Being self-employed is a lot of people’s dream. Call your own hours, answer to no one, take vacations when you want, earn as much money as you want, and those awesome tax write-offs.
This is hardly the case. Any self-employed person will tell you it is a lot of work. Much more than anyone can imagine. In most cases you will work way more being self-employed versus being an employee. And then there are the responsibilities of being the owner. It’s all on you.
And that’s all on the business side of things. Self employed people get so wrapped up in their business that they often forget their business and personal lives are separate. Where this really hurts self-employed people is trying to get approved on a mortgage.
It really comes down to two reasons why self-employed people cannot get approved on a mortgage.
Time – Most mortgage companies want to see two years of self employment. Reason being is they know most self-employed (sole proprietor, etc.) businesses fail in their first three years which means you’re not going to make mortgage payments. In their eyes you are risky to lend to because you do not show a consistent work history.
There might be exceptions to this rule if you are refinancing a mortgage and have been self-employed for at least six months in a similar field as before. Such as being a lawyer to now consulting lawyers. You’ll need to show income deposits, have great credit, assets, and equity in the house.
Buying a house will be much harder if you have less than two years of self employment. You may need to put a lot of money down (20% or more), have assets (savings, 401k, etc.), and have great credit. It’s really up to the mortgage company.
You may be able to provide a license or certificate proving self employment over two years to help your case.
Income – What’s the one thing self-employed people love? Write-offs. How many times have you heard your self-employed friends talk about their write-offs? Here’s the thing about write-offs. When the mortgage company asks for your 1040s and they see your self-employed business brought in $200,000 in revenue but after writing off $150,000 in expenses they see it as you make $50,000. Not $200,000.
And that’s what most self-employed people do not understand. The write-offs are whats keeping them from buying a house or refinancing.
If they didn’t write off everything or justify buying a new car, computer, office furniture, or going on “business trips” to get a write-off they didn’t need they would show more income on their 1040s.
Self employed people write off everything so they can pay less income taxes at the end of the year. I do not blame them. It makes sense in their eyes. Just not in the mortgage companies eyes.
What To Do?
Co-Signer – Is someone buying the house with you who is not self employed and working? Mortgage companies will work with this. Same goes for refinancing assuming the other person is on title of the house.
Stop Justifying Write Offs – Yes, if you have write-offs then include them on your 1040s. No need to pay more income taxes. Can you run your business bare bones for two years without buying new cars, computers, office furniture, and going on “business trips”?
The difference in getting approved on a mortgage when buying a home showing $200k in income with $150k in write-offs ($50k in yearly income) versus $200k in income with $75k in write-offs ($125k in yearly income) is huge. You are talking about a $125k home versus a $300k home.
It can be very tricky trying to get approved on a mortgage when you are self-employed. Mortgage companies want to see you’ve been at it for at least two years and that you’re making money.
You need to keep these in mind if you see yourself buying a house in the future. Exceptions can be made especially if you are putting down a lot of money (20% or more), have assets (savings account, 401k, etc.), and great credit.
Refinancing for a self-employed person will be easier than buying. Reason being is you are already in the home. This was common when I was a mortgage banker. Many people bought the home when they had a regular job and then went the self-employed route. Taking cash out might be tricky if less than two years being self-employed but if all you are doing is a rate and term refinance then you should be ok.
Be conscious in how your business finances affect your personal finances. Many self-employed people tend to blend the two together which is easy to do. Mortgage companies do not think that way however. And you need to know that when trying to get approved on a mortgage.