Self-employed individuals face unique challenges in qualifying for a mortgage.
In week two of our January focus on Exploring Sustainable Homeownership as a New Year’s Resolution, we look at the unique challenges that self-employed individuals can face in qualifying for a mortgage.
From driving for Uber to running your own consulting business, self-employment is on the rise. But those who are their own boss don’t have paystubs and W-2s to prove steady income. Instead, self-employed borrowers applying for a mortgage need to demonstrate that their business generates enough income after business expenses have been deducted to afford the monthly mortgage payment. Lenders require a look back of two years for this information, and borrowers can be surprised to find they technically ‘make’ less than they think.
Lenders calculate self-employment income using the average of the net taxable income reported on the borrower’s two most recently filed federal tax returns. But since many self-employed individuals merge business and personal finances, their net income can be lower than they expect. Take an Uber driver, for example. Let’s say they have $40,000 of income to report as business income. This is only half of the equation. Later on the tax form, they report $18,000 as business expenses such as mileage, thus excluding this amount from their net business income. This individual then has only ‘made’ $22,000 in income. Sometimes a self-employed individual can even end up with a net business loss for the year. Many self-employed, first-time home buyers are shocked when they learn that their true “income” is less than they believe.
If you are self-employed and thinking of purchasing a home someday, keep this issue in mind. You need your net self-employment income to be high enough to support the mortgage payments on the amount of money you need to borrow. As always, nonprofit Homeownership Advisors are available to analyze your unique personal situation, and help you map a path to successful and sustainable homeownership for you and your family. To find an advisor near you, click here.