Many people hope to buy homes, but struggle to qualify for loans. And this means millions of first-time buyers are deferring their dreams of homeownership until they are in a stronger position to qualify for a mortgage loan.
Today’s renters are renting longer—often not by choice. Half of renters now in their mid 50s and older don’t anticipate buying a home any time soon, according to a survey carried out by Freddie Mac, and 15% don’t think they’ll ever be able to afford one. About a third of renters aged 40-54 don’t anticipate buying soon, with 12% predicting they, too, will never have the financial resources to buy.
Could at least part of the problem be that the mortgage industry has not adjusted to the way millions of renters work?
Increasingly, corporations seek new ways to outsource processes and people. Workers who, in generations past, would have had stable jobs and pensions are now the leaders in our startup culture and the earners in an ever-expanding gig economy.
Traditional, salaried employees would simply show a mortgage agent their W-2 forms to prove their income. The W-2 is the classic assurance that an applicant can make the mortgage payments for the full span of the loan. The self-employed startup and gig workers, in contrast, may be told that they don’t have jobs, at least not in the way mortgage companies define jobs. Many lenders do not regard gig earnings as “income” that fits the approval process.
Underscoring this with statistics is a study reported by Fannie Mae in 2018. When 3,000 mortgage executives were asked how they deal with earnings from gigs on loan applications, about 95% of the surveyed executives said lending guidelines could prevent consideration of those earnings.
When they are considered, gig workers can expect to be sent on a tremendous paper chase. They’ll be digging up tax documentation, profit-and-loss statements, independent contractor pay records, incorporation documents (for business founders), and months of bank statements as the approval process plays out.
Mortgage lenders require a loan applicant to show at least two years of regular and sufficient income, coupled with a reasonable likelihood of sustaining those earnings over a period of years. Traditional W-2 employees are easy for the mortgage lender to assess, with their steady incomes from year to year. But gig workers and entrepreneurs may be pressed to get accountants’ letters on their behalf, vouching for the integrity of their income streams. And those who have started a business within the past two years will face painstaking scrutiny.
It is possible to be approved for a mortgage without W-2s. For those who can demonstrate a long enough history of stable earnings and good credit, a co-borrower for the loan is not necessary. But there will be hurdles.
Borrowers may find offering to make a larger down payment, by lowering the loan amount needed, could ease the approval process. Putting down 30% or more can offset a lender’s concerns about income qualifications. The mortgage Catch-22 is this. Lenders frown on depleted savings accounts. They want to see cash reserves: assurances that self-employed buyers can handle mortgage payments even when earnings drop.
Meanwhile, these borrowers are pressed to minimize their tax deductions. They must show the largest income they can when applying for a mortgage loan, as lenders prefer a debt-to-income ratio (total monthly debt payments divided by monthly income) no higher than 43%, according to the Consumer Financial Protection Bureau.
Two Sides of the Coin
There are good things and not-so-good things to say about the gig economy. “The disruption offered by the sharing economy,” writes Alexandrea Ravenelle, “is simply a hustle.” In contrast, some writers praise the entrepreneurs who have “chosen freedom over a 401K.”
Whatever we might think of the trend, it’s here. By now, perhaps 40% of the U.S. work force is performing some form of gig work. The Federal Reserve, in June 2018, put the number at 30%, counting self-employment and contract work separately—although the line between such forms of earning is not always so clear.
Much gig work is driven by technology, which makes it easy for clients to engage people and services through their phones, tablets, and laptops. Yet the gig economy goes well beyond ride hailing and home sharing. It has come to encompass much of the service sector, and large swathes of publishing, lawyering, and healthcare. Add to this the sought-after thought leaders who work through speakers’ bureaus or serve as consultants. What’s more, three fourths of the total population of U.S. professors today—well over a million—hold precarious contracts, not tenure.
Next Up: A Modern Loan Approval Process?
A system must emerge to create third-party income validation for freelance and temporary contract jobs. Lenders must be enabled to identify capable, committed borrowers.
This is not to say that examining a loan applicant’s two-year income history is obsolete. But the loan approval process needs new ways of accounting for histories of income streams from various sources when taking stock of an applicant’s repayment power. When the mortgage sector catches up with today’s economic realities, the benefits will work both ways. Responsible applicants will apply for mortgage loans with confidence. And the real estate industry as a whole will enjoy greater opportunities to attract qualified buyers.
Indeed, Freddie Mac, collaborating with LoanBeam, has tested the concept of automatically verifying gig workers’ multiple income streams.
As technology continually creates new opportunities for it, the gig economy will keep expanding. The challenges it presents have created a trove of new opportunities for mortgage lenders. Lenders can offer non–qualified mortgages (“non-QM loans”) for borrowers who are able to repay their loans. We expect non-QM financing to come to the fore as a massive growth opportunity for mortgage lenders, because it can assist people working in the gig economy. For committed loan applicants who would otherwise be excluded from getting a mortgage loan, it serves as a welcome route to homeownership.