A friend of mine from the East Coast called the other day regarding a possible mortgage for a new home she was building. She had recently re-entered the workforce as a professor since getting her doctorate and wanted to qualify for a mortgage on her own, without any assistance from her husband.

She had plenty of assets and really didn't need to work, but she was determined to qualify for a mortgage on her own. Her professorship's income wasn't really enough to qualify her for the loan amount she wanted, but she also told me that she had just opened up a specialty retail store last year that was going really well and that income would push her over to the top.

But I had bad news. For my absolute best rate, I couldn't use the income from her business.

Yeah, I had some loan programs with reduced documentation requirements but typically such loans ask for a rate premium.

Why do lenders sometimes scrutinize the self-employed borrower?

Good question.

It's not because the self-employed borrower is more difficult to analyze than one who is paid hourly or by salary by someone else. Analyzing income for those who work for themselves is pretty straight forward and easy to calculate by someone with a little experience. But there are certain questions an underwriter usually wants answered before saying "yes" to a mortgage request.

Let's say my friend had worked in a specialty shop for several years. She knew the product, knew the pricing and was excellent at taking care of her customers. So by taking it one step further and using her experience in retail, she decided to open up her own store. She'd make more money, right? Maybe.

An underwriter wants to see not just that the she has work experience in retail, but that she can run a business. And not for a couple of months, but typically for a minimum of two years.

The amount of responsibility increases dramatically from working somewhere to actually running the company. Now, instead of showing up on time, knowing the product and taking car of the customer the new owner takes on new challenges.

She now pays employees instead of the employer paying her. She now is responsible for wages, taxes and social security withholdings. She also must order her inventory on time, watch inventory velocity and make a profit. Too much inventory means higher bills and less profit to pay the rent. Too little inventory and she doesn't make enough money to pay the rent. Much less wages, taxes and insurance.

If she has the right inventory, is she marking it up sufficiently to turn the merchandise and make a profit to cover her overhead? How is her cash flow? Is the company liquid? In case of an emergency, how long can she survive with only money in the bank? How are her credit lines of her business? At the maximum, minimum? Is her business credit rating good? Terrible? Is she growing? Is she failing? In effect....

Does she know how to run a business? An underwriter won't know that crucial question unless a pattern can emerge over an extended period of time. That time period is usually two years.

So even though she had experience in retail, she didn't have experience running a business. And until those management skills are proven, that additional income can't be used for qualifying.

For more articles by David Reed, please press here.

Published: November 23, 2001

Use of this article without permission is a violation of federal copyright laws.

, a veteran Mortgage Banker, successful Real Estate Consultant and author of Your Guide to VA Loans, Mortgages 101: Quick Answers to Over 250 Critical Questions About Your Home Loan, Who Says You Can't Buy a Home!, and Mortgage Confidential: What You Need to Know That Your Lender Won't Tell You, is a former columnist and Contributing Editor with San Diego-based Mortgage Originator Magazine. Reed is President of CD Reed Mortgage Bankers, Austin, TX and is a Past President of the Austin Mortgage Bankers Association.