Being self-employed has its benefits, such as flexible work hours and being your own boss. It has downsides too, including unpaid vacations, no paid sick days and one that the self-employed might not think about: buying a home.
Qualifying for a home mortgage can be difficult enough for full-time workers with steady jobs and a paystub from W-2 forms to show lenders.
But without a regular income and an employer's tax form to show proof of employment and how much taxable income was earned in the past year, self-employed workers can have a little more difficult of a time qualifying for a mortgage. It's not impossible, say bankers and self-employed workers, just a little more complicated and requiring a little more forethought.
Here are some things for the self-employed to be aware of when trying to qualify for a mortgage:
Before the recession and the housing market collapse, it was easy for any self-employed person with good credit to buy a house by just telling the bank how much money they earned. "You literally just write a figure down and sign it" as stated income, says Dan Abbate, who owns several independent businesses, including one that specializes in selling giant hot dogs that feed a crowd. Those loans were given to the wrong people too many times, and now banks are checking income sources.
"Stated income originally was for stated income borrowers, but then it later became available to all," says Cyndee Kendall, regional sales manager in the mortgage banking division at Bank of the West.
Self-employed home buyers still must have stated income, which for many of the self-employed can be from multiple sources of income, Abbate says.
Thirty percent of Bank of the West's mortgage loan applicants are self-employed, Kendall says, and the bank requires more proof of income than it does for full-time workers. That includes two years of business and personal tax returns, and financial statements such as profit/loss statements.
The bank validates that it's the same information the IRS receives from the business, and that the business owner has a business license, she says.
"The one thing that came out of the credit crisis is that documentation is key," Kendall says.
The self-employed can also use a verification of employment form that a bank can provide to prove they're working. Liz Anderson, owner of E.H. Anderson Public Relations, had her husband fill one out because she works for the agency.
A tricky part of determining stated income and successfully getting a home loan is proving you make enough money to afford the home, but not so much that you're paying more in income taxes, Abbate says.
For example, if a business owner takes in $200,000 one year and puts half of that money back in the business as a business expense that's tax deductible, then it will only be reported as $100,000 in income. But if a higher income is needed to qualify for a home loan - say $50,000 more - the business owner could put $50,000 into the business and keep $50,000 more as income.
Banks don't always understand that business expenses are flexible, and can be moved around as stated income if needed to pay personal bills, Abbate says.
"They don't look at the details of how your income is derived, which creates a lot of back and forth," he says.
Business expenses should be in a separate business account and shouldn't be counted as part of monthly personal expenses, says Bank of the West's Kendall. The idea is to show business income and expenses as a way of proving how successful the business is and if the self-employed owner can afford a home, she says.
The business owner should show stable or increasing income, with a two-year average of business income required, Kendall says.
Although it can lead to paying more in income taxes, keeping more business income and having fewer business expenses can increase an income enough to qualify for a mortgage, says Abbate, who has bought three homes as a business owner.
"If you really want to make it easy on yourself, you jack up your income on your tax return," he says.
A two-year window of net income is very important, Kendall says, which may require some self-employed borrowers to think two years ahead before buying a home.
Longer loan process, maybe
Getting a home loan may take a little longer for the self-employed who don't have a W-2 form to whip out, Abbate says.
"It's not that you're showing anything different, it's just that you're showing more of it because it's income from multiple sources," he says of tax returns and other proof of stated income.
And because banks consider submitted documents old after 60 days, updated documents such as bank statements may be required, he says.
Some self-employed, however, are finding fast turnaround times. Anderson, the PR business owner, says their home loan took only two weeks to process in June because they were organized and quickly provided the documents requested.
For the self-employed borrower who has their documents ready, getting their loan shouldn't take any more time than it would for anyone else, Kendall says.
"If you have these records and can hand those to your lender as you're applying for the loan, it shouldn't affect the timing of the loan," she says.