Getting a Mortgage If You’re Self-Employed
As you set out to buy a home for your current or future family, you set out on a journey with more peaks and valleys than you probably could have imagined. From walking through the perfect house to learning you’ve lost a fifth consecutive bid, the process definitely takes an emotional toll.
Self-employed home buying is even more challenging. Finding an affordable house and winning over the seller requires you to jump through a couple of extra hoops. On paper, someone employed by a large corporation always has greater appeal than the applicant who runs his or her own operation. This means you can work your tail off to launch a business and make good money, but someone with less confusing paperwork and a smaller salary might still beat you out for a house.
As much as the deck may feel stacked against you, I’m not about to let anyone pull the plug on his or her home-ownership dreams. Anything worth having is worth fighting for, and you just need to know a little more about how self-employed homebuyers have to play the game.
1. Put Your Income in Big, Bold Letters
I don’t actually want you to fill your application out in Sharpie, but I do want you to make your income very apparent to take care of any initial apprehension the mortgage broker might feel.
It goes without saying that you shouldn’t be buying a house if you have underwhelming earnings. Long before you get into the details of applying for a self-employed mortgage loan, you should have honestly asked yourself: “How much house can I afford?” People should never take out a dangerously large loan in order to buy real estate they can’t legitimately support. If you fear the bank will turn its nose up at your earnings because your income is insufficient, then there’s no working around that problem until you increase your savings.
For the self-starter with strong earnings and bright horizons, the game begins with your tax returns, both business and personal. Most people hate tax season because it feels like a battle against the IRS, but the stakes are much higher; you have to keep your business records looking as attractive as possible when it’s time to get a mortgage. Filing may be a pain, but tax returns make the best kind of proof of income for self-employed individuals.
If you’ve been self-employed for only two months or so, you won’t have the business history lenders want to see. This doesn’t leave you completely defeated, but it makes your options fairly clear: wait a couple of years to buy a house, or prove you have loads of working capital from your previous employment. In general, trying to buy a new house concurrently with starting a new company puts you in a tough situation.
The mortgage self-employed borrowers get – or don’t get – depends as much upon their future earnings as it does how much they made in the past. Therefore, lenders will likely want to see 2-3 years of tax filings as proof of income for self-employed applicants, as well as possibly your year-to-date earnings statement. This sheds light on not just what you made, but the direction in which your company is trending. If your business made $500,000 one year, then $350,000 the next, most potential lenders will put much more stock in the more recent, lower number.
Because of this, you have to time your purchase strategically. If your business sees better returns in the first half of the year, consider shopping for a house in the summer when your year-to-date records look more appealing. If your marketing is about to undergo an expensive overhaul and reduce your bottom line, you need to either hold off on the marketing or put your self-employed home-buying dreams on temporary hold.
If you work freelance with variable income from multiple sources, producing paperwork becomes even trickier. Lots of freelance writers and developers take advantage of numerous tax write-offs, but that can actually come back to bite you later. More write-offs = lower net income = disapproving looks from the mortgage provider.
In addition to using tax returns as proof of income, self-employed people with uneven earnings (meaning freelancers and some consultants) should be able to prove their savings via bank statements. While lenders like proof of consistent future income, evidence of cash on hand can also go a long way toward helping your case for a self-employed mortgage loan. The hardest part might be keeping it all tidy; consider ways to add information to a standard application that won’t result in hundreds of additional pages or leave the lender wondering what you’re trying to prove.
At the end of the day, traditional employees have pay stubs and self-employed homebuyers do not. This means you need to make your tax returns as pristine as possible and show the lender that your business and cash flow are healthy.
2. Your Credit Is a Glowing, Neon Sign
Being self-employed while looking for a home means you already have one strike against you. If you have the good fortune of meeting a lender who looks past strike one, you better believe they aren’t going to forgive a second strike.
In some cases, a good credit score will be the only indicator that you have the financial security needed to buy a house and manage a mortgage, self-employed or not. A single blemish will raise red flags on your application, and credit-related concerns are hard to overcome. Any sort of default or a credit-to-debt ratio that’s just a smidge too high could spell doom for your request, even if you have a briefcase full of money to offer as a downpayment and iron-clad proof of income for your self-employed activities.
If you have bad credit (or, if you’re married: if you and your wife’s combined credit isn’t great), your bid to be a self-employed homebuyer will almost certainly be cut short. At a minimum, you’ll have to take a hard second look at how much house you can afford. To save yourself the trouble, take a few steps that will hopefully get your credit back on track:
● Check your score
● Pay down debt
● Talk to creditors
Checking your business and personal credit will do two things. First, it shows you where your report might be lacking. Second, and more importantly, it can alert you to potential errors by the credit bureau. Your score is comprised of all sorts of minutia collected from numerous sources and transactions, and scoring errors happen frequently enough that they’re worth looking into. How great would it feel to check your credit, make a phone call and then have your score magically improve?
Once you know what kind of credit you’re working with, you’ll have an idea of how much effort you need to put into fixing it. If you’re close to 800, you can relax. If you’re below 700, you might need to get busy on credit repair. If you’re below 600, you need to focus on all sorts of things other than buying a house – a self-employed mortgage loan is not going to be on the cards for you any time soon.
Fixing your credit is as easy as paying down debt and as hard as paying down debt. In some cases, if you’ve defaulted on a loan or struggled through a foreclosure, things become even more difficult. In those instances, your home-buying options are essentially narrowed to paying the full price upfront in cash.
If your subpar credit is the result of student loan debt or nasty credit card balances, you have to get to work on those. Even if it means using money you’ve painstakingly saved up for buying a home, you won’t get the house you want if you have too much debt weighing you down. Frankly, it’s not that responsible to think about taking on a home mortgage when you’re self-employed and have additional outstanding balances.
On top of tackling debt, both that of your business and your personal accounts, this is a good time to talk with creditors and see about lowering rates, raising limits, and striking late payments from their books. At the end of the day, Visa, Mastercard, AMEX and the rest of them really want to keep you as a customer. If you have a clean history except for that one late payment while you were on vacation, there’s a good chance they’ll take it off your record.
No one directly benefits from you having bad credit; it’s not like there’s an industry that gets a kickback when your score drops a few points. If there’s a way for your bank or card issuer to cut you some slack and improve your financial outlook, it’s at least worth asking.
Credit, of course, is important for anyone looking to buy a home, no matter how they’re employed. When it comes to self-employed homebuyers, there’s not really a way to hide or overcome a damaging score. The nature of your income has a sort of ambiguity that lenders find alarming, and any problems with your financial past might push them over the edge. Before filling out a mortgage application, self-employed home buyers should take every step they can to clean up their credit score.
3. Make a Down Payment that Makes Sense
Lenders will bristle when they see you’re self-employed. They’ll bristle a little more as they look through your tax returns and discover that you (gasp!) have been writing off expenses. If, on the heels of all this bristling, you offer a downpayment that’s inadequate, or even average, you might just get thrown out of the building.
If you’re a first-time homebuyer with a steady salary, some providers will approve your mortgage and sale with only 3.5% down. If you run an LLC and get paid in sporadic bursts that are hard to document, do not expect to get such a great deal.
And, when you think about it, 3.5% down helps you out a lot less than you think. The less you pay upfront, the more you pay down the road. Rates have been on the rise and bigger monthly payments will cost a lot more over the course of your 30-year mortgage. Even if you do get approved at 3.5%, you really want to make a larger down payment.
Aside from the money you’ll save yourself with a bigger payment at the outset, that gesture will go a long way toward calming whoever you hope will front the money. First off, your unstable income (as it is perceived) scares the living daylights out of financiers. If you can put up enough money to significantly reduce what you owe in the future, that makes you less risky and less terrifying.
Just as importantly, a bigger down payment offers fairly concrete evidence of your earning and saving abilities. Let’s say your business makes $100,000 a year, putting you in a decent position to buy a house. The lender already has doubts about the consistency of your earnings, and only offering 10% on a $200,000 home will reinforce that dubiousness.
Alternatively, if you make the same $100,000/year but waltz in with a $50,000 down payment, the reality of your earnings and your ability to successfully pay for a house come into much clearer view. It won’t replace a flawless application or a tempting credit score, but a substantial down payment will at least make lenders consider your application seriously.
Buying a house, or any other sort of real estate, is a big decision. There’s a reason every house is so hotly contested, and a reason people make so many millions selling properties. If you want to be part of the home-buying conversation as someone who’s self-employed, you need to have enough money to play ball.
Now What?
Unfortunately, some of you may be discouraged. If I planned on buying a house containing a bedroom for each kid with a down payment as low as 3.5%, I’d be pretty upset if someone told me that wasn’t really an option and I had to drastically re-evaluate how much house I can afford. Nevertheless, self-employed homebuyers have to be especially realistic about this kind of thing. If you don’t plan ahead and think things through, you either never get the house you want or you end up with crippling debt that makes owning a home stressful and irresponsible.
When it comes down to it, freelance work and running your own business come with certain benefits and drawbacks. If you aren’t making enough money to save up for a sizable down payment, it’s on you to decide if that’s worth it. If you love what you do and need to prioritize job flexibility above buying a house, you should make the decision accordingly.
In a perfect world – a world which I believe can exist, by the way – you’d be able to do both: buy a house and also find that balance between work and personal life that eludes so many people. You don’t have to be ridiculously wealthy to live in your own home, and you don’t have to work an ultra-structured job that isn’t fulfilling. The system might cater to that format, but you don’t have to conform for the sake of conforming.
The important thing is knowing what steps you can take to improve your chances for successful self-employed home buying. Understand what roadblocks self-employed mortgage applicants face and how you can best overcome these. Plan ahead so you can get your finances in order and impress those hard-to-please mortgage lenders. It might be an uphill battle, but I believe a consistent effort will get you to the top.
Make it happen!
Taylor & Megan Kovar
The Money Couple
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