How to Navigate the Home Buying Process If You Are Self-Employed

Posted on May 14, 2015 by resourcefulman

Buying a home is intimidating to anyone, but it is known to be hell if you are self-employed. It is more difficult for people to get a mortgage when they are self-employed because it is not easy to prove that you have a stable income. It takes a lot of paperwork: tax forms, letters, licenses. The key to keeping things simple is planning ahead. Here’s what you should do.

Make sure you can check your income

Lenders want to know how much money you are making before they decide to give you money. It makes sense; they want to know that you can actually pay them back.

If you have an employer, it’s as easy as checking a pay slip. When you are self-employed, it is more difficult. You will have to file your last two tax returns. To do this, you will complete the IRS 4506-T giving the creditor access to your tax records. From there, they calculate your average “monthly income” by adding up your adjusted gross income for both years and then dividing it by 24.

According to Quick Loans, they will consider any of the following forms that can be applied:

Appendix C: This is a common IRS form for freelancers and small business owners. You use it if you are self-employed and not a legal entity such as a corporation. It documents the profit or loss from your business.
Appendix E: You usually file Appendix E if you receive rental income or royalties.
Form 1120S: Mainly for large corporations. They also document profits and losses.
K-1: This document documents the profit or loss of a shareholder or partner.
Income Statement: A financial statement not owned by the IRS that summarizes the income, costs and expenses incurred by your business.

But that’s not all. Lenders may also ask for other documents to prove your income. Consider having them handy, or at least getting ready to have them on hand:

Your business license issued by your state, city or county.
Letter from the client (including contact information, your name, what you were hired for and when you were hired).
A signed letter from CPA (Certified Public Accountant), EA (Registered Agent) or Tax Preparer confirming the existence and ownership of your business.

Depending on what type of business you have, you may also need to provide proof of workplace insurance, employer liability insurance, or bond insurance.

Beware of large deposits

If you are self-employed, your income can often be irregular. It is okay if it is documented in the above forms. But when you have a large and irregular deposit in the mortgage lending process, it can become a problem.

Mortgage planner Tony Auffant tells Fox Business that the collateral must be part of the borrower’s regular income, which is consistent with “business as usual” in your account. Depositing an irregular large amount of change is actually a problem for anyone applying for a mortgage, it’s just more common among self-employed people. If you can put it off somehow, that’s fine. If not, be prepared to provide even more documentation and answer many of the lender’s questions.

Work to increase your loan

Good credit can improve your chances of getting a loan. Therefore, if you are self-employed, you especially need to make sure that your credit is in good shape.

According to CNBC, lenders usually want a score of 740 or higher in order to offer their best rates. They usually want to get at least 640 points in order to get approved. If you are self-employed and your creditworthiness is low, you have two problems that work against you.

The good news is that there are several ways to control your credit . Here are a few:

Keep your credit card balances low
Avoid applying for other lines of credit when applying for a mortgage
Maintain a good reputation for accounts
Pay bills on time

Raising your score is a message in itself, and luckily for you, we’ve all written about it. But the point here is to improve your credit in order to solve some of the problems associated with self-employment.

Selected personal and business expenses

It’s much easier to organize your budget when your business and personal bank accounts are separate. And when you apply for a mortgage, you want to get organized.

Splitting bills helps lenders navigate your business’s expenses and income. In addition, Bankrate points out that if you pay business expenses with your business account, creditors may not set off this debt against you, as it is an asset to the business. Make sure you set up a separate account for your business income, and then use that account for estimated taxes, business expenses, and an emergency fund. Check out our guide to managing self-employment income to find out how.

Think twice about deductions

However, keep this in mind: business expenses that are too high can work against you. We self-employed people love them at tax time because of the deductions. For example, write off a business trip and your taxable income will decrease.

But lenders look at this taxable income after deducting those expenses. Thus, it lowers your declared income, which can hurt you when applying for a home loan. You might want to meet with an accountant to figure out the correct amount of deductions that won’t ruin your mortgage chances. The vice president of one mortgage company also suggested:

If buying or refinancing a home is part of your three-year plan, do not write off any business expenses you can write off … As a last resort, amend your tax return to show that you have increased net income. (The IRS has a three-year statute of limitations for modified returns.)

In short, if your declared taxable income is too low, your loan amount may be reduced or worse, you may be denied.

Review the loan amount

Another option to avoid rejection is to simply take out a smaller loan. This means increasing your down payment or buying a cheaper home.

Self-employed borrowers often invest more money. According to Zillow, the average down payment for a self-employed borrower is 15.3 percent, compared with 14.6 percent for non-self-employed borrowers.

It’s an easy option, just save more on the down payment, but obviously it’s not that easy for everyone. You may not want to settle for a less expensive home either. But if you find it easier to navigate the mortgage process when you’re self-employed, it might be worth waiting until you have a larger down payment or reconsidering your options.

Explore loan alternatives

When it comes time to shop for a loan , it will probably be difficult for you to get a quote, even if you’ve done your best to prepare.

A traditional mortgage is called a qualified mortgage and falls under rules set by government-controlled agencies. But many smaller lenders offer alternative options for self-employed people. However, these loan options usually have higher interest rates or commissions, and they expect you to make an initial payment of twenty percent.

Whether it’s worth it, the rates and fees are up to you – how badly you want a loan and what problems you have with a traditional qualified mortgage. However, keep in mind that if you have been self-employed for less than two years, it will be even more difficult for you to get a loan. Two years is the standard most banks use, but an alternative loan may work for you.

For example, Bankrate refers to “alternative income verification loans”. This is how it works:

So far, only niche lenders like Western Bancorp offer them. The company qualifies self-employed borrowers using 12 month commercial bank statements and personal bank statements to conduct cash flow analysis. “We determine what kind of positive cash flow that person has,” says Rick Sukulis, chairman and chief executive officer of Western Bancorp. “Borrowers must also submit an income statement to match the bank statements.”

This is just one example of a lender offering an alternative. But their interest rate is one percentage point per hour than a regular mortgage, and the maximum loan amount to the cost is 75 percent to $ 1 million and 65 percent to $ 2 million. You can expect similar rules, fees and higher interest rates with other alternative loans.

Of course, you must be careful when applying for any loan, but especially with alternative loans. Some are mostly subprime loans (loans for people with financial setbacks), but banks and firms are reluctant to use the word because they got such a bad reputation during the housing bubble. This does not mean that they are not viable alternatives, just make sure you do your research thoroughly with any lender and know what you are going for. Dividend.com suggests checking the creditor’s reputation with the Better Business Bureau. Your best bet is probably to work with a licensed mortgage broker who has access to a range of resources.

In addition to the options offered by smaller lenders, you can also consider several other unconventional or unusual ways to borrow money to buy a home:

Keep in mind that these methods are an alternative for good reason. Seller financing (borrowing directly from the person selling the house), for example, is rare, and borrowing after retirement usually means paying early withdrawal penalties. It’s also risky – you don’t want to have a home and are saving nothing for retirement .

You will need to weigh your ROI and do your research to make sure you pick the best option.

Chances are, if you are self-employed and trying to get a mortgage, you will run into some obstacles. Big ones. It won’t be easy, but knowing what to expect will help you prepare, and it can make life a little easier.

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