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Small business is an economic engine that powers
roughly two-thirds of job creation in the United
States. So why is it often so tough for small-business
owners to borrow from large banks? The answer can
be summed up in one word: misunderstanding.
During the global ;nancial meltdown of the late
2000s, “risky mortgages” became the common catch-
phrase in any discussion of blame for the nation’s
economic ills. Although these mortgages certainly
played a role, a slew of contributing factors were often
diminished or overlooked altogether, because it is easier
and safer to simply state: “It was a subprime issue.”
Suddenly, subprime mortgages were thrown over-
board. Angry mobs threw the baby out with the
bath-water. All the good — and there was plenty
of good — was hastily discarded with the well-
Loans involving rational loan-to-value ratios, significant liquid asset reserves and good credit pro;les no
longer had a home because of the excessive debt-to-income ratios established for self-employed borrowers who could not prove their income. A model
designed speci;cally for W-2 (or hourly) employees
did not work for many self-employed entrepreneurs.
It seemed as if brain surgeons had an easier time
operating than ;nding a loan.
Self-employed individuals take advantage of many
legal business deductions so that they don’t overcompensate Uncle Sam at tax time. Among the possible
deductions for a business owner are meals, entertainment, Internet, phones, automobile expenses,
home o;ces, interest on business loans and more —
provided that these expenses are deployed in the
context of that owner’s business.
Consider these steps that could happen on a typical
; Finish work at your home o;ce after funding one
last loan for the week;
; Call a client;
; Research restaurants and movie showtimes online;
; Drive to dinner, where you also will discuss loan
products for self-employed borrowers.
Following all IRS requirements, a self-employed indi-
vidual could legally make deductions for home o;ce,
a simple night out. The employee compensated via a
W-2 could not take these tax deductions.
At the end of the year, all else being equal, however,
a self-employed individual will have a lower adjusted
gross income than a W-2 employee and will qualify for
a substantially smaller loan.
The average household income for self-employed
mortgage applicants is 80 percent higher than that
of individuals who are not self-employed, according to Zillow. But despite those higher incomes, self-employed borrowers often have lower-than-average
credit scores. Although the average FICO credit score
was 695 this past April, a 2015 study by Biz2Credit
found that, for business owners, the average credit
score was only 600-615. That di;erence can lead to
a signi;cantly higher cost of debt for small-business
owners over the course of their lifetimes.
The primary reason for those lower credit scores
is not that small-business owners are making late
payments on their debts. Instead, these entrepreneurs
act in a manner that maximizes their returns, which
often requires short-term capital that they can access
via their business credit cards. Frequently these credit
card balances are reported on their personal credit
reports, raising their utilization rates and hammering
down their credit scores.
The imperfect credit scoring models are not
designed to remove “business” credit from “personal”
credit. The result of this commingled system is small-business owners with artificially low credit scores
that are not accurate predictors of loan repayment.
Large banks have myriad regulators, such as the O;ce
of Comptroller of the Currency, the Federal Deposit
Insurance Corp. and the Consumer Financial Protection Bureau (CFPB). With each of these organizations, a major e;ort has been underway since the July
2010 passage of the Dodd–Frank Wall Street Reform
and Consumer Protection Act to rein in mortgage
It is challenging to address a key concern of Dodd-
Frank known as ability to repay (ATR). Simply put, all
residential mortgage loans made to owner-occupants
must demonstrate the capacity to repay under
ATR. This is exceptionally di;cult for self-employed
borrowers, but the task grows when adding regula-
tions that don’t ;t the self-employed business owner
in a reasonable manner. The net result is: Many times,
large banks simply do not incur the risk and close their
lending doors for good home loans for self-employed
These factors leave large banks in a situation where
they generally cannot consider self-employed borrowers’ true income. The mere mention of regulatory
concerns can send chills through bankers’ spines when
they consider the possible scrutiny. This leads to
mispriced personal home loans or no ;nancing options
at all for self-employed borrowers. This misunderstanding of the true credit picture intimates that large
banks are not interested in small-business owners.
Help from originators
Obviously, large banks don’t really hate small-business owners. For the foreseeable future, however,
they simply aren’t structured properly in the current
regulatory climate to extend owner-occupied residential mortgages that are ATR compliant. On the
other hand, mortgage loan originators have access
to products and capital speci;cally designed for
self-employed borrowers. For all of the listed challenges faced by big banks, originators have solutions.
Business owners understand they belong to the
Fraternal Order of Di;cult to Finance. They have heard
“no” so many times from banks that most erroneously
believe loan products for their fraternity simply do not
exist — and therefore, many don’t waste their time
searching. When dealing with business owners, it is
necessary to quickly quash these feelings with accurate
Income qualification is a starting point for a
loan application. Analyze the business owner’s tax
returns, but understand these returns frequently do
not reflect true income. You must be prepared to
seamlessly pivot to alternative-income documentation that is designed specifically for self-employed
borrowers — namely, bank statements.
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ScotsmanGuide.com | January 2016 130
Denis G. Kelly is an account executive with Citadel
Servicing Corp., a nonprime wholesale lender that
specializes in residential mortgages for self-employed
borrowers, high net worth individuals and foreign nationals. Reach
Kelly at (305) 209-1722 or firstname.lastname@example.org.