The Curse? of Self-Employment

self employed coupleYou work for yourself. You have the privilege of risking your cash and covering overhead. You get to work twice as hard as other people, maybe even for less money.

But what you have is yours. There is no substitute for that. Most entrepreneurs I have known over the years would not trade what they have for greater security and fewer hours, working for The Man.

If being self-employed is such a noble calling, why do lenders make it so hard to get a mortgage? Isn’t it nearly impossible to get a mortgage if you don’t have a “real job?”

Not necessarily. While you may have some hurdles to deal with in qualifying for a mortgage, it is not as difficult as you might think.

Here is what you can expect when you apply for a mortgage as a self-employed person:

  • You will provide all your Federal tax returns for the last two years. If your business is a sole proprietorship, all the numbers will be on Schedule C of the return. If you are incorporated and you own 25% or more of the business, you will have to provide the corporate returns as well as the personal.

    If your income has declined from the previous year, the lender will take the lower net profit of the two years. If it has increased, they will average the two years.

  • Most self-employed people I know take advantage of every possible deduction (“business expense”) for their business return so they can minimize their tax liability. Many businesses involve business use of a personal auto. A business owner can claim 56.5¢ a mile—so if you can justify, say, 15,000 miles for business in a year, you’ll reduce your taxable income by almost $8,500. The problem is, you’ll have to live with that lower net profit number when you apply for a mortgage.

    Many self-employed people chose not to claim every possible legal deduction the year they apply for a mortgage. Paying a little more in taxes can be a small price to pay for getting the mortgage you are looking for.

  • You will have to prove that you have been self-employed for at least two years. You can do this by providing business licenses or a letter from your CPA confirming your status.
  • Some business owners have the business make their car payments and credit cards, even though they got the accounts personally. To avoid having the car payment affecting your Debt-To-Income ratio (DTI) twice, you’ll have to show that the business has made the payment for the last twelve months. Lenders generally want to see canceled checks for this.
  • If you are using business funds for your purchase, you will have to get a letter from your CPA stating that taking that money out won’t harm the business.
  • Speaking of business funds: I hope you have your business account completely separate from your personal account. If you routinely move money around between your accounts, be aware that you will have to explain and paper trail any “large” deposits—that means anything larger than about $500. So if you wrote yourself a $1,000 business check for a fun weekend and stuck that money in your personal account, be prepared to explain and document it.
  • Most lenders today are asking for a “YTD P&L.” Even though they won’t take into account that you may be having the best year ever, they do want to see the trend of your business. The P&L doesn’t have to be fancy; it can be a simple spreadsheet showing your income and expenses to date.
  • The lender will check to see if your business actually exists. They may check the Yellow Pages, Google you, Yelp you; they may even call 411, just to see if your business exists. If you don’t have a domain registered for your business, now would be a good time to get that done. The cost and time involved are minimal. While you’re at it, you could even set up a simple website. There are many places where you can do this for free, or nearly so.

Here’s what I’d like you to take away from this article: getting a loan is not that easy, whether you are a wage earner or an intrepid entrepreneur. It is not impossible, though, so long as you are organized and persistent. Get your paperwork organized ahead of time, so you won’t be chasing it later.

Now that you’ve taken care of all that, you can go back to working your insane hours!

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