One of the biggest challenges faced by someone who is self-employed is getting a mortgage loan. Prior to the financial crisis of 2008, it was possible to solve this problem by getting a “no-doc” loan or some similar loan — and pay an outrageous interest rate for the privilege. Even before the financial crisis, if you wanted a good mortgage rate, you had to jump through hoops as someone self-employed. Now, it is still difficult to get a mortgage loan with an income primarily from self-employment. However, it is possible. I know; I’ve done it.
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Proving Your Income
One of the biggest reasons that it can be difficult to get a home loan when you are self-employed is due to the fact that a mortgage lender is looking for evidence of a steady income. A self-employed person can’t bring in pay stubs and W-2s to show that he or she earns a steady wage.
Instead, you have to show your tax returns and maybe your 1099 Forms. However, a mortgage lender knows that your income is likely to vary from month to month when you are self-employed. Even though your yearly income might be sufficient, the concern about fluctuations in monthly income can cause mortgage lenders pause when approving your application.
Pay Yourself a Regular Salary
A strategy that can help you overcome this state of affairs is to pay yourself a regular salary. Even home businesses can be structured with payroll so that you are receiving a regular salary. This shows up in your payroll/accounting software, and you can even print out pay stubs showing your salary. When you pay yourself as an employee of the business you own, it indicates that your business is structured in a way that provides you with a predictable monthly income.
Another option is to submit to an income audit. This is the path that I took four and a half years ago when I bought a home. We were offered the chance to use a “special” loan, but the interest rate was 12%! We wanted the best possible rate, which at the time was 6.02% in our area. Our lender told us that an income audit, in conjunction with our tax returns and bank statements, could put the underwriters’ minds at ease.
We hired an accountant to audit our income. He looked through bank statements, 1099s, and even contacted a few of my clients to verify information about how long they had used my services, and what they usually paid me. The audit took a little more than two weeks, and we provided additional information to the accountant as needed. However, in the end, the mortgage lender approved our application, and we received the best possible interest rate (it helped that we have good credit).
Can You Afford the Payments?
As you buy a home as someone self-employed, you should be just as concerned as your mortgage lender about your ability to make regular mortgage payments. When relying on irregular income, it’s important to make sure that you are able to comfortably meet your obligation.
If your business has a bad month, or if some unexpected business expense crops up, you will be in trouble if you can’t afford your payment for that month. Instead of stretching to “afford” a house payment, it’s best to make sure that you are well within your comfort zone. My husband and I were approved for a mortgage for twice the amount we ended up paying for our house. We wanted to make sure that, if something happened to my freelance income, we would still be able to afford payments.
Before you apply for a mortgage as a self-employed person, make sure that you carefully consider your options. Look at your budget, and think about the worst case scenario. What if you lost a quarter of your business? Half your business? Do you have an emergency fund that can help you make payments? Right now, our housing costs account for about 1/5 of our monthly income. As a result, we are fairly confident in our ability to handle payments, even in the case of a financial setback.
It’s possible to get a mortgage when you are self-employed, but you will have to jump through hoops. Make sure that you really can afford the payment, and then be prepared to prove your income — on top of showing that you have a good credit score.
9 Tips for Getting a Mortgage While Self-Employed
To sum it up, here are tips to help you get mortgage more easily while you’re self-employed.
- Pay yourself a regular salary from your business
- Keep good financial records
- Maintain an excellent credit history
- Keep your debt level as low as possible
- Make large down payment
- Maintain a good cash reserve
- Find a good lender that has experience working with self-employed borrowers
- Consider buying a less expensive house
- Give yourself plenty of time to get through the process
For a more in depth discussion for some of these tips, check out: Getting a Mortgage with Self-Employment Income at Cash Money Life.
Miranda is a professional personal finance journalist. She is a contributor for several personal finance web sites. Her work has been mentioned in and linked to from, USA Today, The Huffington Post, The San Francisco Chronicle, The New York Times, The Wall Street Journal, and other publications. She also has her own personal finance blog: Planting Money Seeds.