How Lenders Evaluate Contract Work
As more and more people choose flexible work arrangements, we have received an uptick in requests for information about how contractors can qualify for a mortgage. In this article we demystify how lenders evaluate contract work.
Prior to the financial crisis, lenders put less emphasis on documented income, relying instead on a prospective borrower’s down payment (equity) and credit history. While this approach was fine when property values increased 10%+ per year, its flaws were exposed when property values dropped significantly in the late 2000s. Today, there is an increased focus on a borrower’s “ability to repay” as evidenced by a documented income history and a likelihood for that income to continue.
However, many borrowers who are self-employed or are choosing less traditional employment opportunities are finding qualification more difficult, despite having large down payments and exceptional credit.
Lenders that underwrite to Agency (Fannie & Freddie) guidelines will look for a two-year history of your contract income. They will verify this income by requesting copies of your 1099s and your two most recent tax returns to confirm that the income was both earned and reported. Lenders will take the total of your contract income over this period and divide by 24 to calculate your average monthly income which can be counted towards your qualification. If your income has declined during this two-year period, your lender will likely just use your most recent year’s income. Take for example a homebuyer who drives for Uber who has made $80,000 over the past two years. The monthly income usable for qualifying purposes in this case is $3,333 ($80,000 / 24 mos).
If you don’t have a two-year history, a lender may still be able to qualify you if your contract work has a high likelihood of continuing for an extended period. For example, a prospective borrower in year one of a four-year contract may still qualify given the expected continuance of the income.
Lastly, there are some lenders, typically banks, who specialize in lending to consumers with non-traditional employment. Oftentimes these lenders will charge higher rates to compensate them for the additional perceived risk, limit the product types available, and/or require additional forms of collateral, such as putting money on deposit at the institution that can be used to pay back some of the loan in the case of missed payments.