Are you self-employed wondering what it would take to buy or refinance a property?
It is undoubtedly more complicated to be eligible for a home loan as a self-employed borrower since the result is more subjective based on the documentation. Lenders are primarily concerned that all applicants can consistently repay the mortgage and the self-employed have more variation and unknowns in their financial future. They will need to see that your income is high enough to pay for the mortgage and likely to continue, and that you have a good track record of repaying your debts.
You are considered self-employed if:
- You own your own business
- You are a partner with at least 25% ownership in a business
- You receive more than 25% of your income in bonus or commission income
- You are a contract worker
- You receive 1099 forms instead of W2s
- The bulk of your income is dividends and interest
- You are primarily a landlord
- You receive royalties
We recommend contacting us at Focus Capital for a free consultation because we have incredible experience working with self-employed clients. Our experience spans over fifty years and as a reputable mortgage lending firm, have a reputation for outstanding customer service, repeat business and referrals.
Gain invaluable information from a Focus Capital Loan Officer on what to prepare for and how to prepare for a home loan. Besides the standard preparation before applying for a loan such as improving your credit score, paying down existing debt and saving as much as possible, self-employed borrowers should understand what else lenders will be expecting from them to quality.
For starters, it is important to know a lender will consider what a business by someone self-employed made in net profit, not gross profit. For instance, a flower shop owner did $100,000 in revenue over a year. Considering the business also had to pay rent, supplies, utilities and insurance in the amount of $40,000, the lender will only consider $60,000 in profit as real income. When a lender reviews business income, they look at not just the most recent year, but a two-year period. The lender looks for consistency. If you did well one year and then declined in revenue the following year, even if you qualify based on the two-year calculation, the lender could use the most recent year’s declining income only and likely won’t approve your loan. It is a good idea to time a mortgage application after two to three years of consistently good earnings to prove income stability.
A lender will also look at bank statements to examine the cash flow of your business. A lender is looking to make sure there are enough funds in an account to pay the bills.
Business owners write off expenses to pay less in taxes. If your business makes $100,000 and you write off $90,000, a lender will say you made $10,000 or just $833 per month. Therefore, if you plan to apply for a mortgage, don’t go overboard on your write-offs!
Make sure to always disclose a side business because your lender will find out about it anyway from transcripts from the IRS. Again, keep in mind that if you write off too much or your side business is a loss to you, your lender will count this against you. If your tax returns indicate you lost $12,000 last year in a side business, your qualifying current monthly income will be reduced by $1,000.
If you are self-employed, you may disagree with the income the underwriter determines you for you. This is a common feeling experienced by many self-employed individuals. Lenders determine year-to-year trends for gross revenue, expenses and taxable income for the business, which is used to project a trend for the business over time. Self-employed income calculations can come down to a judgment call by the underwriter. The bottom line is that lenders need assurance that you will be able to make your mortgage payments for the entire length of the loan.
Lenders require complete financial documentation for a mortgage application. When you are self-employed, you’ll need to provide both business and personal financial documentation. Here is a list of what you should be prepared to submit:
- Complete personal tax returns for two years
- Business tax returns for two years
- IRS Form 4506-T, giving permission to the lender to request transcripts for tax returns
- Profit and Loss Statements
- Business Bank Statements
- Business verification such as a DBA
- A Business License
- A List of your debts and minimum monthly payments
- Cancelled checks for your current rent or mortgage
- Any additional income or payments such as Social Security or disability
The self-employed borrower will endure more scrutiny than the standard employee. It is important to choose a lender, such as Focus Capital, willing to work with self-employed borrowers and ready to offer customized recommendations for reducing your risk and obtaining approval.