Loan would use stated income

Q:I’m planning to refinance my home and take about $200,000 out to use to buy an

income-producing property. With the exception of my primary residence, this

will be our first try at real estate investment.

We consider ourselves to be conservative and plan on making a large down payment. The problem is that my wife and I are both independent contractors and our tax returns may not show our true income. Our business is thriving and our income is certain to be very good this year.

Would you recommend that we take out a “stated-income” loan?

A: I changed my position on stated-income mortgage loans many years ago. Back then, I discouraged folks from taking out a stated-income loan in this column because of my suggestion that the product encourages borrowers to stretch the truth. In fact, I didn’t offer stated-income products in my company.

For the record, a stated-income loan is just that: an application that discloses income without verification.

After speaking with several underwriting authorities, I since have changed my tune on the product and will certainly recommend a stated-income loan under the right circumstances.

The purpose of a stated-income loan is to lift some of the paperwork burden off the applicant.

Consider a self-employed person such as myself. I own a corporation, which means I must file corporate tax returns. I also must file personal tax returns. The traditional documents required in my situation would be two years’ corporate returns, two years’ personal returns, and a year-to-date corporate financial statement. That’s a lot of paper.

Ten years ago, an applicant had to pay a higher rate for a stated-income loan, which is one of the reasons I didn’t offer them. Although it is a chore, photocopying all the necessary documents was certainly worth the trouble to get a better rate.

Today, many lenders take a much more practical approach. Stated income is often accepted without a jacked-up rate if all the other underwriting criteria is excellent. The applicant’s credit score should be impeccable, the loan amount in relation to the property’s value should be under 80 percent, and the borrower should be able to show a reasonable savings account through investments or retirement plan.

The lender makes the underwriting decision on these factors, rather than verifying income.

The important thing about a stated-income loan is that it must pass the common-sense test. Many lenders disallow stated income for folks who are salaried, simply because a pay stub is easy verification.

Why would a salaried employee insist on a stated-income loan unless he’s trying to pull a fast one?

Self-employed folks are a different story. Lenders are prepared, if all other aspects of the applicant are strong, to accept a signed application using the applicant’s estimated income. The underwriter will examine the type of work of the applicant and check his assets and make sure it makes sense.

Here’s an example that might raise an eyebrow: A self-employed freelance artist is seeking to refinance his $100,000 loan and take out $200,000 in cash, tripling the size of his mortgage to $300,000. He lists his annual income as $120,000. Meanwhile, he has no retirement fund and no savings or investment account. All he can show for savings is a checking account with a balance of $2,200.

While a freelance artist may indeed make $120,000 a year, the fact that his mortgage payment will triple while there’s no demonstrated savings pattern will make any underwriter nervous, even if his credit is excellent.

Let’s get to your situation. There’s absolutely nothing wrong with estimating your income on the application. But remember that you are signing that application and certifying that all the information is true. While your previous tax returns may not accurately reflect your current income, the underwriter will, indeed, put your application through the common-sense test.

I don’t know enough about your situation to give you any advice, so I’ll just stick with this: Fill out a loan application, state your income and re-read this column. You should have a good idea whether you pass the common-sense test.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail (henrysavage@pmcmortgage.com).