Rhonda Abrams, who writes about entrepreneurship, claims in a recent USA Today opinion piece that the CFPB's "Ability-to-Repay" rule will have what most social engineering legislation has: unintended consequences. For small businesses and entrepreneurs, one of those consequences will be that "getting a mortgage will become a whole lot harder soon."
And I'm betting it's going to be a heck of a lot harder for people who are self-employed or own a small business to qualify — assuming the business is run as a sole proprietorship, limited liability company or S corporation and income passes through to a personal tax return.
Why? The very sensible provisions were designed for people who receive paychecks rather than run businesses. Small-business owners and the self-employed are likely to have greater challenges with some of the provisions:
Among the problems for entrepreneurs, Rhonda points out the following:
- Verifying income for an sole proprietor or pass through entity depends on income shown on tax returns, rather than net worth (used as an alternative to tax return income in the "bad old" days of low-doc, no-doc loans). In addition, small business owners may show lower net income because they take aggressive positions on tax deductions and/or plow gross income back into the business. Fewer entrepreneurs may be able to provide the verification needed to satisfy the rule.
- Debt-to-income ratios may be tougher to meet because business debt shows up as personal debt, and, in the case of business lines of credit, the entire line shows up as debt even if no draw are made.
- Personal services businesses are often poor in hard assets but rich is goodwill developed by a highly skilled entrepreneur. In addition, entrepreneurs often live in high-home priced areas, and use their home as their office, which increases mortgage debt.
Abrams advises those entrepreneurs who've been thinking about taking advantage of low interest rates to buy or refinance, to do so this year. She also advises entrepreneurs to think twice about taking advantage of legitimate deductions that lower tax return reported income to the point where qualifying for a home mortgage loan may be jeopardized.
The abuses of the past engender remedies that cause disadvantages for some future borrowers, at a time when the country's problem is no longer that too many loans are being made but too few.