Residential Magazine

Leave No Small-Business Owner Behind

Independent contractors may benefit from an under-the-radar loan option

By Denis Kelly

Over the past five years, mortgage lenders have introduced many creditworthy financing options that address the needs of underbanked consumers. These solutions present an opportunity for originators, Realtors and, most importantly, credit-qualified borrowers who otherwise may have been frozen out of the home-purchase market. 

The underbanked market that has received the most attention is the self-employed borrower category, who now have access to mortgage financing through products such as bank-statement loans. Thus far, these loans are performing soundly and, considering that 30.2 million small businesses make up 99.9% of all U.S. companies, it stands to reason that there has been a focus on addressing the needs of this substantial group.

Generally, bank-statement programs provide mortgage financing options for small-business owners with fewer than 20 employees. Small-business owners with more than 20 employees frequently qualify through traditional, full-documentation income methods. Small-business owners with one or two employees, including independent contractors, frequently do not qualify due to the way revenues are collected. There’s another option that originators should become familiar with — verifying income through 1099 tax forms.

Growing workforce

Independent contractors are the people you meet each day. They include the Uber driver with whom you shared a ride to the airport this morning, the nail technician who provided a lovely manicure last week and the Realtor to whom you are referring your borrower clients. 

Each independent contractor is a small-business owner. Other examples include truck drivers, consultants, hairdressers and barbers, writers and attorneys, to name a few. Add them all up and the share of earners who receive 1099 tax forms to record income accounts for 11.8% of the U.S. workforce. In other words, nearly one in eight workers stand to gain from a mortgage solution that is not based on traditional full documentation nor qualification through bank statements.

What do these professionals have in common? All of them are independent contractors who file 1099 tax forms showing that they received income from an entity or person other than an employer. Frequently, these people are unable to obtain mortgage financing via traditional full-documentation methods or through bank statements.  

It is important for mortgage originators to bridge this significant gap through their knowledge of loan products that are specifically designed for independent contractors. More importantly, if originators desire to stay at the forefront of the industry, then they must be empowered to offer these loan solutions that address the specific needs of this group.

Unconventional documentation

There are multiple valid reasons to know your borrowers beyond providing them with the best overall loan experience, including prevention of fraud or other criminal activities. With independent contractors, the need to know your borrowers is exponentially more important due to the uniqueness of each borrower’s work history. 

Oftentimes, independent contractors have earnings from multiple companies. It is not uncommon for a truck driver, for example, to have worked for and received 1099 forms from several companies during a calendar year. A freelancer may be paid for an assignment but doesn’t deposit the check into his or her bank and cashes it instead. That money wouldn’t appear on a bank statement and couldn’t be used to verify the person’s ability to repay. These workers, however, do have a 1099 form that could verify the income.

It is important for mortgage originators to collect and utilize all of a client’s 1099 forms because this will provide the most accurate reflection of the borrower’s true income, as well as the highest likelihood that the debt-to-income ratio is lower than the maximum threshold for a specific loan program. Ask your borrowers probing questions so that your understanding of them is properly documented and presented to underwriting. 

It is a best practice to include a letter of explanation or a processor’s certification detailing the borrower’s 1099 work history, along with any documentation that has been provided and how their income was stabilized. A little extra effort on the front end of the process minimizes the likelihood of speed bumps later on.

Quality borrowers

An independent contractor, such as a barber, accounts for income differently than the owner of a small landscaping company. This should not, however, be the sole credit reason to lock the independent contractor out of a homeownership opportunity.

Combining well-tested and proven underwriting standards with 1099-only income documentation presents originators with a windfall opportunity to close loans for credit-qualified independent contractors. These underwriting standards include — but are not limited to — loan-to-value ratio, reserves, length of employment in a current field, housing-payment history and FICO score.

Some recent surveys found that more than 30% of the U.S. workforce is engaged in some sort of freelance or gig work. Frequently, independent contractors also are wage earners. A common example is a full-time, wage-earning tech professional who also provides 1099-based consulting services as a source of additional income. 

If separating the income streams for income-documentation purposes allows the borrower to qualify for the wage-earner component with a W-2 form or pay stub, and to qualify for the income derived from independent contracting services with a 1099 form, then the forward-thinking loan officer has taken a denial and turned it into a bankable loan. Mortgage originators who can turn losses into victories tend to be at the top of their referral partners’ contact lists. Who doesn’t want to be No. 1?

If a referral partner presents a loan scenario for which there is a commonly understood and readily available product in the market, and the originator does not have access to this product, then this referral partner will be forced to look elsewhere. This unenviable situation is easily avoidable by including loan solutions for independent contractors in your lending quiver.

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The share of workers who are characterized as independent contractors is substantial, and it is growing while the share of wage earners is declining. Mortgage brokers and loan officers should be acutely aware of present market conditions while constantly having an eye on the future and its predictable changes. 

Addressing the mortgage lending needs of independent contractors enables originators to take advantage of significant revenue opportunities, but it also empowers them to demonstrate their knowledge and professionalism to their referral partners and their community at large. The opportunity is plentiful and the time is ideal to convert this opportunity into funded loans. 


  • Denis Kelly

    Denis G. Kelly is senior vice president of correspondent/national wholesale for Sprout Mortgage, a leading non-agency/non-QM lender with broker/correspondent-friendly platforms focusing on loans in the following categories: jumbo/super jumbo “near miss,” no-income verification investment loans, self-employed borrowers/bank-statement loans, recent credit events/challenging FICOs — all up to $20 million. 

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