You’ve worked what feels like around the clock to grow your business. The perks of being self-employed are great, and you’re getting to the point where the income isn’t so bad either. Now, you’re ready to buy a home, and like most people you need financing.
When you own your business, it can be a little harder to get a home loan than it is for people drawing a steady paycheck. Let’s talk about the challenges self-employed individuals face when it comes to getting a home loan and some ways to overcome them.
Self Employment Definition
If you don’t work for one employer who gives you a steady paycheck, you’re self-employed. You might call yourself a freelancer, an independent contractor, a sole proprietor or some other name, but you either work for yourself or contract directly with clients. The day to day running of your business is up to you. If you have to take a sick day, you don’t get paid.
You probably don’t receive benefits or worker’s compensation from anywhere. You have to find your own health insurance plan, and you probably pay more for it than you would working for someone else. You’re not subject to tax withholding, Clients might give you a 1099 but you’re responsible for reporting your income and paying your taxes.
Self Employment Statistics
In 2016, Pew Research reported around 15 million Americans were self-employed. That’s almost ten percent of the workforce. It makes up an even greater percentage when you consider how many of those who are self-employed also have people who work for them. An additional 29.4 million people get their paycheck from someone who is self-employed. Overall they make up a total of 44 million jobs and 30 percent of America’s workforce.
With today’s gig economy, that number is just going to keep growing. If you’re self-employed, you might do anything from personal training to auto detailing, from graphic design to dog walking. Whatever field you’re in, you probably make more money doing what you do than you would performing the same tasks for an employer. There’s more risk because when things go wrong, it’s all on you. But there’s also the potential for more income.
The risk and volatility makes lenders nervous when you apply for a home loan. You might make great money, but you’ll have to prove you’re going to keep doing so for the foreseeable future.
Mortgage Qualification Problems
Online real estate marketplace Zillow says self-employment means “Mo’ money, mo’ problems” when it comes to getting a home loan. Part of the issue is that often people who work for themselves make more money, so they want more expensive homes. That means borrowing a larger amount than average, and more risk for the lender.
Zillow data says self-employed mortgage shoppers reported an average household income of $145,000 compared to the $80,000 average claimed by other households. They loan shopped for homes in the upper $350,000 range. People in lower income brackets shopped in the low $300,000s.
But even though they made more money, when self-employed people applied for loans, they received fewer quotes from lenders. Basically, banks said, “I’ll pass, you’re too risky. I would rather loan to someone who gets a steady paycheck.”
Why Lenders See Your Income Differently
If you’re scratching your head over the numbers, you’re not alone. A lot of entrepreneurs wonder why lenders would rather finance for someone who makes $80,000 a year than someone who makes $145,0000.
Part of the issue has to do with the fact non-self-employed individuals make about the same amount every month. At your business, you might have a few lean months where you appear to be in the hole, then receive a big payoff as you finish a project. You’ve learned to make it work when it comes to paying your bills, but you’ll have to prove that to a lender.
Banks see your income as more volatile. It also might be harder for you to document. Lenders feel that while you may have made great money within a certain past time frame, there’s no guarantee you’ll do so going forward.
Plus, if something happens to you, there’s no backup. You can’t apply for worker’s comp if you hurt yourself on the job. Your boss isn’t going to pay you for sick leave. Everything about your employment situation is different from regular workers, and different makes lenders nervous.
Your Credit Rating
If you’re self-employed, your credit score is even more important when you need to borrow money, because lenders use it to evaluate your risk. Yet CNBC reports 47 percent of self-employed mortgage shoppers have a credit score below 720, and 14 percent have scores lower than 680. If your credit is iffy and you can’t prove steady income, you might not be able to qualify for a mortgage.
Credit bureaus compile your credit rating from a variety of factors. We break it down in our article How to Fix Bad Credit and Get a Home Loan. The two biggest contributors are your payment history and the amounts you’ve already borrowed. Your payment history is based on whether you pay your bills on time and whether you’ve defaulted on payments in the past. Even one late payment can have a huge negative impact on your payment history.
Banks also look at whether you’ve borrowed near the limit of your available balances. Just because a credit card company allows you to borrow a certain amount doesn’t mean it’s good for your credit to charge that much. All debt counts, whether it’s student loans, credit card debt, a department store card or a car loan.
Court judgements and bankruptcy filings will haunt you long term. If you know they’re on your record, expect a more difficult time qualifying for a mortgage.
Your Tax History
Many entrepreneurs take multiple deductions when they file their tax returns. It lowers your tax bill, but it also lowers the amount of income you report. If you wrote off your vehicle, your home office, your meals and other expenses, your tax burden went down, but you look to lenders like you didn’t make as much. Lenders might be willing to look closer at what you’re writing off, but you’ll have to supply more paperwork and jump through more hoops.
Preparing for Lender Scrutiny
Expect challenges going into the mortgage application process and start preparing early. Here’s what lenders are going to look at when you turn in your home loan application.
- Your credit score – Individuals with a credit score of 740 or higher qualify for the best rates. Our credit rating classes and Home Buyer’s Club can help you clean up problem credit so you have more options available to you.
- Occupancy – Lenders are more likely to give you financing if you’re going to live in the home. Banks prefer not to provide financing if you’re self-employed and buying a home to use as rental property.
- Property type – WestWind Homes are attractive to lenders because they’re single-family homes in desireable Texas communities. They’re new, extremely energy efficient and constructed by experts respected throughout the region. If you’re trying to buy a multi-unit property or fixer-upper in a shady part of town, you’ll have more trouble getting approved.
- Amount of loan – How much you borrow matters for obvious reasons.
- Loan-to-value ratio – If you’re borrowing less than the home is worth, that lowers the lender’s risk if you default and they have to re-sell the property. If you’re self-employed and you can’t prove all your income for the required time frame, you might still qualify for financing if you have a large down payment. With salaried borrowers, the typical down payment requirement is 3-5 percent. Self-employed borrowers might need as much as 20 percent when financing with some lenders.
- Debt to income ratio – This is what your new house payment will be along with all your other debt divided by your stable monthly income. Credit card payments, car loans, child support and other loans all factor in. Lenders like to see debt to income ratios below 43 percent, and the lower that number is, the better.
- Assets and Cash Reserves – If you’ll still have a chunk of change in the bank after you make your down payment and move into your home, that’s a big plus for lenders.
Your Self-Employed Mortgage Application Approved
You face challenges qualifying for a home loan, but WestWind Homes can help. We have credit experts and long-term relationships with some of the nation’s top lenders, so we offer buyers unique opportunities. We have experience helping people who are self-employed, so we know what works. There are also steps you can take to give yourself the best chance of qualifying.
Gather documentation to prove stable revenue. You’re more likely to persuade lenders if you avoid volatile swings. Don’t be creative when you file your tax returns. The more income you can show, the more you’ll qualify to borrow. Even if you have a lot of cash on hand, your credit still matters. Pay your bills on time and don’t run up your credit card balances. Keep your business records organized and accurate. Pay off as much debt as possible.
Talk with an expert as soon as you start to think about buying a home. Even if you’re not quite ready yet, we can help you prepare. For more information, schedule your free and confidential credit consultation today.