Buying a Home While Self-Employed? Here are 4 Things to Consider
By Jessica Larson, SolopreneurJournal.com
It’s the American dream: independence. For some, that means owning their own home; for others, it means self-employment. And it’s not uncommon for entrepreneurs to strive for both.
But just like running your own business is more complicated than simply punching a time clock (who does that anymore?) and drawing a paycheck from someone else, buying a home can be more complex if you happen to be self-employed.
Lenders are pickier about what they’ll accept in qualifying you, and you’ll need to provide more documentation, simply because it’s not all in one place the way it is if you get a W-2 form each year. If you work for someone else, your boss is a disinterested party who can effectively vouch for your income, but if you work for yourself, you’re your own boss, and you have a stake in the game.
Whether you’re buying a home in Asheville or Seattle, there are some steps you can take to overcome these hurdles.
Document, document, document
If you run your own business, you already know how important it is to keep accurate records of receipts, accounts payable, etc. You need to document everything to ensure your clients have paid on time, to keep track of depreciation, and to make sure the IRS has everything it needs to give you a fair shake at tax time.
To track depreciation and long-term obligations, you’ll already have records dating back several years, ideally to the beginning of your business. Make sure you have easy access to these files in clearly labeled folders, both physically and digitally.
Then back up your info on an external hard drive. Choose a software system that lays out everything easily so you can access it quickly. Several good ones for small businesses are available. Keep the files secure with hard-to-crack passwords. Also, be on the lookout for phishing scams that can lead to ransomware attacks.
You’ll need to have a lot of documentation at your fingertips when applying for a mortgage, simply because you don’t have a W-2 that puts everything in one place. Lenders will want to see two years of your tax returns instead to make sure you have a stable income and aren’t operating a fly-by-night business.
Rein in tax deductions before you apply
When you’re running a small business, you’re always on the lookout for tax deductions. But when you’re applying for a loan, you’ll want to ease up on the deductions ahead of time, because they can hurt your debt-to-income ratio. That’s one of the important things that can contribute to determining whether you qualify for a loan, and what interest rate you’ll pay if you do.
Most mortgage lenders are looking for a debt-to-income ratio below 36%, so that gives you an idea of what to shoot for ahead of time. It’s something else to keep track of, and you’ll need to balance it against your business concerns in making the most beneficial decisions possible.
Separate your personal and business accounts
Even if you’re not thinking of applying for a mortgage loan, it’s a good idea to keep your personal and business accounts separate for tax purposes. This is just a standard part of running an economically efficient ship.
But it’s more important still if you’re applying for a loan. If a lender can’t distinguish between your personal and business funds, they will have a more difficult time deciding whether you’re a good risk or not. They won’t want to think you’re using your business to artificially prop up your own finances.
Other money moves to watch carefully:
- Avoid taking out big loans for your business under your own name, as that will increase your personal debt-to-income ratio and make it seem like a bigger risk.
- Don’t move money between your personal and business accounts less than two months before applying for a mortgage.
Keep your credit in good standing
It takes time to build credit, so start working on it well before you apply for a mortgage. A good first step is to get a free copy of your credit report, which you’re entitled to under federal law every 12 months. Three credit bureaus or agencies track your credit: Equifax, Experian, and TransUnion. Two other companies, FICO® and VantageScore, come up with the scale of numbers that are used to represent everyone’s credit scores.
FICO is the more commonly used standard. Under its rating system, which is similar but not identical to VantageScore’s, a number above 800 is exceptional, higher than 740 is very good, and above 670 is considered good. The minimum FICO score to qualify for a traditional loan is about 620, though you can get an FHA loan or VA loan with a 580 score.
To keep your credit score up, pay your bills on time with minimum payments (or more), resolve any late payments or delinquencies right away, and resist applying for any new credit in the months before you plan to apply for a mortgage loan.
If you have money in the bank, using it for a bigger down payment will reduce your loan amount and make a mortgage company more comfortable lending to you. If you’re curious about what you can afford, check out a mortgage calculator.
If you keep these four things in mind, you should be in good shape to qualify when the time comes for you to apply for a loan.