Self-employed borrowers, unlike traditional homebuyers, often encounter a few obstacles when attempting to get approved for a home mortgage loan. The reasons can be complicated. Here's a story that I believe best sums up the experience many self-employed borrowers will encounter when looking to purchase a home.
I recently sat down with a prospective homebuyer who earns an income by selling handmade products on her own personal ETSY website. The homebuyer, who for the sake of this post will be named Sarah, made over $80,000 last year selling her handmade crafts to consumers on the online marketplace. That's roughly $6,600 each month. Pretty impressive right?
Walking into our meeting Sarah assumed her income, combined with her favorable credit history, would land her a mortgage loan without any problem whatsoever. However, because running an ETSY site means she is technically considered self-employed, Sarah learned that she is likely to encounter some unique challenges when it comes to getting qualified for a home mortgage loan.
Spoiler Alert: It took some creative wrangling, but I was eventually able to help Sarah get qualified for a mortgage loan and she is now on the path toward homeownership.
Sorry if I ruined the surprise, but this recent experience made me realize that there are thousands upon thousands of people just like Sarah who want to own a home but are subject to some specific challenges related to their self-employed status. In mortgage terms we call that person a "self-employed borrower."
So, if you run an ETSY store like Sarah, or you're a sub-contractor or freelancer, this post is for you.
The following are two very helpful hints I shared with Sarah that will hopefully help you get the house you've been working so hard to afford.
1. Know your status. In the eyes of the IRS are you considered self-employed?
I'm amazed how many people don't realize whether they are considered self-employed or not.
A good way to tell is to gather your tax documents. From there it's pretty simple.
- If you receive a W2 then you are not what we would consider a self-employed borrower.
The majority of the self-employed borrowers I see are sub-contractors like plumbers, electricians and even real estate agents who are technically not employed by their general contractor or real estate company.
Another common conundrum for homebuyers involves people who have partnerships in a business or are considered part owners in a rental property.
These types of borrowers are those that typically must file a Corporate Income Tax Return (Form 1120) or a Partners Return (1065) each year. Tread carefully though. Whether or not you're considered self-employed in the eyes of a lender is complicated and depends upon a variety of factors, such as your percentage of ownership. This leads me to my next point.
2. Analyze your income and plan accordingly. Your goal is to look favorable to banks.
Don't do this yourself. A mortgage broker, along with the assistance of an accountant or CPA can help you determine your true financial situation. I say "true" because a lot of self-employed borrowers have an idea of what their income is, but don't realize what it truly is in the eyes of the IRS.
Often times the figures end up being two very different things. Most self-employed folks consider their annual income to be the amount of money they make within a given year. That means if their ETSY website made them $80,000 last year than that is what they claim as their income.
However, many self-employed borrowers fail to factor in their expenses, as well as tax write offs, into their final income figure. The IRS ultimately makes the final call on what your net annual income will be after analyzing your profit and loss margins included on your Schedule C.
Sitting down with your mortgage broker and an accountant or CPA will help you strategize how to proceed, given your unique financial circumstances. I can't tell you how many three-way meetings I've had with a client and an accountant to figure out a way to make the numbers work. More often than not solutions are found. Other times the recommendation involves a little patience.
Here are some questions that you should be asking during that meeting:
- What deductions should I make in order to reflect a more favorable debt-to-income ratio?
So like I already told you; Sarah is well on her way toward buying a home despite encountering some of the common challenges that self-employed borrowers come across when attempting to get qualified for a mortgage loan. Her online ETSY store is thriving and she's working with a qualified accountant to adjust her financial situation in order to continue her quality of life and at the same time afford her mortgage loan.
If you're in a situation similar to Sarah, it's a good idea to seek sound financial advice on how to approach applying for a home mortgage loan. Don't skimp on paying for an accountant. The expense often times ends up being justified when you factor in the time and money he or she may have saved you in the process.
Are you a self-employed borrower and have question about getting a mortgage? Please leave your questions in the comments below.