cash flow that does not show up on their tax returns.
For example, if you own a small shoe repair booth and state an income of $1 million per year, that is not realistic and your loan application would be declined.
The income number must be reasonable based on your type of business. To qualify for a stated income loan, many lenders require the borrower to be self-employed for a minimum of two years which is verified by tax returns, business licenses or a letter from a CPA.
You should have decent credit and some cash in the bank. Your interest rate will depend on the quality of your credit, how much money you have in the bank and how much equity you have in your home.
Rates for stated income loans can be as little as one-quarter percentage point higher than regular loans to as much as 3 to 4 percentage points above the market rate. Again, it all depends on the specifics of your financial situation. Each loan is priced on a case-by-case basis.
With a "No Income Ratio" loan you do not state any employment or income information on the loan application. The only documentation required is verification of your financial assets and credit rating.
The interest rates for this kind of loan will be higher than the stated income loan because less information is provided on the loan application.
Again, the actual interest rate you would pay will depend on your individual financial situation. If you have excellent credit, lots of money in the bank and lots of equity in your home, you would get a much lower interest rate than if you had very little money or equity. But in any event, you can expect to pay significantly higher interest rates than those you see advertised for "full doc" borrowers.
If you are business owner who applies for mortgage loans on a fairly regular basis, I strongly encourage you not to get too carried away with using deductions to minimize your taxable income.
By claiming fewer deductions and showing a larger taxable income on your tax returns, you will be able to qualify for lower interest rate loans. In the long run, that may be far more valuable than saving a few hundred or even a few thousand dollars on your income tax bill.
Mail your real estate questions to Steve Tytler, The Herald, P.O. Box 930, Everett, WA 98206. Fax questions to Tytler at 425-339-3435, or e-mail him at economy@heraldnet.com.
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