Are you thinking of buying a home while self-employed? When it comes to buying a home, financing is a crucial part of the process. Unless you are buying a home in cash, you will need to secure a loan (financing) for your purchase. This step is relatively the same for most people. However, for those that are self-employed, there are some extra documentation requirements. According to John Haney of Colorado Mortgage Company, “all buyers, especially self-employed ones, should get pre-approved early and have all financials and documents ready to be reviewed”.
Credit Score
Most loans require a minimum credit score to qualify. Minimums can be as low as 580, but most often start at 620. The higher your credit score, the better your interest rate can be. If you have a large down payment, some types of loans may accept even lower scores. Before starting the home buying process, pull your credit report to check for inaccuracies. Better yet– speak with a reputable, local lender that can help and advise you to put you in the best position possible to buy a home.
Employment history
Lenders are going to want to see your employment history. A strong employment history shows that you have a steady income and will be able to pay back your loan. Switching jobs when you’re about to buy or in the process of buying a home is a no-no. Most lenders want to see at least 2 years of steady employment history, even for those that are self employed. This means you must be able to show that your business has been operating for at least the last 2 years.
Debt-to-income ratio
As a self-employed taxpayer, you may want to deduct as many business-related expenses as you can because it reduces your taxable income – and your tax bill. On the other hand, less taxable income could mean a higher DTI. Your debt-to-income ratio is the amount of debt you have versus the amount of income you have. More deductions means less taxable income therefore less tax to pay– however, it also looks like you make less income than you really do. This is an important consideration when buying a home. DTI is the sum of all your monthly debts divided by your gross monthly income. Your DTI tells lenders how much of your income is needed to pay your current monthly debts and how much is available for a mortgage payment. Your DTI should be at 43% or lower. Despite having plenty of cash flow on hand, not to mention access to credit through their business accounts, self-employed individuals are often shocked when they learn just how much their net income actually is after factoring in tax write-offs and other business expenses. For example: A self-employed electrician may make $200k in gross sales, but if they write off $190k, they’re left with $10k in taxable income. Their gross revenue is much different from their net income. Fannie Mae and Freddie Mac, as well as the FHA, all base their lending decision on net income.
Proof of income/Assets
- Two years of personal tax returns
- Two years of business tax returns including schedules K-1, 1120, 1120S
- Year-to-date profit and loss statement
- Balance sheet
- IRA
- CD
- Stocks/Bonds
Documents
As a self-employed worker, here is a list of documents you’ll be expected to show to validate your income:
- Two years of personal income tax returns (1099)
- All assets- such as retirement funds, brokerage accounts, and savings accounts
- Any liabilities – such as alimony and child support
If you’re a small business owner, expect to provide the following documents:
- Two years of personal income tax returns (1099)
- All assets- such as retirement funds, brokerage accounts, and savings accounts
- Any liabilities – such as alimony and child support
- Two years of profit and loss statements from your company.
- A letter or certificate of good standing for your business from an accountant or state filing agency. This letter proves your company is still in business, has paid taxes, filed required documents, and complied with relative regulations.
- If your business is a corporation or partnership, two years of income tax returns.
- KEEP GOOD RECORDS!!
The Bottom Line
If you are buying a home while self-employed, you should meet with a local, reputable lender prior to starting your house hunting search. This way you can make sure you qualify based on your income for your self-employed business and that you have all necessary documents to get approved. If not, a lender can help get you on track to home ownership! Also, don’t hesitate to reach out to a trusted realtor to start your home search to see what is available at your price point.
Questions?
Do you have additional or more specific questions? Please give us a call so we can help point you in the right direction for your specific situation! If you’d prefer, you can also reach out to one of our preferred lenders, John Haney of Colorado Mortgage Company, for lending questions specifically. As a self-employed borrower, you’re already considered riskier. So anything you can do, whether putting more money down or raising your credit score, will significantly help you when purchasing a home.