"My wife and I are currently considering buying a new house, and I am considering changing jobs to earn a higher salary. I have been at my current job for five years. Rather than changing jobs, I am also considering the possibility of going into business for myself. Whatever I decide to do, should I do it before or after we buy the house?"
The answer to your questions depends on how the action taken — changing jobs or starting your own business — will impact the way a mortgage underwriter views your income.
Underwriters look at three dimensions of a borrower’s income: the amount, which must bear a reasonable relationship to the borrower’s payment obligations; the documentation for the amount, which is the evidence that the amount is what the borrower says it is; and the stability of the amount, which are the indicators that the amount reported will continue in the future.
Changing jobs: Changing jobs may affect the underwriter’s judgment about income stability. Ordinarily, an underwriter wants a borrower to be on the job that generates the income used to qualify for two years or more. Other sources of income, such as financial assets and rental property, are subject to their own rules.
A job change does not necessarily imply a reduction in income stability. If you change your job for one paying more, in the same line of work, and if there is no significant time gap between the old job and the new one, the underwriter will assume that the new job is a continuation of the old one. In such case, it won’t matter whether you change jobs before or after you take the loan.
On the other hand, if you are out of work for four months and the new job is for lower pay and in a different field, the underwriter will view your employment clock as starting on the day you begin the new job. The presumption of income stability based on your five years of steady employment would be lost. Cases that fall between these extremes are judgment calls by the underwriter. …CONTINUED
Assuming the judgment about income stability goes against you, it does not necessarily mean that you won’t be approved. If you have a job, you can document your income, even if you haven’t had that income very long. Although income stability is a weakness in your application, the weakness can be offset by "compensating factors," which include a high credit score, large cash reserves and a low loan-to-value ratio.
Going into business: Going into business is a different matter altogether. It not only makes your employment history irrelevant, but it also makes it difficult to document your future income. That is the major difference between changing jobs and becoming self-employed.
As self-employed, you must qualify on the basis of the income you earn in the business. Even if you generate enough income to qualify, the only acceptable form of documentation is your tax returns, but they don’t disclose nontaxable income on which many business owners rely heavily.
If you had written me three or more years ago, I would have recommended that you take a stated-income loan where the lender accepted the income you reported. With a stated-income loan, the lender would have verified your assets and might have checked your income for reasonableness against what was known in general about incomes in your industry, but that would be it. You would have paid more for the loan, but if your credit was good the increase in rate would have been small.
The financial crisis, however, has eliminated stated-income mortgages, as well as other forms of liberalized documentation. Full documentation is now the rule for every borrower. Those self-employed must qualify on the basis of the income they show on their last two tax returns.
If you go into business tomorrow, the very soonest you could borrow would be in two years, and that assumes that the income shown on your tax returns would be enough to qualify. If it isn’t, it won’t matter that you have pristine credit, 50 percent equity and 50 months of cash reserves, you still won’t get a loan.
Bottom line: If you change jobs to earn more in the same field, it won’t matter whether you do it before or after you buy the house. If you decide to go into business, however, buy the house first.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.
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