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Getting a Mortgage When You're Self-Employed

Christy Bieber, The Motley Fool


Getting a mortgage when you are self-employed can be more complicated than if you have a traditional job. Find out more here.

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Several years ago, my husband and I purchased a home. This meant getting a mortgage, as it does for most people. But, the catch was: we were (and are) both self-employed. Unfortunately, this makes getting a mortgage a little more complicated because we don't have the traditional proof of income -- a W2 -- that most mortgage companies want to see.

When you're self-employed, you can't show that an employer will pay you steady wages. You need to show your business generates sufficient income. This can be a problem for a couple of reasons, including the fact that lenders consider your income after deductions, and business owners tend to have more deductions than traditional employees.

We learned a lot about the process and requirements and were ultimately able to get approved for a loan. If you're also self-employed and are thinking about applying for a mortgage, here are a few of the key things you'll need to know.

The bank will want to see a lot of paperwork

Applying for a mortgage always takes a lot of paperwork, especially when you are self-employed. In particular, the bank will likely want to see several years of your tax returns to better understand the income your business is earning.

If your business is organized as a separate entity, such as an S corp or a C corp, you'll likely need to provide business tax returns too. This means getting even more documents together.

We had to provide two years of both business and personal returns, along with copies of our personal bank statements for the past several months.

The bank may not count all your income

Because many self-employed people have irregular income, as opposed to just earning the same salary every month, it can be harder for lenders to determine the income to use when calculating your debt-to-income ratio. Your debt-to-income ratio is the amount of debt you have, relative to income. If it's too high, you can't qualify for a mortgage loan.

When we applied for a mortgage, lenders did not count all of the income from both of our businesses, as I had experienced an increase in income shortly before we applied for our loan. Lenders were only willing to consider income we could prove we had earned for two years.

For example, say you had a business that earned $60,000 in 2016 and $100,000 in 2017 and you were applying for a mortgage in 2018. Lenders likely would count your income as $60,000, not as $100,000, because you don't have two years of documented proof that you earn that much.

The bank considers income after deductions

Another big problem for many business owners is that many business owners deduct as many business expenses as possible from their income, because doing so reduces their taxable income so they pay less in taxes.

The problem is, by reducing taxable income, they reduce the income that counts for determining if they can qualify for a mortgage. You'll need to consider this issue in the year or two before applying for your mortgage to make sure you don't reduce your income so low that you can't qualify for a loan to buy a home.

Moving around money before closing can cause problems

In the time leading up to your loan closing, it's also important that you try to avoid making any big changes in either your business or personal accounts.

Shortly before we closed on our loan, my husband's company paid out some money to him so we could use the funds as our down payment (because we have S corps, this was called a distribution). This raised red flags with the bank, which became concerned about how the distribution of funds would affect ongoing business operations.

We ended up having to get a letter signed by my husband's accountant indicating that the payout was customary and wouldn't affect the company's ability to produce income in the future.

To avoid this, it's important not to make any big changes to your finances in the time leading up to closing on your loan. This means your business shouldn't move money into your personal account, and neither you nor your business should take out a lot of new debt.

Getting a mortgage is possible -- but complicated

If you're self employed and have two years of proof that you or your business earns a good income, getting a mortgage is definitely possible. Just be aware that it may take a little more time, the paperwork requirements may be a little more onerous, and you may not get credit for all the income you earn when determining how much you can borrow.

If you're prepared for all that going in, you'll avoid unpleasant surprises and will be ready with what the bank needs to give you your loan to buy or build the home of your dreams.

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