If you’ve started your search for a home and you’re self-employed, you’ve probably already discovered that the process is a bit tedious.
While being an entrepreneur and working for yourself is usually an undeniable benefit, when you want to qualify for a mortgage, it can be a hindrance. The tax write-offs self-employed people benefit from suddenly become cause for a lender to get suspicious.
Lending standards are tough for the self-employed, but we’ll talk about the considerations that should go into applying and qualifying for a mortgage and how you can plan to be successful in buying your home.
Why it’s hard to qualify for a mortgage
First, let’s talk about the challenges that come with applying and qualifying for a mortgage when you’re self-employed. Lenders’ standards are always changing and can be tough to meet. Your tax returns can be your enemy. You need to be able to show a year-over-year income increase for most lenders to consider you.
How can you rise up to meet these challenges?
The standard you have to meet
Earning a comfortable living might be all you were out to do when you started your business, but lenders don’t see it that way. In most cases, you’ll need to show two years’ worth of tax returns to your lender. That’s a potential problem because for self-employed tax payers, your take-home pay is radically different from what the IRS says it is.
Taking advantage of loopholes and under-reporting your income in the past can really come back to bite you here. Lenders want to see that you’re bringing in a profit from your business, and while some will allow you to add certain deductions back into your income, others aren’t so flexible.
Thanks a lot, tax deductions
Tax deductions are usually something to sing about, but not if you want to qualify for a mortgage. If you’ve been taking advantage of the plethora of deductions available to the self-employed, you’ve been writing off business meals, interest on business loans, retirement plans, and more.
Reducing your taxable income is a great thing when it comes to paying taxes, but a folly when it comes to applying for a mortgage.
That’s because mortgage underwriters are looking at your taxable income only, for the most part. Your taxable income is likely far less than your actual take-home pay, so it could cause a lender to reduce the amount you’re qualified to borrow, or deny you even though you’re financially able to take on the mortgage.
If you’re making money but your tax returns aren’t showing it, a lender can’t help you. However, certain deductions can be “added back” to your income:
- A large, one-time item
Make sure to check with your lender to find out if these deductions can be added back to your income and help you qualify for a mortgage.
It takes a while to do it right
Sure, you could just collect your existing tax returns and go apply for a mortgage tomorrow, but is that the wisest choice? No way! The best thing to do is to start planning for a year or two before applying for a mortgage. Why?
It gives you time to get your finances in order and make sure you’re completing your taxes correctly before you apply. For a year or two before you apply, make a conscious decision to write off fewer expenses on your taxes, increasing your taxable income and making you a more attractive candidate to any lender.
Don’t take on any personal debt if you can help it during this time. Personal debt can be the factor that determines whether or not you qualify for a mortgage.
Your income should be increasing every year
Lenders don’t really care about rises and falls in income throughout the year–they typically average out and are to be expected when it comes to small business. However, if your returns will show a decrease in income from one year to the next, it could land you on a lender’s blacklist.
This is another reason to take care as you manage your taxes before applying for a mortgage–writing off fewer deductions increases your taxable income and looks more attractive to a lender. Make sure the two years of tax returns you take to your lender show an increase in income year over year, not a decrease.