MORTGAGE MATTERS

4 min read

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May 2017

Could You Be Approved for a Mortgage While Self-Employed?

Self-employment comes in many forms, from being a freelancer to owning a small business, and others in between. One thing most self-employed individuals can agree on is their motivation and drive to succeed, coupled with immense flexibility in operating their businesses, make self-employment a sought-after career choice. However, when it comes to getting approved for a mortgage (which is quite complex in itself!), there are numerous additional factors you’ll need to consider if you are self-employed.

Self-employment and home buying

Applying for a mortgage and purchasing a home is absolutely possible if you’re self-employed, so don’t fret! However, there are several requirements involved that make it a more in-depth process than if you had an employer and received a W-2 each year. When it comes to your earned income and taxes, this information comes directly from you, rather than an employer, so your mortgage lender will require additional documentation that shows important financial details that help you obtain a mortgage.

Claiming income on taxes

Self-employed or not, your income is the most important factor when determining if and how much you’ll be approved for when it comes to getting a mortgage. With that said, income earned through an employer is easy to track, since the company automatically reports it on a W-2.

If you’re self-employed, you may or may not receive Form 1099 for the work you complete, so it’s up to you to keep accurate records of all income and report it on your taxes to the IRS each year.

Sometimes, income from self-employment may accidentally go unreported, which, by the way, is not legal in the IRS’ eyes. It’s also possible to write off business expenses to decrease your income, but keep in mind that will affect how much you’re able to borrow for a new home. If you’re hoping to obtain a mortgage, though, it’s important to ensure you’ve accurately reported all of your self-employment income on your tax return, which leads us to the next topic.

Showing your income history

A big reason why it’s critical to report all of your earnings on your taxes is because your mortgage lender will need to see a record of the past two years’ worth of self-employment income. He or she will look at your income over the course of a two-year period to calculate an average monthly income earned, which in turn will be used to determine how much house you can afford. Most often, your lender will request a copy of Form 4506 or 4506-T, which are essentially copies or transcripts of your tax return — that show your income and tax payments you’ve made.

The two-year income tax documentation requirements have varied depending onFannie Mae, Freddie Mac, or Ginnie Mae. Unlike the others, Freddie Mac was requiring only one year of documentation for all. But effective July 6th, 2017, Freddie Mac is changing those requirements on fixed-rate loans for self-employed homebuyers — where providing only one year of documentation is allowed if you’ve been in business for at least five years, if not then you’ll need to provide two years’ worth of income information.

Why it matters

As an example, when we purchased our home, I had been a freelancer for just over a year and took on full-time self-employment just a month prior to applying for a mortgage. Our mortgage lender quickly informed us that my income couldn’t be factored into our mortgage application, since there was not two years’ worth of income on record. Because of student loan debt on my credit report, it was to our benefit to have my husband apply for the mortgage only in his name, as the debt-to-income ratio was lower and meant we’d be eligible for a better interest rate. Fortunately, that was an option for us, but if we had both been self-employed with less than two years’ of income history, we may not have qualified for a mortgage at that time.

Credit history

Not unlike individuals who earn their income from an employer, your credit history will also be reviewed when applying for a mortgage if you’re self-employed. You will want to keep close tabs on your revolving debt to ensure your debt-to-income (DTI) ratio is on the low end. Remember, the income you report on your taxes is what will be used to calculate your DTI, so if you write off a large number of business expenses to lower your taxable income but have a lot of credit debt, you’ll have a higher DTI ratio.

How to prepare

The complexities of applying for a mortgage while self-employed might seem vast, but it’s important to realize that your lender just wants to ensure you’re financially ready to take on such a huge commitment – 15 or 30 years’ worth!

Don’t assume you won’t qualify for a mortgage while self-employed – while it may take a bit more time to prepare, it doesn’t have to stop you from living the American dream.

  • Don’t assume you won’t qualify for a mortgage while self-employed – while it may take a bit more time to prepare, it doesn’t have to stop you from living the American dream.

  • Focus on paying down your credit debt so you can lower your debt-to-income ratio – this can help you increase your mortgage approval odds and lower your interest rate.

  • Make sure you file (and pay!) your income taxes on time and correctly. The tax filing process for self-employed individuals can be more complicated, but it’s very important to ensure you’ve reported information correctly since your lender will use your tax returns as part of the mortgage application process. You may want to consider hiring a professional to help with this.

Self-employment and mortgages can go together with a little bit of preparation and careful documentation. If you have more questions about how to prepare for buying a home while self-employed, be sure to contact your mortgage banker to discuss your options.