Being self-employed and obtaining a mortgage home loan can be very daunting, but the following information can make that process much more straightforward. We know that it can be very stressful and confusing, especially for self-employed borrowers. In the current industry, traditional lenders view W-2 employees as more secured candidates for a mortgage in comparison to the self-employed individuals. It’s hard for several lenders even to determine whether you are earning enough to make consecutive mortgage payments as an independent worker while other lenders don’t want to take any potential risk that is associated with a self-employed borrower. That makes it more challenging for a self-employed borrower to get a home loan, but buying a house with a home loan is possible even when you’re self-employed.
Your home loan procedure can run more efficiently if you invest some time in understanding what to expect as a self-employed worker. Your mortgage process can run even more smoothly if you take some time to understand what to expect as a self-employed borrower. Here are some essential things that underwriters take into consideration.
Determining the importance of income
To decide whether or not you can qualify for a mortgage, underwriters consider the relation between:
Income history & income compared to monthly liabilities
As we will not be using W-2 form to verify your income, underwriters will try to assess whether you have a good past track record of self-employment and your income is consistent and steady for a period of the most recent two years. You will be required to own at least 25% or more of the business and need to submit the last two years of your business tax returns with us.
Computing income: plan for tax write-offs
Remember when you’re applying for a mortgage home loan, underwriters will look at your last two years’ net income. When you subtract expenses from your gross income, you will get your net profit. However, depreciation on business purchases is the only exception to this rule. You can increase your qualifying income by adding back depreciation to your net income.
Total Gross Income – Expenses = Net Income (Requirement of last two years)
People tend to write-off business expenses for tax benefits; however, when you are applying for a loan, it can limit your qualifying income. It is one of the critical reasons that lenders advise borrowers who are self-employed to plan write-offs, especially when they are also planning to purchase a house.
Computing income: ensuring affordability
When you take a loan, you will become committed for years of payments. As self-employed individuals tend to have income that is more variable in comparison with the W-2 employee, lenders need to take care of that risk by being more conservative in computations. It means:
- Lenders need to take the average of the two years if your net income has increased in the second year in comparison with the first year.
- Lenders will take the lower income of the two years if your net income has decreased in the second year in comparison with the first year.
Funds for a down payment (avoid paperwork)
Home loan lenders also need to verify the funds that you intend to use for a down payment. In case you’re a self-employed worker and use one account for both personal and business purposes, you will be advised to keep both of those accounts separate for the mortgage application process. It’s because if you use the business account for a down payment, lenders will have to look the cash flow of the business so that lenders can verify that using these funds will not hurt your business. It can be a long process, so separating those funds can help you avoid unnecessary paperwork.
Whatever account you pick for the down payment, lenders will have to determine which funds can qualify to be used for your down payment. You’ll also be required to submit the last two months of bank statements of the account that you are planning to use for your down payment. If there are any significant deposits or transfers, you’ll be required to provide explanations for such transactions. If you have received any gifts from your friends and family for the down payment, you will need to submit letters verifying that those are genuine gifts and not loans. You also won’t be able to utilize any unsourceable funds (such as cash under the mattress).
Suggestion: If you’re preparing to buy a house and for that planning to move around money, it would be best if you do it at least two months before applying for your mortgage. It will help you avoid questions from lenders, and you may want to use “seasoned funds” for your down payment. Seasoned funds are funds that have been in your bank account for the last 60 days.
Here at Texas Trust Home Loans, we believe that mortgage should be within everyone’s reach, including self-employed individuals. Want to learn more about your options as being the self-employed borrower? For further information, please visit our website www.texastrustloans.com