“Strict Lending” = Blame the Entrepreneurs

Spiderman is self-employed too

Photo credit: Eneas on Flickr

“Honestly,” she says to me, “there is absolutely no market for stated income loans anymore.”

These were the words I was afraid of, was warned about, and didn’t believe. I wasn’t easily turned away.

“Why? What’s the difference between a stated income loan and a full doc loan… is that right? Is it called ‘full doc’?” I asked.

The woman on the other end of the phone didn’t realize that while I was talking to her I was looking up the big, unusual words I hadn’t had defined to my satisfaction via Google. See, I’m a self-employed Web Chef which gives me the distinct honor of being able to spend my time when and where I want. That sounds great right? Hold that thought because right now – on this phone call – my time was best spent looking up definitions to real estate and lending terminology so that I could continue this word battle.

The woman continues. “Yes, you’re right. ‘Full doc’ means that you have documentation like W-2’s, bank statements, and 1040 tax records that prove that you make what you are telling us, the lender.”

“I see,” I said. “So, this is what’s interesting to me. The government gives us – the self employed and the small business – incentives to start and run these businesses, effectively hiring over 80% of the workforce of America. One of the biggest incentives we get is the ability to claim deductions, which effectively lowers our taxable income. But what you’re telling me is that because my taxable income is essentially in the poverty bracket (and yet, I might add that we rent in one of the more expensive areas of one of the more expensive downtown cities in the nation), that we can’t get a loan?”

Without hesitation, as if she’s heard this hundreds of times before, she answers “Yes, that’s correct.”

Much to my dismay, I’m losing the battle, so I try a more direct approach. I tell her how much we rent for and ask her if we could get a loan where the mortgage would work out exactly the same as our rent. I explain, as if she’s never rented before, that we’ve been paying this amount monthly for a year already, so there’s no way we are unable to afford the amount. At that price, we should surely be able to afford the the nice condo we were looking at. In the most simple terms I then say “Look, we will either be paying this amount in rent, or we can buy a condo and give you the money each month.”

Her response was more than informative. “The unfortunate thing is that because Fannie Mae and Freddie Mac are now government entities, essentially, their new policies are simply not to accept stated income loans. Now, normally, we’d give you the loan and then to free up the cash that we’ve just lent out we’d sell that loan to Fannie or Freddie. That gives us some money back to be able to keep lending. Now, the secondary market for loans is gone. The problem is … ”

… Let me just stop here. This is where I believe she went schizo on me and missed where the blame should have squarely been placed. Ok, let’s continue….

“The problem is,” she says, “so many people lied on their stated income mortgages and then all these people fell into defaulting on their loans, that Fannie and Freddie are effectively not buying these types of loans anymore.”

Ok, I have to interject again. If you haven’t seen this video on how all this economic situation really came about, I highly recommend watching it. If you’ve seen it or you don’t believe a word she just said, then feel free to continue right along. For those of you who need some fiscal education, watch this:

The Crisis of Credit Visualized from Jonathan Jarvis on Vimeo.

Now, I was sunk.

Of course I couldn’t argue with her about who started this whole mess (ahem *cough cough* the lenders *achoo*), because that surely won’t help me get the loan I wanted. But, if that’s the way she wants to spin it, fine. Whatever, let’s move on.

Recap

Many people love to blame the current economic situation (consumerism being down, people losing their jobs, housing and lending industries creeping, etc) on the housing bubble. Now, I’m all for reading fine print – I know, call me a geek, I’m used to it – but most of the people out there aren’t like that. They do what people tell them to do, especially ones who seem to know more than they do about a particular domain. Thus, perhaps a ton of people did lie on their stated income returns even though they had W-2’s, 1040’s and bank statements to prove that they didn’t make enough to pay for a house, a car, their alimony and child support and that 61 inch TV they just bought from Best Buy. I mean hey, perhaps they did have income coming in some other way right Mr. or Mrs. Lender? Let’s just believe them and sign that loan document so you can collect a big fat commission check. Great.

So what’s the problem with all of this? Let’s do a quick summary:

  • The loan officer: walks away with a big fat commission check because they got a loan signed. Who cares if they could actually afford it?
  • The bank: Well, they got stuck with the bill when Fannie and Freddie stopped buying loans that had a massive risk attached to them, so they got screwed at the end of it. But, while the loans were being signed and sold, they were happy-go-lucky. It’s only because they got caught holding the red hot potato that they’re failing now.
  • The W-2 employee who bought a house: Well, it sucks for them because now they have to walk away from a house that’s worth half (or less) of what they originally (stupidly) signed a loan for. Even if they did it because the loan officer convinced them, they’re back where they were before – renting with no intention to buy in the near future. If they did want to get a house now though, they could just break out their W-2 and 1040, show they still have a job and cut back on their crazy spending habits and debt, and go buy a house (again) without blinking (this time, the right way).
  • The self-employed person who didn’t buy when the market was hot but is now ready to get in when it’s reasonably priced: Oh these guys? They get completely screwed. Yea, screwed. We’ve been running a legal, profitable business for 15 years on tax benefits that stimulate the economy. We hire employees and contractors and spend money only when we have it because that’s called cash flow and business people know this term inside out. We’re the ones who get screwed.

Now this is the part of the story I call “Getting Frustrated”

Now that I’ve pointed more fingers than I possess, I’d like to offer some possible solutions. Solutions which I have absolutely no faith will be adopted in my lifetime. But, I hate coming to the table and just complaining. So here they are:

Option 1: Only allow people to do stated income loans who are not W-2 employees of any companies and yet do meet certain minimum revenue minimums for at least a year. This way, you’re keeping out the people who simply misstate their income (the so-called “liars” the lender mentioned), as well as those who obviously don’t make the amount of money they should to qualify for a loan.

Option 2: Allow, nay, certify via a CPA, the backing out of certain deductions that the IRS allows small businesses to take such as home office space, utilities, office equipment, and food and entertainment budgets. These are absolutely used for business, but they are also used in a personal context (ie a room in the home dedicated to business, eating, drinking, traveling, and more). Being able to certifiably back those expenses out would have easily given us the ability to quality for a loan – as a documented fact.

Option 3: This is the easiest. If someone is able to afford, let’s say $1500 per month in rent for a year, and nothing has changed in the last 2 months, there is absolutely no reason why that person shouldn’t be able to afford a $1500 mortgage (including PMI and taxes). That easily qualifies them for $230k+ house even with almost no money down. Proving your rent should be just as much considered full documentation as a 1040. Not accepting a 3rd party’s certification (and even their tax records if necessary), is simply asinine.

… Now, I hate leaving an article with the word “asinine.” So, go ahead, tell me your thoughts on the matter. Whatcha got?

Nate Ritter lives in the Pacific Northwest (U.S.), popularized the #hashtag and creates web applications for a living. He also does miles and point hacking to enable cheap travel for his family. More here →

10 Comments on "“Strict Lending” = Blame the Entrepreneurs"

  1. joe mahavuthivanij says:

    hey buddy, sorry to hear about the loan situation. i just wanted to add a few notes that i think were overlooked in the post.

    1. the w2 employee won’t get the loan even with full docs if he defaulted the first time because their credit is shot. if they were lucky enough to sell the house in a short sale, then they would fit the situation you described and could buy another house.

    2. unfortunately for us entrepreneurs and self-employed people, the reason why we wouldn’t qualify for the loan is because the income is unpredictable. if a venture or contract ran out, then there would theoretically be no income left to make the loan, despite having plenty to make the rent. unfortunately, we can’t show at least a 2 year history of steady income paired with our otherwise immaculate credit, and that’s a big reason for why we wouldn’t qualify for the loan. that’s what is important here, not the rental history.

    we’re just dollars and cents to the bigwigs and fatcats and they’re not taking any chances. as far as they’re concerned, we’re just like everybody else. it doesn’t matter that you or i or anybody else are upstanding, morally and financially responsible citizens because they don’t know who we are. they see that we haven’t had that steady job and therefore pose a riskier bet than joe shmoe who makes $45k/year and has been at his job for 2 years.

    it sucks, but that is unfortunately the reality of the situation. if you can afford to put at least 20% down, have a great credit score, and show a reasonable combined income over the last 2 years, then you will make a much more compelling argument for them to give you the loan. good luck and i hope you can lock it down and get the condo!

    ps. i moonlight for a broker as an agent and, if you want, can find out if there’s anything they can do to help. holla!

  2. David Safeer says:

    Thanks for the great commentary. Why is a W-2 full dock and not a tax return showing substantial income. I have friends with W-2 income but made the mistake of fully documenting themselves as the owners of the company that pays them the W-2 wage. DENIED! Their employees can get loans but they can’t. The twisted logic of it all!

    Dsafeer

  3. nate says:

    Hey Joe,

    Thanks for the info. Yea, I did skip the part you mentioned about the potential where the W-2 employee screwed over their credit history, but that’s a completely different issue to some degree. If they still had the money to put forward, however they receive it (at their job or via an inheritance or whatever), they’d still have a better chance at getting a loan than I would.

    The problem isn’t my history at all. I’ve been doing this for 15 years, full time for over 10 of those years and it’s been extremely stable over the long term – moreso than my employment history if they cared to look at the difference. The problem is that I can’t prove that to anyone in the ways they want it proven. The problem I’m pointing out is that the methods to prove that you are able to afford something are messed up. You could say that stated income loans were too relaxed. I’d just say unregulated.

    I’m not one for more regulation, but at least defining some kind of middle ground here is what’s missing.

    If it were simply showing a 2 year history of steady income, I don’t think I’d have this problem at all. The loan officer I talked to did mention a 2 year history, but it was with 1040’s. That’s where the problem lies. On the 1040’s I don’t make jack squat. But we all know that’s not truly the case. I take as many tax deductions as possible to keep my taxable income low. The problem is that they’re looking at my taxable income – the very thing I’m trying to keep low so I don’t have to pay much in taxes is the thing they’re looking at as “enough” income. There’s the problem right there. You can’t pay less taxes AND show that you make enough money to support a loan simply because the lenders won’t look at the true amount of money you have to spend on housing (even though we pay that amount in rent every month with no problem).

    I fully understand it’s the “reality of the situation”… I’m just calling it out as not being how it should be.

    p.s. I appreciate the offer, but I think we’re just going to be sitting tight for now unless we do find a bank who will lend to us.

    Cheers friend.

  4. joe mahavuthivanij says:

    i totally agree with you about disagreeing with the yard stick for measuring income. it’s a funny thing with deductions (and presumably expenses) as they’re a total double-edged sword in this case. the very thing that shows you net zero each year makes the bankers scoff at the thought that you could possibly afford a mortgage.

    the system is so screwed up against entrepreneurs and self-employed people. like with teachers being able to afford homes, there should be special scrutiny given to self-employed people for things like loans to prove we could afford the payments. the same goes for incentives for starting businesses or being self-employed in the first place. since businesses are the ones who hire the employees who become the rank and file, they’re a huge part of the employment solution vs. being part of the problem. i’m not even going to get myself going with that one…

    but yea, totally agree that that’s not how it should be, and i’d be the first one on the boat to trying to make it all right.

    hopefully see you at the next ignite!

  5. nate says:

    Definitely Joe! Definitely.

    (on both your comment and on getting to the next ignite.)

  6. Chris says:

    Great article. Its the exact position I’m in now. I sold my house to move into a better area hoping to capitalize on the down market. Running into issues with loans now. Even though I paid for a mortgage for the last 5 years I’m having issues getting a new one. The irony is my employees, who are w2 are having no issue qualifying.

    So here is my comment & question: Good ideas for solutions – but we’re talking about a mindset change for the entire banking industry – what do guys like us do in the here and now?

  7. nate says:

    Chris,

    I think what we have to do is put ourselves on W2 payroll for 3 months to prove our income, buy the house, and then take ourselves off to save that 10% payroll tax. That’s the only solution I’ve come up with so far.

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