1099 and mortgage qualification

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floppyb
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1099 and mortgage qualification

Post by floppyb » Tue Sep 11, 2018 8:34 am

Earlier this year I switched from being a W2 employee to a 1099 contractor. Before I switched, I thought I had worked through all the financial considerations, but the one thing I forgot to consider was how it would effect me getting a mortgage. It was a bit of a shock when I was informed that banks weren't willing to qualify me until I had two years of tax returns as a 1099 and that the income they used would be different than if I was still W2. So now I am trying to understand what a bank will use as my income when I do get a mortgage as a 1099. I was told that it wouldn't be based on gross income, but on income minus business deductions. My big question is: do retirement contributions to a Solo 401k counts as a business deduction? I ask because I can contribute both as an employee and employer. Say I make $250,000 and have no other business deductions. I contribute that max of $55,000 to a Solo 401k, my taxable income is now $195,000. Is that the number a bank will use to base my mortgage off?

Simply put: how can I figure out what number a bank will be using for my income to qualify me for mortgage as a 1099?


Thanks so much.

JBTX
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Re: 1099 and mortgage qualification

Post by JBTX » Tue Sep 11, 2018 8:38 am

floppyb wrote:
Tue Sep 11, 2018 8:34 am
Earlier this year I switched from being a W2 employee to a 1099 contractor. Before I switched, I thought I had worked through all the financial considerations, but the one thing I forgot to consider was how it would effect me getting a mortgage. It was a bit of a shock when I was informed that banks weren't willing to qualify me until I had two years of tax returns as a 1099 and that the income they used would be different than if I was still W2. So now I am trying to understand what a bank will use as my income when I do get a mortgage as a 1099. I was told that it wouldn't be based on gross income, but on income minus business deductions. My big question is: do retirement contributions to a Solo 401k counts as a business deduction? I ask because I can contribute both as an employee and employer. Say I make $250,000 and have no other business deductions. I contribute that max of $55,000 to a Solo 401k, my taxable income is now $195,000. Is that the number a bank will use to base my mortgage off?

Simply put: how can I figure out what number a bank will be using for my income to qualify me for mortgage as a 1099?


Thanks so much.
My recollection is they will want parts of your tax return, such as Schedule C. I don't think contributions to a retirement account or going to count against you. They aren't reductions of Schedule C business income. The reductions flow through on the 1040.

RickBoglehead
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Re: 1099 and mortgage qualification

Post by RickBoglehead » Tue Sep 11, 2018 8:39 am

In short, you can't, because banks do what they want to. 1099 is always viewed as less desirable. You'll probably be asked to supply two years of tax returns. Your return will clearly show, and you should point out, that you gave VOLUNTARY CONTRIBUTIONS to your retirement, which you could have used to pay your mortgage. In other words, both the employer contribution (which is a business expense) and your contribution (which is not a business expense), would be available if needed.

The bank should take your business expenses, minus the 401K company contribution, and subtract those from your business income. I'd advise a lot of communication, documentation, etc.

Edit - saw JBTX's post, wanted to clarify - the company employee contribution to a 401K does appear on Schedule C as a reduction of Schedule C business income. It's the employee company contribution that does not. But it does reduce business income and needs to be added back.
Last edited by RickBoglehead on Tue Sep 11, 2018 10:19 am, edited 1 time in total.

Spirit Rider
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Re: 1099 and mortgage qualification

Post by Spirit Rider » Tue Sep 11, 2018 9:35 am

RickBoglehead wrote:
Tue Sep 11, 2018 8:39 am
Edit - saw JBTX's post, wanted to clarify - the company contribution to a 401K does appear on Schedule C as a reduction of Schedule C business income. It's the employee contribution that does not.
No it does not.

The Schedule C Line 19 Pensions and Profit Sharing deduction is only for employees. The owner's employer contribution goes on Form 1040 Line 28 along with their employee contribution.

A bank would use your compensation, which is your net earnings from self-employment. I.e. your Form 1040 Line 12 Bussiness profit - Line 27 1/2 SE tax.

Finally, banks do not just "do what they want to". Compensation guidelines are clearly spelled out in Fannie Mae and Freddie Mac underwriting requirements. The have no choice on underwriten loans.

floppyb
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Re: 1099 and mortgage qualification

Post by floppyb » Tue Sep 11, 2018 2:35 pm

So to be clear, the employee contribution of $18,500 to a 401k will reduce my net earnings, right? But that the bank should hopefully add that back when calculating how much I can borrow? Is that correct?

Spirit Rider
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Re: 1099 and mortgage qualification

Post by Spirit Rider » Tue Sep 11, 2018 3:03 pm

As I said; both employee and employer contributions are deducted on your personal Form 1040 Line 28. They have nothing to do with your net earnings form self-employment.

The lender is required by underwriting guidelines to not just take your Schedule C at face value. They will also look at the stability and recurring nature of the income as well as any business liabilities.

floppyb
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Re: 1099 and mortgage qualification

Post by floppyb » Tue Sep 11, 2018 10:18 pm

Spirit Rider wrote:
Tue Sep 11, 2018 3:03 pm
As I said; both employee and employer contributions are deducted on your personal Form 1040 Line 28. They have nothing to do with your net earnings form self-employment.

The lender is required by underwriting guidelines to not just take your Schedule C at face value. They will also look at the stability and recurring nature of the income as well as any business liabilities.
Ah ok. I think I understand it now. Thanks so much!

InvestorThom
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Re: 1099 and mortgage qualification

Post by InvestorThom » Wed Sep 12, 2018 4:39 pm

Just to clarify...

OP will have to wait two years before re-applying for a mortgage because income is based on a 1099 vs W2?

Spirit Rider
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Re: 1099 and mortgage qualification

Post by Spirit Rider » Wed Sep 12, 2018 5:21 pm

It is not guaranteed to be two years. The underwriting guidelines say 12 - 24 months.

My personal experience was they wanted a minimum of one tax return and then prorated it by the months in business. In my case say $60K for the first tax return, in business for 18 months = $60K * 1.5 / 2 = $45K was the wanted to use for my compensation. This was years ago.

YMMV.

floppyb
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Re: 1099 and mortgage qualification

Post by floppyb » Wed Sep 12, 2018 6:09 pm

Chase, Wells Fargo, Bank of America all said they wanted 2 years of tax returns before they would review my application. Working with a mortgage broker, I was able to find other offers, but they were for loans like 5 year ARM. Nothing currently in the 15, 30 year fixed rate world.

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HueyLD
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Re: 1099 and mortgage qualification

Post by HueyLD » Wed Sep 12, 2018 6:14 pm

Do you do your own taxes or do you have an accountant?

We used to receive requests from banks asking for clients' 2-3 years of tax returns (with clients' written authorization of course). For some reason, banks did not trust the copies provided by mortgage applicants.

CurlyDave
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Re: 1099 and mortgage qualification

Post by CurlyDave » Wed Sep 12, 2018 7:16 pm

floppyb wrote:
Wed Sep 12, 2018 6:09 pm
Chase, Wells Fargo, Bank of America all said they wanted 2 years of tax returns before they would review my application. Working with a mortgage broker, I was able to find other offers, but they were for loans like 5 year ARM. Nothing currently in the 15, 30 year fixed rate world.
If the choice came down to buying a house now with an ARM vs. waiting a 12-24 months for a fixed rate mortgage, I would opt for the ARM.

Don't misunderstand, I prefer a fixed rate mortgage, but I have had dozens of mortgages over my lifetime, maybe 30-50% were ARM, and never once have I been been hurt by an ARM. Not that it can't happen, but if you keep looking at mortgage rates and stay willing to refinance when you have enough years of being a 1099 employee it is highly unlikely that you will be stuck in an ARM when rates significantly increase.

Every time I have had the stark choice presented to me of house now with ARM vs. no house, the ARM won out.

michaeljc70
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Re: 1099 and mortgage qualification

Post by michaeljc70 » Wed Sep 12, 2018 7:44 pm

After the tax savings, the after tax difference between 250k and 200k isn't going to be that great. Are you cutting this mortgage that close? As indicated, it is probably moot because they aren't going to look at anything really since it sounds like you don't have two years of taxes on a 1099. I was in the same situation a few years ago. I was able to get a mortgage after having one year of taxes filed working on a 1099 using a mortgage broker that knew what they were doing. That was based on me doing the same exact kind of work from W2->1099, but just being paid differently which is what it sounds like you are doing.

Of course, there are non-conventional mortgages at higher rates with completely different rules.

floppyb
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Re: 1099 and mortgage qualification

Post by floppyb » Wed Sep 12, 2018 8:38 pm

CurlyDave wrote:
Wed Sep 12, 2018 7:16 pm
floppyb wrote:
Wed Sep 12, 2018 6:09 pm
Chase, Wells Fargo, Bank of America all said they wanted 2 years of tax returns before they would review my application. Working with a mortgage broker, I was able to find other offers, but they were for loans like 5 year ARM. Nothing currently in the 15, 30 year fixed rate world.
If the choice came down to buying a house now with an ARM vs. waiting a 12-24 months for a fixed rate mortgage, I would opt for the ARM.

Don't misunderstand, I prefer a fixed rate mortgage, but I have had dozens of mortgages over my lifetime, maybe 30-50% were ARM, and never once have I been been hurt by an ARM. Not that it can't happen, but if you keep looking at mortgage rates and stay willing to refinance when you have enough years of being a 1099 employee it is highly unlikely that you will be stuck in an ARM when rates significantly increase.

Every time I have had the stark choice presented to me of house now with ARM vs. no house, the ARM won out.

Interesting. Part of me is terrified of ARM and the other part of me thinks we will be fine refinancing in two years. Probably worried about it because I wasn't expecting it to be my own option.

michaeljc70 wrote:
Wed Sep 12, 2018 7:44 pm
After the tax savings, the after tax difference between 250k and 200k isn't going to be that great. Are you cutting this mortgage that close? As indicated, it is probably moot because they aren't going to look at anything really since it sounds like you don't have two years of taxes on a 1099. I was in the same situation a few years ago. I was able to get a mortgage after having one year of taxes filed working on a 1099 using a mortgage broker that knew what they were doing. That was based on me doing the same exact kind of work from W2->1099, but just being paid differently which is what it sounds like you are doing.

Of course, there are non-conventional mortgages at higher rates with completely different rules.
Those aren't my real numbers, but I understand your point of cutting it close. One broker I spoke with did mention that with one year of tax returns, my options might open up.

michaeljc70
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Re: 1099 and mortgage qualification

Post by michaeljc70 » Wed Sep 12, 2018 8:58 pm

To get back to your original question, when I made a SEP contribution as a sole proprietor, that comes off on the 1040 (line 28) and not the Schedule C (Business Profit/Loss) so I highly doubt they would exclude that from your income. It comes off in the same section that deductible IRA deductions do. I believe that this could vary depending on how you are setup (type of corporation vs. sole proprietor).

michaeljc70
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Re: 1099 and mortgage qualification

Post by michaeljc70 » Wed Sep 12, 2018 9:03 pm

InvestorThom wrote:
Wed Sep 12, 2018 4:39 pm
Just to clarify...

OP will have to wait two years before re-applying for a mortgage because income is based on a 1099 vs W2?
Pretty much. As I said above you can get away with one year sometimes. When I was going through this I wound up having to pay cash for the home and then get a mortgage later. I know many people don't have that option. When I said to the mortgage broker that I had enough cash to pay for the house, doesn't that matter, he said it doesn't matter if you have enough to buy 3 of them.

Basically, conventional mortgages are made for mainstream America and highly count W-2 employment and discount (or completely ignore) net worth and self employment income that isn't well established. Essentially, many people could have a W-2 job, get a mortgage, lose the job the next week and not be able to make the next payment (many people have little saved) but apparently they prefer that to someone with cash.

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