Owning your own business can come with a lot of perks, but it can also come with a lot of headaches. One of those headaches can come from getting denied for a mortgage.
No one likes rejection, and if you’re a business owner, you might know the feeling all too well. The good news is that just because you were denied once, doesn’t mean you will be denied again and again. And because lenders are required to detail the cause for denial in a formal rejection letter, you’re given all the information you need to correct your situation.
Here are 4 of the most common reasons why business owners get denied for mortgages:
1. How Much Money Shows Up On Your Tax Return? If you own your own business, and that business is your primary source of income, then you are functionally the opposite of a W-2 hourly or salaried employee. When W-2 employees get paid, the money goes first to the government to cover taxes, unemployment, social security and Medicare. The employee then gets to live off what's left.
Business owners earn money, then expense or deduct whatever they can legally omit from their income and then pay taxes, unemployment, social security and Medicare. If you can manage your money well enough to not come up short at tax time, this is a great way to earn money. Unfortunately, your tax returns look like you're broke.
2. Collateral and Cash Small business owners and the self-employed can qualify for a mortgage, but you will need to provide some proof that you have the ability to pay back the loan. By maintaining a good credit score and avoiding deductions that zero out your income on your tax returns, you can prove that you're worthy of a mortgage.
Start planning early whenever possible. The bank will need to see two years of tax returns for qualifying purposes, so try to avoid using your deductions to wipe out your income for a couple of years worth of returns to demonstrate you can afford the house.
3. Get Rid of Other Debt Your Debt-to-Income (DTI) ratio will also be considered. If you have a great deal of recurring debt, such as student loans, credit card debt or car loans, this can impact your income and limit your ability to borrow.
4. Build Good Relationships If you have received a business loan from a bank, they will probably be able to help you pre-qualify for a mortgage. Stick with them and work to build up a great payment history. Relationships matter in business and in finance, so if you're on the edge of qualifying for a mortgage, the fact that your bank is pleased with your payment history may help you across the finish line and into your own house.
Final Thoughts The numbers on your tax return matter. You aren't legally obligated to pay more than the taxes that you owe, so it makes sense to take all the deductions you can. However, make sure not wipe out your income if you plan to purchase a home.