Being self-employed certainly has its perks, especially at tax time. One big downfall however is when it comes time to purchase a home. Navigating the mortgage process when buying a home is challenging for anyone, but when self-employed the process can become formidable. Fortunately, by planning ahead, you can work through any issues beforehand in order to make the process smoother when the time comes.
Notice the key word here…ahead. Without being able to show steady income via a pay stub, you need to be able to show steady annual income. That means having at least two years of taxes that show an amount sufficient for lenders to determine that you can make your monthly payment. Lenders will typically calculate your average “monthly income” by adding your Adjusted Gross Income for both years, and then dividing it by 24.
However, beware of red flags. Lenders don’t like to see huge increases or decreases from one year to the next. The ideal situation is one that shows a steady increase from year to year to prove business is good. Beware also of making any huge deposits during the mortgage process. This will only lead to having to answer more questions and provide more documentation.
One of the biggest things you may want to think about is taking fewer deductions. While this may mean a higher tax bill for the year, you’ll look better on paper. This means making clear separations between personal and business expenses too.
Be prepared to show extra documentation to prove your business exists. This can include items such as your business license, website, letters from clients and a letter from your CPA. Depending on what kind of business you have, you might also need to provide proof of worker’s comp insurance, employer’s liability insurance, or bond insurance.
And, of course, make sure your credit score is as high as possible. Good credit can improve anyone’s chances of getting a loan, so if you’re self-employed, you especially want to make sure your credit is in good shape. 740 or above is a good number to aim for, but you’ll need at least a 640 just to be approved. By planning ahead and checking your credit in advance of purchasing a home you will have time work on any irregular issues and make sure your accounts are in good standing.
Keep in mind you may need to lower the amount of the loan to match your income on paper. As a last resort, you may want to look into alternative financing options or finding a co-signer with a regular source of income.
While it is more challenging to purchase a home if you work for yourself, knowing what to expect will help you prepare and be ready to make your dream of owning a home become a reality.
