Who are the self-employed? Typically, the 1.7 million self-employed people in California fall into two categories.
There are the freelancers, which are mostly designers, writers, editors, translators, programmers, marketing professionals, virtual assistants, researchers, coaches and consultants.
There are also the small business owners, which typically include professionals, such as lawyers, dentists, accountants, doctors, therapists, etc., as well as “mom and pop” businesses, such as restaurants, daycares, hair dressers and corner stores.
Being self-employed has its advantages. You hear about them all the time:
- You are your own boss.
- You make your own hours.
- You can work from home.
- You can work in your pajamas or your underware.
- You spend less, even if you work outside the home.
- You pollute less than a commuter.
- You create your own, less stressful environment.
- You choose your clients.
- You can have a better work/life balance.
- Your earning potential is as high as you want it to be.
- You can include variety in your job.
- You don’t have to deal with co-workers.
- You own your work.
- You control your workspace.
Most of these advantages are non-economic. They are more about work and life satisfaction, about freedom and flexibility.
But here is no denying the economic advantage of having lower expenses. If you work from home, the cost of commuting and of office clothing dips drastically, and even if you work outside the home, you get to choose where, so it will more than likely be just a few minutes away. For instance, if you live in Berkeley, CA, you won’t set up your office in San Mateo, CA. If you move to Riverside, CA, you won’t set up a clinic in Santa Monica, CA.
Self-employed people have another economic advantage; they make more money than the rest of us. According to the SimplyHired calculator, self-employed people make $65,000 per year. Meanwhile, the mean wage in the US for all occupations in 2014 was $47.230.
Higher income, lower expenses…self-employed people are rolling in dough. Well, not all of them. A self-employed dog groomer doesn’t make as much as a self-employed chiropractor. Still, it does mean that self-employed people can typically afford nicer homes in nicer neighborhoods.
Despite their economic advantage, self-employed people still find it harder to arrange a mortgage. Why?
Because self-employed people are a higher risk than W-2 employees. Without some large organization guaranteeing them a paycheck, it is difficult to predict their income level. And given the feast-or-famine roller coaster ride that many freelancers experience, banks have a point. So they turn down applications and jack up rates.
It’s not fair. But it is reality.
At Avrus, we love self-employed people for this very reason; we specialize in helping people get mortgages at good rates when the banks can’t be bothered. Here are some tips for self-employed people seeking a mortgage:
Tips for self-employed people to get a mortgage
First, let’s be clear. It is easier for some self-employed people to get a mortgage than others. Not only is income an obvious factor, but also whether you already own a house and how much of a down payment you will have available.
But the nature of your career will make a difference. A dentist who has a steady roster of repeat clients coming to him year after year and providing a fairly steady month-over-month income is a fairly good risk for a lender. A freelance writer who has been at it only a couple years and has been juggling the feast and famine cycles is a very poor risk, and will have a much more difficult time getting a mortgage.
Gather your tax returns.
Lenders will want to see your adjusted gross income for the past two years. Add it up and divide by 24. That’s your monthly income. And with most banks, that’s the end of the story.
With smaller lenders and independent mortgage brokers (like us), however, we’ll be happy to hear if these figures are misleading, such as if you had a one-time expense that might artificially drag down your income. If that’s the case, you might want to support your position with tax returns going a couple additional years back. In fact, the more you can show, the better, so why not bring them all along anyway?
If you don’t have two years of tax returns, what do you have? Contracts for future work? Proof that you have been making strong and regular income from sources you were working with before you went freelance? Let’s see what we can put together for you.
Hand over IRS Form 4506-T
Form 4506-T gives lenders access to your tax forms from a trusted source, the IRS directly. If you shop around for a mortgage, you’ll need to give this to each lender. If you go through us, once is enough.
Don’t forget the dividends.
If you’ve set your business up as a limited company, don’t forget to include both the salary you draw from your company, and also the dividends you collect.
Watch your tax deductions
For the self-employed, tax deductions can be a windfall, lowering your taxable income and thereby lowering your taxes payable. But when you apply for a mortgage, that lower taxable income tells the bank that you don’t make much money, and it could make it tough to impossible to convince them to loan you money to buy a house.
If you know you’ll be planning to buy a home shortly, defer tax deductions until later, if possible.
Don’t forget that if you run your business from home, you’ll be able to claim at least a portion of the mortgage loan interest as an income tax deduction - but that won’t help you get approved for a mortgage.
Calculate your DTI
DTI is your debt-to-income ratio. Most lenders will approve you for housing costs of up to 28 percent of your income. And they won’t approve you for an amount that pushes your total debt payments, including mortgage, credit cards, other loans and child support, beyond 41 percent of your income. Some might draw the line as low as 36 percent.
Pay down debts
The single quickest way to qualify quickly for a bigger mortgage is to pay down that car loan or pay off your credit cards. That will lower your DTI and make room for a higher mortgage amount.
Don’t quit your day job.
So you’re a part time blogger with a day job, and you want to quit the day job to take your passion on full-time. But you also want to buy a house.
Don’t quit that day job just yet. The steady income from the day job is what will get you your mortgage and it will also help you make the payments. At what point should you quit the day job? When you have several months of living expenses in a reserve fund, preparing for a rainy day. But only after you’ve settled into the new financial routine of making mortgage payments.
Be wary of ownership fees
Condos and some other homes come with HOAs - Home Owner Associations - and with them are HOA fees. They will consume some of the 28 percent of your income that banks will allow you to spend on housing costs, leaving less room available for a mortgage.
Watch your credit score.
A good credit score improves your chances of getting a loan and decreases the interest rate you will be charged. Make sure you have credit (a credit card that you are actually using is ideal) and that you are paying at least what is due each time (in the case of a credit card, pay the balance in full every month). We posted more credit score tips here.
Get a co-signer.
It might be that the bank’s concerns might be justified. You might have just enough famine episodes in the feast-or-famine cycle that making regular mortgage payments could be dicey. If you have a spouse or a parent or a sibling with steady, predictable income, you might consider getting them to co-sign.
Know your limit.
You know your lifestyle better than lenders do. What is most important is that you will be able to afford to keep paying your mortgage even in famine months. This means you might also want to have a few months of living expenses kept in a liquid format, such as a high interest savings account, as a reserve fund for a rainy day.
Skip the banks.
The banks rarely have the flexibility to take individual situations into account when deciding whom to qualify for a mortgage. Independent mortgage brokers, such as Avrus, have a lot more leeway, because we have a much wider variety of lender options at our fingertips. And it is our passion to make sure that self-employed people get as good a break as W-2 employees do, so come in and let us help you..
