Congratulations! You’re self-employed. Whether you’re embracing the gig economy or generally taking your financial destiny into your own hands, your professional independence means you’ll have to walk a different path when getting a mortgage.
Self-employed homeownership has been slow to recover after the recession. While mortgage use for salaried households fell to 87.7%, the rate for self-employed households dropped down to 80.6%.
When you don’t have a steady income, banks see lending to you as risky. Before you get defensive, remember that you are a risk-taker. You took a risk in your decision to be self-employed and that worked out. Prepping for a mortgage as a self-employed person is all about showing your mortgage lender the trait that makes them nervous is actually your best quality.
Getting a mortgage when you’re self-employed is different, yes, but it doesn’t have to be harder. If you plan for what’s coming, you can avoid surprises (and the headaches that go along with them).
What You’ll Need
Two Years of Tax Returns
In order to verify income that’s coming in from several places via 1099’s, lenders rely on your tax returns. In some cases, you may be able to qualify for a home loan after you have one year of tax returns. In general, though, you’ll want two years of tax returns. Your lender will be looking at the history of your income in order to predict future income.
An Understanding of Your Net Income
The most common problem that self-employed homebuyers run into when applying for a mortgage is claiming to make a different amount than the government says you do. Key lenders—including Fannie Mae, Freddie Mac, and the FHA—base their decisions on net income.
This is where your savvy tax strategy may come back to haunt you. Maximizing deductions reduces your tax burden, but it also reduces your net income. As far as your lender is concerned, the mortgage you can afford is dependent on your net income, not your gross income.
A Bigger Deposit
These days, many people can forgo the traditional wisdom about needing a 20% down payment. But for self-employed individuals, bigger is better when it comes to down payments. Lenders see this as mitigating their risk. A larger down payment upfront helps to offset the potential risk of inconsistent income in the future.
A Great Credit Score
Having great credit is going to make your lender feel more at ease. A credit score between 800-850 is considered “excellent” and will help to sweeten the deal when you’re applying for a mortgage. Your credit score is considered “very good” between 740-799, “good” between 670-739, and “fair” between 580-669.
(Maybe) a Cosigner
If all of this is too much—or if you strongly feel that your paperwork isn’t going to accurately reflect the mortgage you can afford—you may want to get a cosigner on your mortgage.
A cosigner is someone who does not have an interest in your property—it could be, for example, a parent—but can help you to qualify for a mortgage because of their stronger employment and salary history. The cosigner is essentially there to tell your bank “I’ll make sure this mortgage gets paid.” If you don’t have two years of tax returns from freelancing or if you’ve been maximizing your tax deductions in a way that makes your income look too small to qualify for a mortgage, a cosigner can help.
How to Plan
Set a Timeframe
At the very least, plan to give yourself a couple of months to get all your paperwork in order. If you’re new to the freelance game, you may need to wait for those tax returns to come. If you’re in the beginning stages of your self-employment, you may need time to earn enough to qualify for the mortgage you want. So, plan to prep for anywhere from two months to two years, depending on how much you have locked and loaded already.
For a home that costs $100,000, you’ll want to save $24,500 ($20,000 deposit + $4,500 closing costs). For a $200,000 home, you’ll want $49,000 ($40,000 deposit + $9,000 closing costs). For a $300,000 home, you’ll want around $73,500 ($60,000 deposit + $13,500 closing costs). And for a $400,000 home, you’ll be looking to save about $98,000 ($80,000 deposit + $18,000 closing costs).
Boost Your Credit Score
There are a number of ways to improve your credit score. Make sure to pay bills on time and pay down debt. You may also benefit from leaving unused cards open, and you’ll want to stay away from opening too many credit accounts. Following these strategies to boost your credit score can help you go from good credit to excellent credit. The process can take a year or more, but it will make you more appealing to lenders.
Set Goals for Your Earnings
A good business practice is to set goals for your earnings for the year. If you know you want to buy a home in the next couple of years, do some initial research on what kind of mortgage you can afford. Then, you can set your financial goals with that information in mind. Steps for increasing your credit score include paying bills on time, refraining from opening a bunch of new credit cards, and keeping credit cards you may not use very often as open with no remaining balances.
Manage Your Tax Deductions
Remember: Lending decisions are based on your net income. So, if it doesn’t mean moving up in a tax bracket, you may want to forgo some of your deductions to make sure your net income is in line with the mortgage you’re trying to get.