Tapping the Untapped Market - Lending to the Self-Employed
Lending to the self-employed is time-consuming and costly, particularly in today’s competitive market. Across the industry, fintech-driven automation has fast-tracked overall loan production, but not much has changed in lending to self-employed borrowers.
Until now. Recent innovations in self-employed borrower income assessment have created significant opportunities for lenders to improve the borrower experience, become more efficient and grow their base of business.
Who Are the Self-Employed Borrowers?
How we work is changing. New platforms are shifting work performed by full-time employees in traditional organizations to a crowd of individual entrepreneurs and on-demand workers. “The economy we are heading into will rely far more extensively on freelance and small-business work arrangements than on traditional stable employment,” according to New York University Professor of Business Arun Sundararajan.
While the quantification of self-employed workers varies, the number of working Americans who fall into this category is growing and trending toward increasingly affluent, well-educated Gen X and millennial homebuyers.
For example, using a narrow definition of the self-employed, the government puts the number of independent workers at about 15 million—or 10.1% of the total labor force. Yet another study classified 41.8 million Americans as independents, defining them as consultants, freelancers, contractors, temporary or on-call workers.
Millennials are forecasted to increasingly dominate this population as tens of millions form new households and move into the prime homebuying age bracket (32 to 38 years of age). The self-employed among this generation are also expected to earn more as they advance in their careers, more so than their Generation X and baby boomer cohorts in this segment of the workforce.
The Hurdle to Underwriting the Self-Employed
The personal and business-related tax returns of these borrowers don’t always reflect their true earnings due to deductions and write-offs. For example, removing personal expenses from company profit-and-loss statements and validating the cash flowing into personal income can take hours, compared to minutes when inputting a W2 figure into a loan origination system.
The complexity of determining qualifying income for self-employed applicants usually requires seasoned underwriters who often circle back to processors and loan officers for missing tax-return documentation. The back and forth drives up costs, delays closing times and most importantly, frustrates the borrower.
“These loans take hours, even days, to analyze borrowers’ incomes and requires experienced, expensive underwriters,” said Andy Higginbotham, senior vice president and chief operating officer of Single-Family at Freddie Mac. “Lenders keep telling me it boils down to production costs that eat up so much time to process.”
In the third quarter of 2018, the cost of producing a residential loan averaged $8,174, according to the Mortgage Bankers Association (MBA), while net production income averaged $480. While the MBA doesn’t publish figures on self-employed borrower loans, they generally cost more to produce, which can generate a lower return.
A Growth Opportunity in Today's Market
Competition is fierce in the mortgage industry, with fluctuating interest rates adding to a complicated landscape. The ranks of the self-employed are growing in numbers. Lenders who gain traction with such customers stand to grow their business beyond the highly competitive traditional borrower market by leveraging technology to help them scale.
“The mortgage sector is casting a wider net for new customers,” said Chris Boyle, Single-Family chief client officer at Freddie Mac. “Nontraditional wage earners – or self-employed borrowers – are a promising borrower segment for lenders who can deliver them a better borrower experience.”
Homebuying demand outstrips supply in today’s market. To win out against rival bidders, buyers must prove to sellers upfront that they’re fully qualified for a loan from a credit and ability-to-repay perspective. The self-employed are no different.
They want a quick turnaround from lenders about whether they qualify for a mortgage, can meet the sellers’ asking price and quickly close on a deal. The more time it takes, the greater the risk the customer loses the home to another buyer.
Consumers in this on-demand, real-time era want a fast, full credit and capacity underwrite. This is difficult for a lender serving self-employed customers given the complexity of income documentation and calculation requirements. However, recent innovations in technology addresses these pain points for lenders, automating an otherwise complex process.
Technology as a Gamechanger
There is now a fully GSE-integrated automated solution to help lenders efficiently assess self-employed borrowers. It uses highly refined OCR technology to extract and read tax return data at a 99.7% accuracy rate, automates the assessment of self-employed income, and flags any missing documents necessary to arrive at an accurate number. In addition, the solution—powered by LoanBeam®—is integrated through Freddie Mac Loan Product Advisor®, allowing the lender to receive real-time feedback on the assessment of the qualifying self-employment income and the associated determination with respect to relief from certain representations and warranties.
With an automated process to capture tax return data in digital form and derive income in accordance with investor guidelines, the underwriter can sign off on a loan typically within an hour of collecting the tax return documents.
Lending to the self-employed is time-consuming and costly. But a fully GSE-integrated automated solution that help lenders efficiently validate self-employed borrowers can:
The Future is Now
This relatively untapped, nascent market of self-employed borrowers is an opportunity for lenders to grow their business. Loans for self-employed borrowers make up less than 20% of their current business but could soon exceed 40%.
For example, loans underwritten for self-employed borrowers averaged 16%—or $4.2 billion—of total monthly production volume sold to Freddie Mac over a 12-month period ending in January 2019. In contrast, some 84%—or $21.8 billion—of the production volume went towards loans for salaried borrowers.
In today’s market, self-employed homebuyers don’t want to compete at a disadvantage. The automation of borrower income assessment is a technological breakthrough where lenders can quickly approve loans that meet Freddie Mac guidelines. By doing so, lenders can meet these borrowers’ expectations, win their business today and position themselves to succeed in the future.
Visit our AIM for self-employed web page for more information on this topic.