A steady income stream, a FICO score higher than 780 and an asset base that exceeded the desired mortgage amount: My loan approval should have been straight-forward, right? Unfortunately, it wasn’t.
While applying for a home equity line of credit, I experienced a snag. My tax strategy of maximizing my business deductions has cost me access to my home’s equity—capital I was hoping to diversify. I was penalized despite the fact that a notable amount of my business’s expenses were paid from an asset—a corporate savings account—not from revenue.
My scenario is no surprise to Kory Kavanewsky, branch manager and senior loan officer at CMG Financial in Coronado, Calif. “The home-buying process has become increasingly challenging for the self-employed,” he explains. “That’s because while business deductions sound like a great idea during tax season, they are almost always counted against you when qualifying for a loan.”
So, I have two options: I can leave a significant amount of my net worth tied up in an illiquid asset (my house) or sell it outright, only to risk being denied a mortgage when I go to reinvest in a new home. That’s not a risk I can afford to take, especially considering the beneficial impact my existing mortgage interest and property taxes have on my current tax liability.
On top of that, Kavanewsky points out another strike that could be used against me. “The process used to determine an entrepreneur’s income is typically at the discretion of the lender,” he says. “Fluctuations in earnings often result in the calculation of a two-year average. When your most recent tax return reflects a decline in taxable income by more than 10 percent, that lower amount will be used.”
Kavanewsky also warns against commingling personal and business funds. “Your lender will want to see that your business’s performance does not rely on your personal assets,” he says. If you’re using personal funds to pay down business debt or costs, the lender will spot it and increase your personal debt-to-income ratio, which will decrease your ability to borrow.
Fortunately, help is coming—but it won’t be cheap. Lenders have begun originating loans that typically require less documentation and allow debt-to-income ratios to exceed the standard 43 percent benchmark, according to Appaswamy “Vino” Pajanor, executive director of San Diego-based Housing Opportunities Collaborative, a nonprofit organization that provides housing assistance. However, he says, these loans come with higher interest rates and lower loan limits, and require higher FICO credit scores.
No thanks. I pride myself on making smart financial decisions, yet my recent challenges in securing a loan reminded me that even a savvy, strategic plan could have blind spots. Looks like I’ll be staying put for a while.