How to Get a Mortgage without W2 Income

[Christopher Erwin]

A critical element of RE investing is access to good financing; rapid lender approvals and good terms provide an investor significant advantage in winning deals and generating strong ROI.

For first-time investors or those with just a small portfolio, attractive mortgage financing is typically a result of a W2 job and good credit.

Well, I’m no longer a W2 employee. Instead, I own a new business and take periodic cash distributions. Having taken the entrepreneurial plunge just about a year ago, I can definitively say that being my own boss is one of my greatest professional achievements. But, said plunge has also brought new obstacles for my real estate investing, like losing my pre approval status for traditional mortgage financing. Traditional lenders are highly risk averse and follow a very specific underwriting protocol (see anecdote to this point at bottom of post), and my new employment status fundamentally changed my borrower profile.

Let’s break this down. Traditional mortgage lenders like:

• Steady, long term employment from a stable employer
• Regular pay check
• Low debt to income ratios
• Liquidity / cash cushion
• Track record of paying back loans (i.e. good credit history)

Hence my challenge as a new business owner applying for financing:

• My company had been incorporated for less than a year (far from “stable”)
• No regular salary (those familiar “pay stubs”)
• Lower earning profile while business ramps and we invest earnings into growth

Fortunately, I had done my financial homework.

I knew my access to mortgage financing would change when I started my new co, so I reached out to various lenders and my accountant last year for advice. I asked how I could best position myself for mortgage financing considering my new employment status. Here’s the advice I received:

“Develop a regular income record, and generate documentation that lenders are familiar with.”

So, put myself on traditional payroll, right?

Not if you're a member of an LLC (which I am). With traditional payroll, I'd unnecessarily incur payroll taxes as well as deductions like FICA (social security and medicare), federal and state income taxes. Yes, I in fact made this payroll mistake for a couple months.

Instead, as an LLC member, it's tax-advantaged to take "gross member distributions".

The workaround? I put myself on something that “looks” like payroll.

I now take gross member distributions on the same timetable we pay our full-time employee: twice per month. And, I do it using our payroll provider, Gusto. No taxes or deductions, just a direct pass-through.

• Regular pay check? Yes.
• Documentation that a lender understands (e.g. “pay stubs”). Yes.
• Tax-advantaged distribution for an LLC member? Yes.

I’ve now been on “payroll” for 2+ months, and just last week I reached back out to my lenders to begin mortgage pre-approval conversations. This is timely, because I have a goal of purchasing another multi-family investment property in Omaha before year end.

Based on my lender convos this week, I still have more work to do, but I’m on my way. I’ll report on their feedback and next steps in my next newsletter.

The big lesson here is that there are no insurmountable obstacles in RE investing. Stay informed and know your options. Like all things in life, many roads lead to point B. Find the best fit road for you, and make something awesome happen.

ANECDOTE: My accountant told me a story about one of his clients who owns an LLC and makes $5mm+ per year…and still couldn’t gain access to traditional mortgage financing. His client therefore had to acquire the property in cash, “season it”, and then obtain a mortgage. Crazy.

[Chris Mason]

Originally posted by @Christopher Erwin:

A critical element of RE investing is access to good financing; rapid lender approvals and good terms provide an investor significant advantage in winning deals and generating strong ROI.

For first-time investors or those with just a small portfolio, attractive mortgage financing is typically a result of a W2 job and good credit.

Well, I’m no longer a W2 employee. Instead, I own a new business and take periodic cash distributions. Having taken the entrepreneurial plunge just about a year ago, I can definitively say that being my own boss is one of my greatest professional achievements. But, said plunge has also brought new obstacles for my real estate investing, like losing my pre approval status for traditional mortgage financing. Traditional lenders are highly risk averse and follow a very specific underwriting protocol (see anecdote to this point at bottom of post), and my new employment status fundamentally changed my borrower profile.

Let’s break this down. Traditional mortgage lenders like:

• Steady, long term employment from a stable employer
• Regular pay check
• Low debt to income ratios
• Liquidity / cash cushion
• Track record of paying back loans (i.e. good credit history)

Hence my challenge as a new business owner applying for financing:

• My company had been incorporated for less than a year (far from “stable”)
• No regular salary (those familiar “pay stubs”)
• Lower earning profile while business ramps and we invest earnings into growth

Fortunately, I had done my financial homework.

I knew my access to mortgage financing would change when I started my new co, so I reached out to various lenders and my accountant last year for advice. I asked how I could best position myself for mortgage financing considering my new employment status. Here’s the advice I received:

“Develop a regular income record, and generate documentation that lenders are familiar with.”

So, put myself on traditional payroll, right?

Not if you're a member of an LLC (which I am). With traditional payroll, I'd unnecessarily incur payroll taxes as well as deductions like FICA (social security and medicare), federal and state income taxes. Yes, I in fact made this payroll mistake for a couple months.

Instead, as an LLC member, it's tax-advantaged to take "gross member distributions".

The workaround? I put myself on something that “looks” like payroll.

I now take gross member distributions on the same timetable we pay our full-time employee: twice per month. And, I do it using our payroll provider, Gusto. No taxes or deductions, just a direct pass-through.

• Regular pay check? Yes.
• Documentation that a lender understands (e.g. “pay stubs”). Yes.
• Tax-advantaged distribution for an LLC member? Yes.

I’ve now been on “payroll” for 2+ months, and just last week I reached back out to my lenders to begin mortgage pre-approval conversations. This is timely, because I have a goal of purchasing another multi-family investment property in Omaha before year end.

Based on my lender convos this week, I still have more work to do, but I’m on my way. I’ll report on their feedback and next steps in my next newsletter.

The big lesson here is that there are no insurmountable obstacles in RE investing. Stay informed and know your options. Like all things in life, many roads lead to point B. Find the best fit road for you, and make something awesome happen.

ANECDOTE: My accountant told me a story about one of his clients who owns an LLC and makes $5mm+ per year…and still couldn’t gain access to traditional mortgage financing. His client therefore had to acquire the property in cash, “season it”, and then obtain a mortgage. Crazy.

Hate to break it to you, but forming an LLC isn't magical. If you own >25% of the business entity, you're considered self employed no matter what your paystubs say. Full business tax returns will be required covering the most recent two tax years. An LO who isn't doing their full due diligence or who is new might miss that and write you a preapproval letter, but an underwriter wont. That's the difference between "pre"approval and approval.

The most common thing that comes up when people try to get around the Fannie requirements by establishing new business entities, or drastically changing their self-paid comp plan/structure, is that they effectively reset the 2 year clock. On a one-off case-by-case basis underwriters will sometimes work with the change provided the time since restructure plus time before the restructure adds up to 2 years (your anecdote quite possibly being an example), but the income they calculate is generally less than if there wasn't an attempt to circumvent the guidelines. 

If you want to buy before the 2 year mark, you're probably looking at one of the bank-statements-instead-of-tax-returns-for-income programs like Shaun is talking about. Rate will fall below hard money but above Fannie. 

Also note that tax professionals and mortgage professionals disagree with each other a LOT. Best not to take tax advice from a mortgage person, or mortgage advice from a tax person. The two professions understand each other just enough to give bad advice.