By Jessica Larson, SolopreneurJournal.com
Things get more complicated when you’re self-employed. You’ve got to worry about benefits and expenses in a way you never would have if you were traditionally employed: things like health care coverage, retirement plans, and quarterly taxes.
If you’re in the market for a home, you can add mortgage applications to that list. Whether you’re looking to buy a house in New Orleans or Texas, you’ll need to know you can afford it first.
And while there are a number of ways buying a home can get more complicated if you’re self-employed, that doesn’t mean it’s impossible. Far from it, in fact. With a little planning and organization, you can still get the home you want. Here’s how.
Keep Your Credit Stellar
Applying for a mortgage loan is a way of applying for credit. Of course, there’s more at stake (for you and a prospective lender) than there would be on, say, a credit card application, because the amount you’ll be requesting is likely to be a lot higher.
The better your credit score, the better your terms will be on a mortgage loan. For example, if you’re requesting a 30-year loan on a $200,000 mortgage at a fixed rate, you can expect to pay just over $93,000 in interest over the term of the loan if you have a credit score between 760 and 850. But if your score is in the 620-639 range, that cost balloons to nearly $157,000.
Credit history plays an even bigger role in your application if you’re self-employed. Avoid applying for any other new lines of credit in the months leading up to requesting a loan. So-called hard inquiries can pull your credit score down.
Check your credit report (it’s free once a year) so you can resolve any late payments and dispute any errors you find there. If you need to rebuild damaged credit, consider a secured credit card: You deposit money in a linked account to gain a line of credit. By paying your balances on time, as with any credit card, you strengthen your credit history every time you use it.
Minimize Your Tax Deductions
Before we go further, it’s a good idea to define what “self-employed” (or freelancer or contractor) means when it comes to home loans. If you’re self-employed, you own at least 25% of your business and receive a 1099 tax form instead of a W2. If you own less than one-quarter of your business, a mortgage lender won’t consider you self-employed.
This brings us to the issue of taxes. If you know you’re going to be applying for a mortgage, minimize your tax deductions for the two years prior. Yes, it’s a good idea to find deductions for tax purposes, because it saves you money with the IRS, but the opposite is true when you’re looking to buy a house.
That’s because the more deductions you have, the less money you’ll appear to have earned. This will increase your debt-to-income ratio and make you look like a bigger loan risk, making lenders more likely to shy away from you. Simply put: Lenders only consider taxable income when determining whether to approve a loan and for how much.
Keep Your Accounts Separate
Keeping your business and personal accounts separate is always a good idea, even more so when it comes to seeking a mortgage loan. Blurring the lines between the two can muddy the waters and make it difficult for a prospective lender to determine your creditworthiness.
By the same token, resist any urge to move money between your business and personal accounts if you’re considering an application. Lenders will need to verify down payment funds, and they’ll have a difficult time doing so if they think some of the money in your personal account is tied up in your business.
That said, you should pay yourself a salary, which lenders will view as income that can help you obtain a loan.
Put Cash on the Barrelhead
The best way to avoid having to apply for a mortgage, of course, is to simply pay cash for your home. Unless you’ve come into a windfall like an inheritance or lottery winnings, though, you may not be able to do that.
Still, you may be able to swing more than the minimum down payment, and if you can do that, it can improve your chances of getting a loan. The less you have to borrow, the smaller the risk to the lender, and the more likely it is they’ll be willing to approve you. (Lenders are looking for a ratio in the range of 36% to 43%.)
Document Everything
When you’re self-employed, you need to keep complete and accurate records, and lenders will want to see them — which gives you even more incentive to do so.
Since you won’t have a W2 form, as you would with a traditional employer, lenders will want to see two years of your business tax returns to ensure your employment and income are stable or growing. Don’t expect them to calculate your loan based on your highest-income year, either. More likely, they’ll average the two years out and work from there.
Applying for a mortgage when you’re self-employed is a bit more complicated than it would be if you worked for someone else. But with good documentation, planning, and consistency, you can get approved for a loan and begin planning for a future in your new home.
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