How to snag that mortgage when you are self employed.
If you’re a business owner, freelancer or one of the countless other self-employment professions, you are among the 9.9 million Americans who have forgone traditional w-2 employment to be your own boss. While working for yourself can provide a number of perks, it also requires a lot more work –especially if you are considering buying a home.
Despite a steady rise in the number of self-employed workers every year – it’s estimated that 40 percent of workers in America will be self employed by the year 2020 – lenders still tend to be a bit more timid when offering loans to people who are self-employed, requiring higher interest rates and larger down payments if they are willing to make an offer at all.
If home ownership is your dream, don’t be discouraged. While it may require a bit more effort and planning, it is still possible to be self-employed and be approved for a home loan.
If you’re considering buying a home, especially if you’re looking to buy within the next 3-5 years, here’s some of the things you need to know.
Tax Returns, Credit and DTI… Oh My!
The first and most important thing you can do is keep good records. Income tax returns are the best and most credible way to prove income and they give lenders a glimpse at your overall finances. For the best chance of getting approved for a loan, you should be able to provide a minimum of two years of income taxes – the biggest reason the self-employed get denied is because they haven’t been self-employed long enough.
As with most things, whether self or traditionally employed, it’s important to have a healthy credit score. Taking actions to raise your credit score because higher is always better. You credit report will also contribute to figuring out your debt-to-income (DTI) ratio.
DTI is calculated by adding your new house payment and all non-housing debts – which includes things like car payments, student loans, child support and any business loans you might have – then dividing them by your average monthly income. A good range for your DTI is about 30 percent.
Deduct with Caution
One thing that all self-employed people need to know is that taking too many deductions, while a great perk of owning your own business, can hurt you in the long run because it lowers the amount of profits your business earns each year. So if buying a house is on your radar, you might want to be more conservative with yearly deductions leading up to the purchase of a home.
Don’t Mix Business with Pleasure
It’s important when being self-employed, to keep your business finances and records as separated from your outside life as possible. This can prove challenging for many self-employed people, especially those who work from home or maintain a home office. And let’s be honest, keeping separate records is more work. However, if a lender can’t decipher business profits and expenses from personal expenses, they are more than likely not going to want to take on the risk of whether or not you will be a good candidate for a mortgage loan.
Things you can do to make yourself a more appealing candidate include keeping business banking accounts completely separate from your personal accounts when possible. You should also be as detailed as possible when keeping records, especially for anything business related like balance sheets and profit and loss statements.
Show Them the Money
Beyond having a long history of being self-employed, one of the best things you can do to help your chances of getting approved for that mortgage loan is the ability to put down a large down payment. This shows lenders that you are capable of paying your mortgage and that you are disciplined with your money.
How much of a down payment should a self-employed home buyer bring to the table? On average, lenders require anywhere from a 10 to 14 percent down payment for salaried employees. According to several lenders, it is estimated that on average self-employed individuals should expect to bring at least a 15 percent down payment to the table and, if at all possible, closer to 20 percent. However, just like any mortgage it is entirely based on ones income and their ability to prove that income. We often see self-employed individuals get by with as little as 3% down.
Plan early, plan well and have patience. The process might take a bit longer and be more tedious than that of your traditionally employed counterparts, but the sooner you begin taking steps to prepare your business – and yourself – for home ownership the more likely you will be a candidate that lenders welcome with open arms and the sooner you’ll be getting the keys to your brand new home.
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