Understanding Your Income | With Randy Atkinson

Randy Atkinson of Capstar Lending join the show.  We discuss the challenges of using income for buyers to approve them for loans, some tips to help you maximize your purchase power and how your tax returns and deductions can affect the income you can use to qualify for a mortgage.

 

Troy: Welcome back to Real Estate Insights with Troy Schlicker. Today's guest is Randy Atkinson of Capstar Lending. How's it going today, Randy?

Randy: It is going great. How about you?

Troy: Doing well, it's been and just been a busy week obviously. Don't release the podcast, the day after. We necessarily do them all the time. So, it's always a little interesting to talk about your week and then release it two weeks later and you're like, oh, that's how that week went.

But we're actually recording this. During the week of tax season. So that obviously for anyone who's especially self-employed like I am, is always something you tend to wait till towards the last minute to get done just because it's a lot more work of things to do than normal. But yeah, I really can't complain if things have been going pretty well and, the weather's pretty nice, spring in Texas is a good time to be in Austin going.

Randy: Yes, sir.

Troy: On that kind of topic of taxes, thought it would be an interesting thing to bring up, or hopefully a useful topic to bring up because, having been in the loan space myself for a number of years, and obviously as a realtor now and being here in, in Austin and just with the way. The world's going.

More and more people are self-employed or have at least some elements of income that they make outside of a regular W two job. And that is awesome but can also lead to a little bit of headaches when it comes to trying to buy a home. Primarily that everyone's trying to take as much deductions as humanly possible within IRS guidelines, of course, but take as many deductions as possible because they want to reduce their income. But they don't realize that can have an adverse effect on what they can buy in a house because of how the guidelines are generally set up for home buying.

Randy: Yep.

Troy: I don't know, maybe you can just go over a little bit of that kind of what that some of the pitfalls or things that you see people running into that could potentially be avoided.

Randy: Yeah. I'll say that since the beginning of my career, this has been a, an issue that just comes up. And I think the biggest piece of the puzzle is. Buyers are not thinking about this early enough. Especially with somebody that owns a business. Somebody that owns a business should be thinking about how their taxes are done at least two years or more before they actually buy a house. Many times. Self-employed folks that want to purchase.

It's not their first house they're buying. I see more of the client, the clients that start in a business and then figure out, Hey, I can do this on my own and then start a business. I see more of that than I see somebody that is maybe just outta college and they say, okay, I'm gonna become an entrepreneur.

And they start a business and then they say, okay, I wanna buy a house. It does happen, but it's not as common. So usually what I see is somebody that has established themselves in some kind of profession and then gone out and created their own business within that profession. Many times they've already purchased a home.

But they're trying to buy the next house because they're doing well. They're seeing things differently because of that self-employment that business is starting to blossom, et cetera. The big thing to think about is whenever somebody is self-employed, the way that we as lenders have to qualify is we have to use two years of file tax returns to calculate income.

Now, some, there are some exceptions to that, but. Typically is an umbrella statement. We have to have two years. That being said, if somebody's reporting to the I R S that they made $500,000, but they had $400,000 of expenses, we can only qualify the MS lenders as a hundred thousand dollars income buyer. That's gonna be a lot different than typically somebody that makes $500,000 in net revenue. Or in gross revenue wants to buy. And so sometimes that can be a very tough pill to swallow. So the message is number one, to people that are entrepreneurs. If you're going to, if you're going to potentially buy a home, talk to your CPA super early and say, Hey, just, I love that you're doing my taxes.

I want you to help me as many ways as you can, but know that I'm gonna be looking to buy a house. In two to three years. That way the CPA can stay in front of it and not ride off everything under the sun. That takes the buying power of the client down to almost nothing. Does that make sense?

Troy: Yeah. Yeah. Oh, for me, a hundred percent, obviously, having been a lender, like it's definitely something I've had to deal with clients as well too, right? What? And the other thing I wanted to point out is, especially here in Austin with the texting, a lot of times we'll see it as well for people that go from W2 to suddenly independent contractor.

Like they really don't, it's a little bit easy. You might not need the two year side of it, but but you go from being W2 at Dell, Samsung, apple, wherever, to suddenly an independent contractor. Now you, a lot of the things that were taken out. Before you ever saw a paycheck with Apple are now things you have to take out.

And so that's why, yeah, you're making more money theoretically than your previous salary, but those additional deductions are things that a lender has to take into account because they're gonna be required for you to continue being an independent contractor or for you to continue to run a business like we can't.

In that your example, like we can't assume you can just make $500,000 because we assume that those $400,000 of expenses have to be paid. Like we don't think you can just be like, oh no, this year I don't want $400,000 expensive. Cuz for most businesses, if you don't have, those are expenses needed to run the business.

And so if you don't have those expenses, then your business income is usually going to go down. That's not always the case. If you're doing, there are certain things that you can. Deduct that aren't, gonna have as big of an impact. But there are other things that you get to deduct, your cell phone, some of some other things that we would, don't have to take into account if you're a W2 employee, but if you're self-employed and it's showing it on the taxes, a lot of times you do have to take that into consideration.

And it's gonna, it's gonna impact it. But like I say, the biggest thing, whether you're self-employed or not, in my opinion, is talking to people early planning, right? If you're talking to a financial planner or a cpa, They should have good re they should know, understand this stuff as well. But they also then should have contacts as a loan officer, as a realtor that can be like, Hey, great, you don't wanna buy for two years.

Let's see where you stand today. So that way we can plan for what we need to do over the next 12, 18, 24 months to make sure that you can qualify for a home when that time comes.

Randy: Correct. Yeah. And the, again, time is the big thing and I, is this something that I tell my clients? Time is on our side until it's not. And when you're self-employed, you have to look way down the line to stay in front of it. And the other piece of that puzzle is just be, if you own a business, if you are a owner of a business, just be prepared.

When you buy a house, you're gonna have to supply quite a bit of documentation. Not only you're gonna have to supply. Your personal tax returns. But if you have business tax returns and you own more than 25% of that business, you're gonna have to supply those, and you're gonna have to supply the K one s that flow over to the personal returns.

So we're gonna be asking for a lot of things so we can see the full picture of the business because we're qualifying not only you, but the business itself, because the business is you. So it's a, it's something that. When we get into it, it can feel like a lot, but again, if it's, if you're prepared for it, it's not a big deal.

But if you wake up on a Saturday and you go look at an open house and you're like, I'm gonna buy this house, and you don't have your ducks in a row, and we get the tax returns, it may not work. Or you're gonna have to jump through a lot of hoops to make it work. I'll give you an example. I had a client two Saturdays ago, call me.

Self-employed trying to buy a 1.2 million home. Hey, I make a lot of money. I'm like, okay, I need to see your tax returns. Sammy's tax returns, he does make a lot of money, but he also has a lot of debt because of the business and he also writes off a lot. So in order for him to buy this 1.2 million home, he had to put down his down payment, plus he had to pay off about $50,000 worth of debt.

So that can be a tough pill to swallow because then not only are you doing your cash to close for the house, you're having to come up with some additional cash so you can make room and the overall debt to income ratio, which we have to use to qualify in order to move forward with the property. And then it becomes, do I truly want to do this because I'm coming out of pocket with a lot of assets just to buy this one property?

In his case, the answer was yes, but we had to have that conversation on a Saturday when he was trying to write an offer and it can be a little nerve-wracking.

Troy: Yeah, if there's not already enough stress in trying to get it done to realize you suddenly have to deal with all of those things as well. And yeah, like I say it's the world we live in where PE like you get to do, there's so many things in life you get to do spur of the moment. Between Amazon Prime and just, any, almost anything in life, you can just decide, Hey, this is what I wanna do and do it.

But that when it comes to buying a house, you can still do it that way, but it just may not work out how you want it to, because again, all the those guidelines and rules are generally com, across. All different companies, all different lenders, because they're rules that the government agencies, Fannie Mae and Freddie Mac have in place for trying to make loans as as safe and secure as possible.

Randy: Yep. I've had self-employed folks come to me and say, Hey, I wanna buy a house. There's a house that I have my eye on already. And one of the very first questions I'll ask them is, How long have you been in business? Two years. Awesome. I need to have your last two years file tax returns.

I have not filed my most recent years. Tax returns. I've had an extension. I can't do anything at that point. Now as exceptions to the rule, if the business has been in longer, been in existence longer, we could do something. But if somebody's been in business for two years and they haven't filed two years of tax returns, I can't.

I don't have an outlet for them. Now there may be some other lenders that do, but it's not gonna look like a traditional type financing scenario.

Troy: yeah. You're u yeah. If you can find a lender to cause lenders on top of the loans that Fannie Mae and Freddie Mac do usually have what's called portfolio loans or loans that their lending institution, their bank, whoever their investors are willing to take on. That aren't quite, don't quite fit in that box, but that usually means that your things like your interest rate, your down payment, your closing costs are usually gonna be higher because they're just more risk involved with those types of loans.

And so that risk shows up in higher interest rates. Higher down payments higher closing costs. And one of the things as a lender I always got were people why do I need two years of tax returns? And it's like you went back with needing the business returns as well too.

Like we need to see a history of, a lot of businesses do not have the same steady income that you do as a W2 employee. So you might have and again as a self-employed real estate agent, My income the last couple of years when bi, when the market was going crazy was different than the last part of 2022 when the market shut down.

And so you need to be able to see that those ebbs and flows to really understand, okay, is this a one-off scenario where the income looked really good for one year, but that's not what. The history shows, or is the business in decline for some reason? Is there is income, over two or three years?

Has the income continued to drop? That's obviously not a great sign. If you're trying to get a 30 year loan and you're trying, you're willing to give up money for a 30 year loan. Like the banks are looking at all that because they're trying to just understand the risk that they're That they're dealing with when providing a loan.

And again, while we take for granted how low interest rates used to be, and we claim how much they are now in the six, six to 7% range, that's still historically is a really ridiculously low interest rate. And part of the reason it's that low is because lenders do generally a very good job of understanding the risks and not lending to people that are, have too high of a risk profile.

Randy: Yeah. Speaking of interest rates I saw something, I don't remember, somewhere on social media. And it was a clip from 1981. And it was a newscaster, and he was like, this week, the 30 year mortgage rate has dropped at 18.1% from 18.2% last week. I'm like, golly. How far have we come? But it's all relative compared to the last,

Troy: Yeah. Yeah. If you have a loan like myself alone, that's at 3.25%

suddenly thinking about having to go to 6%, it's wow, that's gonna be a pretty big jump in interest rate. And it would be, but it's definitely all kind of perspective and what you have been having to deal with, speaking of the news and rates and stuff like I know the government has.

Announced that through Fannie Mae, I think either through Fannie and Freddie, or through the FHA loan program, that they're actually looking at raising rates and costs on buyers that are a little bit more qualified in order to subsidize some buyers that are a little less qualified. And I don't think it's, it isn't to the extremes of. The 2006 market crash where it was like, get anybody approved that you can, we don't care. But it's been I've seen a lot of interesting thoughts and takes on the developments of that. What are, what's some, what, do you have any additional thoughts in.

Randy: I'm, I don't know enough about it just yet. To speak super intelligently, but here's what I will say, I don't think it's gonna end up happening. I think this is something that has been floated. It's not in effect yet, and I think that there's been so much backlash about it just in the day or so that it's been announced that it's gonna be walked back.

Kind of like earlier in the year, we had an announcement that pricing. For mortgage loans was gonna be affected by D T I. So debt to income ratio. If you have a higher debt to income ratio, we were going to, we were gonna get a bump in the charge for the interest rate meeting that the client was gonna pay more.

Across the board, everybody squawked about that and that's been walked back. So I have a feeling I'm not, I'm just a guy, so I don't really know, but I have a feeling that this is not gonna be something that ends up being cemented because. If you really think about it, it's not common sense. Why would you charge people that have done a good job taking care of their business, more money, just so people that haven't done that can maybe qualify for a loan?

Troy: Yeah. No, it's again like I understand. The, I understand the theory of wanting to try to help people that are struggling to be able to afford a home, cuz there's a lot of benefits in people being able to afford homes. But that doesn't mean that we, again, and not that it's extreme of what oh six would've been like, but you, we have to draw the line somewhere and you definitely shouldn't be penalizing people who have been doing a good job with their finances, with down payments, with their credit and all those kind of things.

Just to try to make that happen.

Randy: Yeah. Yep.

Troy: Speaking of loans and income stuff one of the questions I had was going back and forth with somebody on social media, was like debt to income ratios and how much people are qualified for, and it made me think or wonder a little bit about how how often people really.

End up using the max that they're able to qualify for. So like in the example you gave about the business owner that was trying to buy the house for 1.2 million, my guess is he ended up basically qualifying for or using about the maxi who qualify for, if you're TR starting to, if you're starting to pay off debts, you're usually at the.

You've re, you're trying to reach a maximum amount that you can truly qualify for. But in my experience, generally the higher someone's income is usually the less likely they are to really be maxing out their budget in that case. And curious from your perspective there, cuz like in this specific case the people said they made almost a quarter, like it was a husband and wife made almost a quarter million dollars a year.

But what they thought they could qualify for was. Maybe really only 80% of what they could actually qualify for. Now, there's again, a lot of times the difference between what someone's comfortable in a home payment and what they qualify for. And you shouldn't, you should never feel obligated or forced or stressed out to feel like you have to go above what you feel comfortable with.

Sometimes to be in a neighborhood, you might have to. To do that, but it, but that's up to you then if you want to, but I'm curious, how often you run into that in the different kind of income levels for people?

Randy: man. I would love to give you a percentage or something, but. It's client by client, because some people's appetite for quote unquote maxing it out is not, they don't have, it's not a big deal to them. Ah, we'll figure it out. And then I've got some other clients that there is a set number in their head, and they will not go any higher than that as far as their monthly payment or sales price, but they could go exponentially higher.

So the risk tolerance is across the board different. I do see more people buying, let's say under $400,000 getting closer to maxing themselves out typically because they're trying to move into a typical ra, a specific neighborhood, or maybe this is their first house and they're not like fully established in their career or something of that nature.

Usually when I get into the second, third, fourth home with clients it's not even close. They just know that they're, they want to live in a certain area. They've got the cash to put down and they're gonna, they're gonna qualify probably, but we always have to run the traps. So I don't know if I would, I don't know if I would Say it's all the time.

It's sometimes it's just tough

Troy: No, and there's definitely not. There's definitely not it all the time. But yeah, like again, I tend to see that lower home price point. One, it's a lot of times it's a first time home buyer price point, and like y'all said, it's usually someone a little bit less established in their career, so their income is only a certain level.

And so at that point to get into the market, there's just a minimum. You can't go a whole lot lower, right? There's not $150,000 homes available in Austin, Texas, so you're gonna have to, you're gonna have to spend a certain amount and in order to get in there. And so then a lot of times that does mean.

Maxing out what you can qualify for. Where

Randy: the down payment to, to

Troy: to adjust that too. Exactly right. They haven't

Randy: they're financing more usually. So usually when you get your buying the second, third, fourth, House, you're putting at least 20% down or more

Troy: Yep. Yeah, you've, you have that.

Randy: piggybacking off of what you made on that initial house, and then it's stairsteps itself.

Troy: Exactly. Yeah. No 100% agree. And so I think though sometimes that, and everyone's different, but like sometimes there are people who don't want to go above that number and then, Talk themselves out of what would still be a good financial decision. Now again, it's up to them. Yeah, never I'm gonna force someone to try to move into a home or into an area and stuff.

But but sometimes again, as I've said a number of times, buying a home is stressful. And so sometimes that, that little bit extra on the payment above what you really were hoping to stay at is stressful as well too, but, It does, but it does make the best decision for the long term because you're locking in that principled interest payment, at least not the taxes necessarily, over time you're locking that in.

Whereas if you decide, ah, I can't go there, I'm gonna keep renting that rent payments feels better today, but in five years that rent payment's not gonna feel as good as having locked in a home price.

Randy: Yeah that's the old hindsight's 2020 thing. Five years later, you look back and go, Ugh, I could have bought that house at three 50. Now it's six 50.

Troy: Yeah,

Randy: I can't buy that house anymore.

Troy: no, exactly. It's definitely something everyone has to balance when they're trying to make that decision because again, there are definitely plenty of times when it's. Even though home price is gonna go up, that doesn't mean you can just go buy whatever home you want.

We're not, you and I aren't buying, a home a week because we know real estate's gonna go up in Austin, even though that would be a pretty smart thing to do if you could really afford to do it.

Yeah. But that doesn't necessarily mean that that can happen. Cool. No, I appreciate you taking the time to, to jump on today. I know it had to be a little bit quicker. It's, one of those busy days, which is a good thing. And,

Randy: Yep.

Troy: Always fun to chat a little bit about mortgages since I've

Randy: Absolutely. Anytime.

Troy: time.

Randy: It's the language I speak.

Troy: There you go. Very much cool. Have a wonderful day.

Randy: All right, you too.