Everyone knows the story. The great housing crash was caused by a bubble forming when home values peaked in 2006 and then started declining before finally hitting record lows in 2012. On December 30, 2008, the Standard & Poor’s/Case-Shiller home-price index showed the single largest annual price drop in the history of its reporting.
The resulting credit crunch caused by people suddenly owning much less valuable homes at a time when they had been overextended by overzealous lenders led to the Great Recession. This crash didn’t only affect homeowners. The chain reaction caused lenders, homebuilders, real estate agents and hedge-fund managers to lose their shirts. The worries about the collapsing housing market were such that a bailout was organized by the federal government to help some homeowners who were suddenly underwater on their mortgages.
After the mortgage industry stumbled (to put it in the nicest of terms), the recovery process involved creating safeguards for lending that would enable prospective homebuyers and current homeowners to borrow only the money that they could safely pay back for their mortgage. The industry began to recover from the enormous crash. There was, however, a large and growing segment of the population that was left out in the cold by these regulations: self-employed borrowers.
Self-employed borrowers … were virtually unable to get a loan for a house, or to refinance at any kind of reasonable rate.
Self-employed borrowers, including anyone from small-business owners to day contractors, were virtually unable to get a loan for a house, or to refinance at any kind of reasonable rate. The issue was that tax returns were considered the only safe way to gauge income, and self-employed borrowers need to write off everything they can to offset their wages and avoid paying higher taxes.
This forced many of these consumers to borrow money at higher rates or to be unable to borrow as much money as they could reasonably pay back. That’s because their taxable income wasn’t as high as their actual income.
This is a real problem in today’s gig economy. Although one can make a solid living working several different jobs at once, the only way to make it work financially is to write off everything possible and to lower your tax burden that way.
The same principle applies for small-business owners. Every write-off is a boon to their bottom line and enables them to pay less in taxes. It lowers their taxable income, however, meaning that lenders think the borrower doesn’t make enough money to qualify for the loan they want. This is clearly an issue.
There are 28.8 million small businesses across the country, per the U.S. Small Business Administration. They employ 56.8 million people nationwide. This is a huge segment of the population that may have trouble getting a mortgage and that’s unfair. Bank-statement mortgages solve this problem.
The bank-statement mortgage program uses the borrower’s bank statements to establish income. Tax returns and other paperwork that used to be essential for a mortgage are not necessary with this program. It opens up a huge potential market for lenders that has been underserved for nearly a decade.
Not every lender can do these programs, however. They have to be able to make their own credit decisions. For the nuts and bolts of the program, income is calculated using the average deposits into the borrower’s bank account over a 12- or 24-month period. The borrower is able to:
- Purchase a new home with as little as a 10% downpayment.
- Refinance term or rate (changing the length of the loan or the interest rate) of up to 90% of the home’s value.
- Take out a cash-out refinance.
Loan amounts vary widely and that means this program could benefit a great number of people. Being able to help both struggling gig-economy workers and successful entrepreneurs makes this program essential to the mortgage industry.
Borrowers need to be self-employed for at least two years. This ensures that they are not taking advantage of a program that is not built for them. They also have to have a debt-to-income ratio of 55% or less. There are a few varieties as well. There are loans available in both adjustable and fixed-rate options, and there are also interest-only options available to borrowers.
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This program has truly expanded the availability of mortgages to homeowners who wouldn’t previously have had an opportunity to buy. With interest rates so low, and the demand for homes and mortgages so high, this program is essential for helping people who want to buy a home accomplish that goal.