That Terrible Year Keeps on Giving

As we all try and put 2020 behind us – the lock downs, the empty streets, and the closed businesses, we do see hope in the flood of economic activity and Hawaii once again being a tourist mecca. This ray of good news has sprung hope to many who were greatly impacted financially.

When interest rates took a dive last year, millions of Americans took advantage and refinanced their homes. They were the lucky ones that continued to receive income and could qualify. There were two distinct groups that were really impacted by covid – those that are self-employed and those that own short-term vacation rentals. These two groups also share a common thread as to how lenders look at their income, which is why they were stuck – and for many, continue to be unable to take advantage of low-rate financing.

The self-employed and those with investment property income fall into the category of “income – other than wages”. It’s an important distinction because the rules on how we in lending determine and verify that income is significantly different than those whose income comes from “a job”. Specifically, underwriters review the most recent 2-years of federal tax returns.

For the self-employed, we take an average of one’s net income for those 2 years. In the case that the income of the most recent year is less than the older year, we just use the most recent year’s lower number. Calculating net rental income is done roughly in the same manner.

When everything stopped last year due to the pandemic, all the rules were tossed out. If you were self-employed and your business was shut down, you had zero income. It didn’t matter what your income was the year before, or over the last decade for that matter – you were out of luck. The same held true for those owning vacation rental condos here in Hawaii. With “the rock” sealed off as Jack Lord used to say on Hawaii 5-0, all those condos were empty with zero rental income. If the owner wishing to refinance needed that rental income to qualify, they too were out of luck.

Let’s jump forward a year to Summer 2021! The State is open for business. All those short-term vacation rental condos are now filled with tourists again, and hopefully if those self-employed were able to hold on, they have seen their businesses return to normal pre-pandemic levels.

But there’s a problem.

Despite those self-employed and vacation condo owners now back up and running, if they try and apply for mortgage financing, they will most likely get shot down. Why? Remember that underwriters use your most recent 2 years of tax returns. Even if they’re doing great in 2021, that 2020 stinker of a tax return will kill many applicant’s chances.

And it gets even worse.

Let’s jump ahead to 2022. This same group of people have now filed their 2021 tax returns with nice looking income. Underwriting guidelines required that a 2-year average be used for qualification. That means that 2021 will be averaged with 2020. That could prevent a lot of people qualifying for financing, even if covid is just a vague bad dream.

As of right now there are some exceptions. If you have been self-employed for 5 or more years, you may be able to qualify using only the most recent filed tax return, not averaging the most recent 2-years. That will help many self-employed after they file their 2021 return next year. For the investment condo owners, only if your unit is rented out long-term (rental periods of 6-months or longer) can you claim that new income without averaging prior years of transient rentals.

The year we all want to forget will not be so easy for a large segment of our population. The tragedy of the lock downs and the destruction of our economy in 2020 will not only haunt that unfortunate group now – but may impact their ability to get financing until they file their 2022 tax returns in early 2023.