How to prepare to buy a home when self-employed
The US Bureau of Labor Statistics estimates that there are more than 15 million self-employed workers in the country. For many Americans, being self-employed is the ultimate dream: breaking free of the 9-to-5, setting their own schedule, and becoming their own boss.
“If you’re self-employed, you have to acknowledge that the reality is you’re starting at a disadvantage,” said real estate attorney Mazyar Hedayat. “It’s part of the price you pay for calling your own shots, for being your own boss.”
When you no longer have a W-2 from an employer, however, buying a home can become a more difficult process. If you are self-employed, there are a number of things that should be done before applying for a mortgage.
Documentation is key
All banks and lenders require certain documentation before approving a mortgage application.
“You’re still going to start with a rate quote, you’re still going to fill out an application, you’re still going to sign paperwork, and you’re still going to be required to provide documentation,” said Jason van den Brand, co-founder and CEO of online mortgage company Lenda.
This can be trickier for those who are self-employed without a W-2 as proof of income. Prepare to include at least two years’ worth of financial details, including debts, assets, and 1040 federal tax returns.
Pay attention to deductions
Handling deductions can be difficult when small business owners apply for a mortgage; as the owner of the business, they are able to write off expenses that regular employees cannot.
“That’s where it gets tricky,” said van den Brand. “Their actual net income after all the write-offs actually is a lot lower than it would be otherwise.”
This can make it more difficult to qualify for a mortgage as it can affect your debt-to-income ratio. One way to avoid this is by paying yourself a W-2 wage rather than taking an owner’s draw.
Prepare to pay more
No matter your credit or financial history, some lenders view self-employed applicants as high-risk borrowers. Because of this, you may want to prepare to pay more for a mortgage – at least initially.
“If you’re a self-employed borrower, you have to make a decision,” Hedayat says. “Are you prepared to pay a little extra for the money, in a slightly higher interest rate? My answer to that is that it usually is worthwhile because good credit leads to good credit.”
Several years of consistent, on-time payments may help you re-negotiate at a lower interest rate in the future. Likewise, consider working with a local credit union of other smaller lender; they may be more flexible with a fellow small business – and can help you build connections.