Moshe Wilshinsky – Mortgages

Rich Man, Poor Man

Tax evasion is illegal (true in whichever country you are living in). Tax avoidance, however, is legal. Tax avoidance is defined as the legal usage of the tax regime in a single territory to one’s own advantage to reduce the amount of tax that is payable by means that are within the law. Not surprisingly, it is a multibillion dollar business, with a plenitude of accountants, tax consultants, and investment advisers receiving substantial fees for their skill in minimalizing or completely erasing a private company’s profit or an individual’s private income.In a small business, you are allowed to include expenses such as a percentage of home utilities if you have an office at home. These expenses exist for a salaried employee but the mortgage bank does not use them in their mortgage payment to income ratio analysis. Even on a lower income level, any small business person worth his or her  salt will want (quite legally and properly) to include every single allowable expense in order to minimize earnings by maximizing operating expenses, but this may have unexpected and unwelcome consequences.

While Israeli mortgage bankers are not mandating income tax compliance (yet), they tend to rely heavily on official Annual Tax reports; and serious questions arise when tax evasion is obvious. The Bank of Israel (the Israeli Banking Regulator) introduced a regulation setting a maximum percentage of the borrower’s monthly income that can be used for the monthly mortgage payment (i.e. they are dictating what loan payment is affordable). Based on this regulation, in most cases the bank needs to look at current as well as previous (two years) income. This makes documenting income much more important than ever before. Furthermore, banking regulation introduced as a result of the crash in 2008 also ties the perceived risk of the borrower defaulting to the mortgage interest rate the bank is likely to use for the mortgage that borrower will be offered.

Before this new regulation, even though a borrower’s tax reports did not show income, if they had other ways of showing cash flow to pay the loan, many mortgage banks understood there is more to meet the eye than what is reported in his tax forms and, since it was up to their discretion to consider what is income, a loan could be approved.

For a borrower who is an employee and not a principal, this new regulation had little effect on their ability to qualify. For the self-employed borrowers the effect was significant.

As mentioned above, a small business person who has added every expense he can find to his tax filing will have a hard time getting the mortgage banker to understand which expenses did not need to be there. While you are giving an honest description to both the lender and the tax authority, the fact that you have included every expense in your operating income for the report to the tax authorities now has undesirable consequences.

As long as there was actual cash flow (meaning you really did make money), in some cases with the assistance of a sophisticated mortgage banker or the help of an experienced and knowledgeable mortgage broker, an analysis can be done to show just that, and thus to prove that the ratio of income to mortgage payment is sufficient or even good. There are also other ways that an experienced and knowledgeable mortgage broker can help explain an entrepreneur’s income; but keep in mind that Yaish M’Eiyin (something from nothing) is only in the realm of the One above.

It is important to remember that the picture of just making ends meet you present at tax time to the tax authority will not be received so sympathetically when it comes time to qualify for a mortgage. In other words, while you may be able to feed a “poor boy sandwich” to the tax authority, making an argument to the mortgage lender that your net income is really much higher than what is reported may be too rich a story for the mortgage bank’s underwriters to swallow.


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