According to Pew Research Center, 14.6 million people are self-employed which is about 10% of the workers in this country.
Of course, there are many perks that come with working for yourself like autonomy and flexibility. But, one major drawback of self-employment is how challenging it is to qualify for a mortgage.
Lenders typically use pay stubs, W-2s, tax returns, and employment history to verify your income. Self-employed workers don’t have the same documents and their income is often variable which makes the application process a little more difficult.
Fortunately, it’s still possible to get a mortgage when you’re self-employed if you prepare early with these tips:
Self-employed workers take advantage of as many tax deductions as possible to reduce taxable income. Unfortunately, this practice works against you when you’re trying to finance a home.
In lieu of W-2s, lenders will ask for at least two years of past tax records and average your net income to make sure you bring in enough money to pay your mortgage. Net income is your bottom line after business expenses and tax deductions, so it’ll look like you take home less money than you actually do.
Schedule a meeting with your accountant to discuss adjustments you can make to your tax filing to show enough income for the type of house you want to buy.
You should also look for a lender who has experience working with people who are self-employed. They’ll know how to dig deeper into your tax documents to qualify you for a home.
Your debt-to-income ratio or DTI (your debt divided by income) is an important part of the mortgage application where the use of net income can hurt you.
Lenders look for a DTI below 40% to make sure you can afford mortgage payments. Low net income will negatively impact your debt-to-income ratio and ruin your chances of getting approved for a mortgage.
How can you improve your DTI?
Make adjustments to your tax deductions and pay off other consumer debts like credit cards, personal loans, and car notes. You should also avoid taking on any new debt until you’re approved for a mortgage.
There are other perks to paying off your consumer debt as well. It can increase your FICO credit score and improve your chances of qualifying for the best interest rates.
You look risky to lenders when you have unpredictable income, especially if you’re running a new business with little income history to verify.
You’ll look more attractive to mortgage lenders if you save the full 20% down payment for a home and you have several months of mortgage payments in cash reserves. This shows you have enough liquid assets to fall back on during the feasts and famines that often come with self-employment.
If you have trouble meeting the requirements of a loan on your own you can always fall back on a cosigner who has a solid employment history, income, and credit score.
Most people are hesitant to co-sign for someone else on a home purchase and for good reason; they’re also on the hook if you can’t make payments. This will probably be your last resort, but it’s still a viable option if you’re unable to get financing.
Interested in learning more about your mortgage options or prequalifying for a home loan?