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When buying a home, your employment and your income are a key factor in whether or not you will be approved for a mortgage loan. If you are self-employed, you may face some unique challenges to get a loan. The income from being self-employed is often less stable and consistent than what you would receive working for someone, and this inconsistency can lead to your lender needing to probe more deeply into your financial records.
Who is Considered Self-Employed?
You are considered self-employed if you have sole ownership or at least 25 percent ownership in a business or if you are a freelancer or contract worker whose income is mostly covered under IRS Form 1099-MISC.
Documentation You Need
If you are self-employed, you will need to provide your lender with a year-to-date profit and loss statement, and something to show your current finances, two years of your individual tax returns and business tax returns, and a list of your partners and/or stockholders. The lender may also want to see your business license and a letter from a CPA stating that you are still in business.
This is more in-depth than you would have to provide as an individual because your lender needs to ensure that you have the income necessary to make your mortgage payments. They need two years of income records to ensure that your income is not dropping every year and is either remaining steady or increasing. If you do have a significant drop every year, you will need to provide a written explanation for this drop, but if it is too big, your lender is likely to decline your loan application.
The process of proving your income is a little easier if you have recently taken over a family business, if the business has a proven track record of success. In this case, you only need to provide one year of income, though the more you give the lender, the better they can determine how much to give you for your mortgage loan.
Net Income
One area the lenders will focus on is the business losses and expenses. Your net income is what you make after your expenses, so everything you write off on your taxes is not taken into account by lenders. The tax write offs are something that businesses like to utilize on their taxes, but having too many expenses can be problematic when seeking a loan. Writing off expenses gives you less taxable income, which is all that lenders are allowed to count when they process your loan application.
For example, you made $80,000 last year, but you wrote off $25,000 of it in expenses. This means that your net income for the last year is only $55,000, which is all the lender will count in your income.
Keep Personal and Business Accounts Separate
Proving your income is difficult enough when you are self-employed, so keeping your personal and business finances separate is important. If you work alone, it can be easier, since you know which expenses are personal and which are business, but if you have a partner it can be a little bit trickier.