A growing number of Americans are making the choice to be their own boss. In fact, Everlance reports that some 27 million Americans are expected to make the switch to self-employment between 2017 and 2020, raising the number of self-employed workers to 42 million. That means nearly one-third of the American workforce will be self-employed. Being self-employed offers freedom and flexibility, but it also makes certain things more challenging. Buying a house when you’re self-employed can be tricky, but it is doable. What do you need to know?
Buying a House When You’re Self-Employed
In the past, lenders required W-2s and pay stubs for proof of income, items that you may not have if you’re self-employed. However, the Dodd-Frank Act opened the door for lenders providing home loans to also use tax returns, financial institution records, and “other third-party documents that provide reasonably reliable evidence of the consumer’s income or assets,” according to The Mortgage Reports. That makes buying a house when you’re self-employed easier, but you’ll still need to do your part to win a lender’s favor.
The Challenges of Showing Enough Income
Lenders want to know that borrowers can pay them back. That’s why they verify your income and assets before approving you for a home loan. A steady paycheck offers some reassurance. What do you do if you don’t have that? As The Motley Fool advises, be prepared to show that your self-employment provides a reasonably steady stream of sufficient revenue using tax returns and other documentation.
That said, it’s important to remember that lenders are interested in your income after tax deductions (source). It’s a bit of a catch-22. Writing off business expenses reduces your verifiable income while also saving you money on your tax bill. Not writing off as many expenses will raise your income in the eyes of lenders, but it means you’ll pay more at tax time. What if you aren’t sure how to strike a balance between maximizing your income and managing your tax burden? SmartAsset suggests turning to an accountant or tax professional. As an added bonus, having your taxes done by a professional can reassure a lender about the accuracy of your returns.
What Lenders Want to See from Self-Employed Applicants
If you want to present a persuasive case, you need to know what lenders are looking for in a borrower. According to U.S. News & World Reports, lenders generally want self-employed applicants to demonstrate things like the following:
- Steady Income: While some fluctuation in income is okay, lenders want to see that your income is generally steady. If it’s increasing, that’s even better.
- Consistent Demand for Your Work: Although no one can see into the future, past performance can support certain predictions. Lenders prefer to see at least two years of stable self-employment income. This is used to determine if there is a reasonable demand for your services and a reasonable expectation that your business will continue to bring in sufficient income to repay your loan.
- Savings: People who are self-employed are more likely to see fluctuations in their income than those drawing a paycheck from an employer. Lenders want to know that you have the resources to make your mortgage payment even if your work dries up for a while. Having cash reserves set aside suggests that you’ll be able to pay your bills even when your earnings are down.
- Strong Credit: Good credit is important for any borrower. Lenders want to see that you have a habit of managing credit effectively and repaying your debts.
- A Substantial Down Payment: Borrowers who bring a large down payment to the table are seen as less of a risk. Having a hefty down payment may be a deciding factor if other aspects of your loan application are a little shaky.
Tips to Improve Your Chances of Being Approved
What can you do increase the likelihood that you’ll be approved for a home loan when you’re self-employed? As NerdWallet reports, keeping clean, accurate business records is vital. Avoid mingling personal and business accounts, and be sure to register and license your business. If you’re planning to apply for a mortgage soon, choose your tax deductions wisely and take steps to reduce your debt load. You may also want to consider switching from an owner’s draw to a W-2 wage when paying yourself.
Would you like to learn more about buying a house when you’re self-employed? Contact the friendly professionals at PrimeLending Twin Cities. Our loan experts offer personalized guidance and customized loan programs, so we’re ready to assist a wide range of aspiring homeowners in reaching their goals. To discover more about our services and how they might benefit you, contact us today.