One of the primary factors that lenders look at when they decide whether or not to approve a mortgage loan is your employment history and income—a factor that is typically validated by a paystub. But what happens when you are the boss? As a self-employed person who doesn’t get a typical paycheck, it can be hard to prove your income and creditworthiness to a potential lender. It’s not impossible to do, but it does require some extra effort.
The Income Conundrum
One of the benefits of being self-employed is the ability to write off business expenses to reduce your total taxable income. The problem is that lenders use tax returns to verify income when determining whether or not they think you could pay back a loan. A self-employed person can take advantage of many legal tax deductions related to running their own business, but then the income you report to the IRS each year is lower, and that is what a lender will see. The problem is that you don’t want to report any more income than you are legally required to according to IRS rules (because you will owe more in taxes), but your tax returns might not reflect your actual take-home pay that could qualify you for a bigger home loan, or qualify you for a loan at all.
Talk to a Mortgage Lender
Anyone who is self-employed should plan ahead when they are considering a home loan—often much longer than another borrower might have to plan. You might consider writing off fewer expenses in the two years leading up to your home purchase so you can show a higher total income to the lender.
It’s also very important that you review your finances to make sure personal and business expenses are clearly divided. Pay for all business expenses (especially large purchases) on business credit accounts instead of personal ones so lenders can clearly see the difference.
Show Income Increases
If your business is running successfully, make sure that you show that when you are ready to apply for a home loan by showing year-over-year increases. Most lenders will average out seasonal ups and downs by looking at total income over the past two years, but if your returns show that your income went down from two years ago to last year that could be a red flag.
Consider Other Options
If you are unable to qualify for the home loan you were considering because of self-employment, consider taking out a smaller loan on a condo or townhome first. You can also find someone who is willing to co-sign if that is an option for you.
It’s not impossible to get a loan when you are self-employed, but there are additional requirements and preparations you must take in order to ensure the highest chance of success. Talk to a mortgage lender in Utah today to find out more.