For many of us, living the dream means being self-employed. You get to be your own boss, work on your terms (or at least some of them) and manage your time and resources. If you are doing work you are passionate about, there is an excellent chance you are self-employed.
Of course, living the dream also comes with downsides like not having a company retirement plan, paid vacations, parental leave, health benefits, or insurance. Another possible disadvantage is that lenders tend to scrutinize self-employed individuals more than corporately employed applicants when assessing whether to give you a loan and what interest rate to charge you for it.
Many people are intimidated by the idea of getting a mortgage while self-employed, and some may tell you it is difficult. However, don’t let this stigma get you down, as being independent doesn’t necessarily make it any harder to get a mortgage in reality. There are ways to improve your rates and probability of approval when getting a mortgage while self-employed.
Get Organized and Document Everything
As with any mortgage or larger loan, your lender will ask for a lot of documentation and proof to gather a detailed picture of your financial condition and ability to repay the loan. For people employed by a corporation, lenders typically require 6 to 12 months’ worth of tax returns as proof of income. For the self-employed, that number increases to 2 years, and the lender may ask for a lot more information such as information about your outstanding debts and any relevant assets.
If you have been in business for over five years, the lender may not require business returns. If you have experienced a verifiable increase in income over the past two years, the requirements may be more relaxed. However, expect to provide proof for at least the past two years of your business income as a general rule of thumb.
Watch Your Deductions
One of the most significant benefits of being self-employed is all the numerous tax write-offs that you have access to. Often they can reduce your tax burden significantly, which can take a load of financial stress off your shoulders.
However, lenders primarily focus on your adjusted gross income (AGI), not your pre-tax gross income. In other words, they consider your income to be the taxable income you claim after all the deductions have been made. So if you claimed $20,000 worth of deductions last year and made $45,000 in gross income, the lender will consider you to have earned only $25,000 last year! That may seem unfair and unreasonable, but the logic is that the lender cannot count on income for debt repayment if it has already been assigned to cover other essential expenses. Deductions can be written off because they are necessary business expenses, after all, and you need those deductible expenses to operate your business and earn your income.
Keep Business Separate From Personal
Lenders like to see neatly organized income and expenses. If you are currently mixing your business finances with your personal ones, it will complicate things, as the lender would have to comb through bank and credit card statements to understand your actual liabilities. This could potentially complicate things when it comes time to get approved for a mortgage.
For example, if you buy an expensive printer for your business but use your personal credit card to buy it, the lender will count it as a personal debt rather than as a business one, because you are personally responsible for repayment. If you use a dedicated business-only credit card and have an LLC, for example, that should help keep things separate and avoid any confusion or frustration in the approval process.
Take Good Care of Your Credit
No matter how much income you generate from your business activities, if you have a bad credit score or negative marks on your credit report, that will harm your approval odds. It will also mean you get charged a higher interest rate than you otherwise might have been offered if you’d had a better score.
Also, having a lot of debt balance outstanding could harm your approval odds and your rate, as well as negatively impact the loan amount. Lenders like to see minimal consumer debt because they know that your debt payments such as credit card bills and car payments will compete with your mortgage when the time comes to pay the bills and things are tight for the month.
There’s Nothing to Worry About. You Can Do This!
If you have been working as a self-employed individual for the past several years and continue to make the same gross income or a bit more each year, you can be equally appealing to lenders as anyone who has a corporate employer. As a matter of principle, most lenders are looking for stable, predictable, verifiable income that is sufficient to cover debt repayment with a margin of safety. As long as you can prove consistently steady taxable income, you should not have any problem getting approved for a mortgage.
While it may seem like a daunting prospect to apply for a mortgage when you are self-employed, it is nothing to fear. If you have your documentation in order and have maintained a good credit and income history, you should be well on your way to approval.