True Homes is proud to say that many of our new homebuyers work for themselves. Many times, they enter the home buying process tentatively, thinking their self-employment may prevent them from qualifying for a mortgage. We’re happy to report that self-employment will NOT lock you out of homeownership!
Here are some home financing tips to consider if you’re self-employed and looking to buy.
Remember that a lender’s primary concern when providing home financing is that you have the ability repay the loan. That means you need to show a history of being responsible about paying your debts (your credit score) and you need to assure the lender you have the ability to continue paying your debts responsibly in the future.
You’ll fare the best in the first department if your credit score is at least in the 700s. Loans are available with lower scores, but they are more expensive and, especially with the added risk of self-employment income, may be harder to come by.
The lender predicts your future repayment success in three ways: reviewing your business, looking at your income, and calculating your debt load in relation to your income.
Accessing a mortgage loan with self-employment income is easiest if you’ve been in business at least two years or, if you started working for yourself more recently, if you previously held a paying position in the same industry.
To demonstrate income and the viability of your business, be ready to provide the following documentation:
1.Personal income tax returns for the two most recent years, including all schedules.
2. If separate, complete business income tax returns for the past two years.
3. A profit and loss statement audited by a CPA for the most recent year, if a tax return isn’t yet available.
4. A copy of your business license or a statement from a CPA confirming you’ve had your business at least two years.
To estimate the amount of home financing you’ll qualify to borrow, a lender reviews these documents and calculate your monthly income. Because self-employment income can vary paycheck to paycheck, the lender takes the sum of the annual taxable income for the previous two years and divide it by 24 for a monthly average.
The lender then totals your monthly recurring debts, including payments for auto loans, student loans, credit cards and alimony/child support, and divides that number by your monthly income. The resulting percentage is your debt-to-income-ratio. Once your new housing payment is added into your monthly debts, lenders typically want to see that percentage at 43% or less, depending on the loan program.
Now that you know how the initial process works, here are some home buying tips that may help.
First, separate out your business funds and expenses where possible. For example, if you set aside money to pay your quarterly taxes, keep those funds separate from the account you’ll use to make the down payment on your home. Separate your business debt from your personal debt too. You don’t want the money your business owes to eat into your personal debt-to-income-ratio, leaving you with less room in your budget for a mortgage payment.
Next, watch your deductions. Your monthly income is based on your taxable income. If you take a lot of business deductions – say, for extraneous travel you could avoid – your taxable income will not be as high. Sure, you’ll avoid the taxes, but you also may not qualify for the mortgage need to buy the home you really want.
Then, follow all those other home financing tips the people who report their income with a simple W-2 form also follow. You know the ones – things like maintaining your credit score, paying down your debts and saving for a down payment. Lenders may look at those types of things even more closely for you!
Finally, before you go on your first home buying excursion or set your foot in the first model home, talk to a mortgage lender. They’ll be happy to review your situation and help you through the process of gathering any documentation you will need. And if the first one says they can’t work with you based on your self-employment income, then try another. Different lenders or mortgage brokers can tap into different programs. Just because the first lender can’t help doesn’t mean that no one can.
At True Homes, we have worked with many lenders and home buyers over the years. If we can offer homebuying tips or introductions to lenders who may be able to help with your specific home financing needs, please ask. We’ll be glad to help.