My wife and I recently bought a new home and it was more of an adventure than I anticipated it would be. And when I say adventure, I really mean hassle. Part of the reason is that my income comes from various sources, and even though most of it is in the form of a standard paycheck, my lender wanted to see proof of everything I earn, my past tax returns (personal and business), proof of assets, and more. It was much more than I anticipated and it took 3 weeks longer than the initial time estimate.
Tips for getting a mortgage while self-employed
In response to the mortgage crisis and its after-effects, mortgage lenders have made many changes in the last few years. Unfortunately, many of those changes make it more difficult for those who rely on self-employed income to get a mortgage. Our self-employment income plays a large role in our personal finances and it was imperative we list our self-employment income in our mortgage application. The following tips are based on my personal experience of getting a mortgage approval:
Pay yourself a real salary – and beef it up if you can. There are many ways to pay yourself as a business owner. For example, my business is taxed as an S-Corp, which means I pay myself a “reasonable salary” in the eyes of the IRS, and I can take the rest of the income as dividends. The difference is that my salary is taxed as self-employment income and the remainder of my income is taken in the form of dividends, which are taxed at my personal income rate (business dividends in this instance are different from investment dividends which are taxed at 15%). This allows me to legally reduce my taxable income and save money on taxes. But if you are planning on applying for a mortgage it is important to show yourself taking a salary, and the bigger your salary, the more proof of income you can show your lender (your salary will be reflected on your W-2). Reducing the number of deductions you take may also help you establish a larger income in the eyes of the lender. I recommend speaking with a tax professional if you are in this situation because paying yourself a larger salary and/or taking fewer deductions will increase your taxable income in your current tax year. But it also may make it more likely to be approved for a mortgage.
Keep excellent financial records. Make sure your financial records are in excellent order before applying for a mortgage. My lender wanted to see my personal and business tax returns for 2008, 2009, and 2010. I hadn’t filed my 2010 tax return by the time I applied for my mortgage (in mid February), so my lender wanted a copy of a Profit and Loss statement from my CPA – during the busiest tome of the year for accountants. Thankfully I was able to find a CPA and get my documents to him with enough time to prepare them. Even with a quick turnaround from my accountant this delayed my application a few days. A great way to keep track of your business finances is with QuickBooks or another accounting program. [See how I manage my business income for more tips].
Make sure you have plenty of time. As I mentioned in the opening paragraph, it took 3 weeks longer than the initial time estimate my lender quoted me. I sent in the required paperwork, which lead to more questions and requests for more paperwork. Personally, I think the lender could have done a better job of this by having a script for these situations – a process they follow each time. It would be easy for them to set up and would likely save them and their borrowers thousands of man hours and wasted rework each year. We also bought our home in the beginning of spring, which is a time of year when applications rise. I spoke with a representative at our lending bank who mentioned they went from processing an average of 400 mortgage applications to over 3,000 almost overnight, which further delayed our process. Thankfully, we built a buffer into our schedule and it didn’t affect us too much, other than adding frustration to the process.
More mortgage application tips:
These apply to everyone applying for a mortgage, but may receive added attention if you are self-employed or rely on irregular income:
Improve your credit score: Your credit score is very important for your mortgage, especially the FICO 8 score, which is a credit score specifically designed for mortgage lenders. Work on improving your credit score in the months before you make your application. Also note that being approved for a mortgage can increase your credit score over time, as long as you make regular payments.
Make a large down payment: Lenders are more willing to make a loan when they know the borrower has more skin in the game. My wife and I used a VA Loan for our mortgage because it had lower mortgage rates at the time of our application. Even though VA Loans don’t require any down payment, we put down over 20%. You should always shoot for a minimum down payment of 20% or more so you can avoid private mortgage insurance (again, we did this even though VA Loans don’t require PMI).
Have cash or other investment reserves: Our lender wanted us to prove our liquid assets before approving us for a loan. Self-employment income is generally viewed by lenders as riskier than a traditional salaried position, and our lender wanted to know we had assets in the bank in the event our self-employment income was reduced.
Search for the best mortgage rates. You should always shop around for the best mortgage rates before applying for your mortgage. I visited several websites, made a few phone calls and received multiple quotes before selecting my lender. You can get free mortgage rate quotes, from several financial institutions to shop for the best rates. Several financial institutions offered comparable rates, and I recommend you use the institution which offers the best all around offer based on your situation.
Meet with a lender that has a local presence: My bank is a large financial institution, but they don’t have a local presence where I live. If I had to do it again, I would consider going with a local bank where I could meet with them in person. It is much easier to establish a relationship when dealing with someone in person and I think it would have shaved a couple weeks off the process as much of the wasted time was spent in sending documents back and forth and waiting for them to review the documents I sent. Having a personal contact would have sped up the process considerably.
Do you have any experiences with getting a mortgage while self-employed or while relying upon irregular income?