Qualifying for a mortgage when you're self employed can be challenging. During the past several years, as folks struggled to survive the economic downturn and job loss, many smart people turned to entrepreneurship. In fact, working for yourself, either part-time or as your full-time gig is the reality for millions of Americans. Additionally, many companies turned to hiring freelance or contract labor (1099 status) rather than fully employed workers (W-2 status) in order to cut costs and reduce both overhead and employment expenses such as benefits, labor insurances and employment taxes.
While many people returned to regular full-time employment since the economy started improving, a large segment of the population continue to earn income through self-employment, free-lance or contract work, enjoying the freedom from dress codes, specific work hours and income limitations of regular jobs. Additionally, as "business owners," self-employed taxpayers qualify for a whole host of tax breaks that reduce their bottom line and consequently, their provable income. The freedom is great, but how do you qualify for a mortgage?
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Since the mortgage industry bases credit-worthiness on provable income, using W-2 forms and tax returns, qualifying for a conventional loan may prove difficult for many self-employed would-be homeowners.
Since conventional lenders follow prescribed formulas in proving income and credit-worthiness, most mortgage underwriters only look at the after-tax and post-deduction income, resulting in a far lower provable income than most entrepreneurs or self-employed workers believe expresses the reality of their situation. In a few cases, certain lenders allow specific deductions to be added back into your income including some one-time investment expenses, depletion or deductions for business use of your home. But for the most part, qualifying for a conventional loan is much more difficult for the self-employed buyer with an irregular income.
While a conventional loan (salable to government-controlled agencies such as FannieMae and FreddieMac) may not be an option for you, some investors see an opportunity and are funding smaller lenders that offer loans outside these restrictions. For these loans, the risk is higher, so to hedge their investment, these loans typically have a higher interest rate and require a down-payment of at least 20 percent and sometimes more, or a large portfolio, or really great credit.
The bottom line
If you're newer at the self-employed lifestyle but know you want to buy a home in the near future, you'll need to start now to position yourself to qualify. Here are the best practices to incorporate into your business and personal life to set yourself up to be approved:
Don't wait until you want to buy a house to start getting your financial house in order. If may take several months to up to two years to create a provable paper trail for yourself.
Keller Williams NWRE LLC
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