Buying a Home When You’re Self-Employed

by Jessica Brita-Segyde

Does your tax return include a Schedule C? Do you want to buy a house? If you answered “yes” to both of those questions, then you’ve come to the right place! Self-employment makes you unique. You do many things differently than the nine-to-five crowd. Those differences will come into play when you apply for a mortgage.

Proof of Income

The biggest challenge for the self-employed borrower is to demonstrate the likelihood of future income. Maybe you got a nice paycheck last month but that doesn’t guarantee anything with respect to next month. The self-employed earner knows this reality all too well, and it’s understandable that most lenders will require a two-year history of income. A documented history allows the underwriter to project future income based on previous earnings. You can prepare by making copies of your complete tax filing for the past two years (not just the page that shows your adjusted gross income).

Proof of recent income might also be requested. Documentation of recent income varies depending on the borrower’s profession. An example would be a recent paid invoice attached to the related bank deposit. Your input will be helpful to your loan officer as he or she works with the underwriting department to assemble a solid application package.

Your lender may even dig deeper and take other factors into consideration when determining your expected income. Plan ahead for this: Always pay your taxes on time and keep 1099’s or other income records handy. If your industry is likely to face a downturn, the underwriter may base your loan eligibility on a percentage of your average income from the past two years (leaving a margin for a possible decrease in earnings). Either way, be ready to offer plenty of documentation. Complete income documentation may seem excessive but self-employed borrowers naturally present challenges for the underwriting department.

Spousal/Co-Borrower Income

Self-employed applicants may benefit from the addition of their spouse and/or another co-borrower to the loan. If your income is difficult to quantify or if it simply doesn’t fit within typical underwriting parameters, income from a second borrower can help. One caveat: the second income only helps if the additional borrower has acceptable credit. Usually the co-applicant will be someone who plans to live in the home, but non-occupant borrowers may be allowed depending on the loan program. This advice also applies in cases where the underwriter is only able to qualify part of the primary applicant’s income.

The Four C’s of Underwriting

Basic underwriting guidelines revolve around four C-words: Capacity (ability to pay), credit (history of payment), collateral (the house), and character (willingness to pay). The difference between self-employed borrowers and those who receive a regular paycheck is that capacity can be more difficult to quantify.

If one of the C’s is difficulty to assess (in this case, capacity/income) then the underwriter may rely more heavily on the other three. If you plan to apply for a mortgage, now would be a good time for a self-audit. Try to think like an underwriter when assessing your own “four C’s.” How have you handled responsibility in the past? Do you typically pay things on time? Are there any previous judgements, liens, or bankruptcies on your record? Time helps to heal these financial wounds, but the recovery process is a slow one. Credit problems may still show on your credit report for years after you’ve settled them. A history of poor financial character could cause your lender to decline your loan application, to offer a mortgage but with a higher rate, or to require a larger down-payment on the collateral. If any of your C’s need attention, address those issues as soon as possible.

Home Office

If you plan to work from home, consider purchasing a property with a separate room or space for your home office. This way, you can take advantage of the business use of home tax benefit down the road. The Internal Revenue Service (IRS) has specific rules stipulating what can be classified as a home office and the related expenses that can and cannot be deducted for tax purposes. One such stipulation is that the space being claimed as a home office must not be used for any other purpose. Familiarize yourself with the related tax code here and consult a CPA or tax professional before filing any deductions related to the use of your home for business.

The two biggest takeaways here are to present good character and to keep proper documentation. Pay things on time and maintain good credit. Keep accurate documentation of your income and taxes. This way, you’ll be ready to get pre-approved when it’s time to shop for your next home.

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