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Why Buying a Home May Be Hard If You're Self-Employed

Mortgage rules have undergone numerous changes since the housing collapse to ensure that only qualified buyers have access to loans. Meeting certain lenders’ requirements can be particularly difficult if you’re self-employed. If you’re one of the nearly 15 million self-employed Americans and you’re hoping to buy a home this year, here’s what you’ll need to keep in mind.

Documentation Can Make or Break Your Loan Approval

When you punch a clock at a regular job, mortgage lenders use pay stubs and direct deposit slips to verify that you have a steady source of income. When you’re self-employed, proving that you’re making enough money to buy a house can be tricky.

Generally, when you’re self-employed, banks want to see tax returns from the past two years. They then average your income for both years and come up with a number that represents how much you’re making from month to month. That’s the number they’ll use to calculate your debt-to income-ratio during the application process.

It’s important to keep track of how much money you’re earning so that you can present that information to your mortgage lender. Your lender’s going to want to make sure that you have enough cash to buy a home. If you receive a large check as a payment from a client, it’s a good idea to get a copy of the deposit slip from your bank to show where that money came from.

You’ll also need to be able to prove that you are, in fact, running a business and not making money from a hobby. This can be fairly easy if you’re operating a business that requires you to have a license. If you’re an independent contractor, on the other hand, you might need to have receipts from your clients in addition to tax forms and bank statements to show that you’ve been in business for at least two years.

Taking Large Deductions Can Work Against You

Why Buying a Home May Be Hard If You're Self-Employed

When you own a business, you’re responsible for paying both self-employment tax and income tax on what you make. One of the ways you can offset the size of your tax bill is by deducting certain business-related expenses. But those tax deductions can prevent you from qualifying for a mortgage if they substantially lower your taxable income.

When you’re making $75,000 a year but writing off $30,000 in expenses, for instance, that can reduce how much house you can afford from a lender’s perspective. If you have paperwork to prove that your income was lower because of a large, one-time deduction such as an equipment purchase, that could bolster your chances of getting approved for a mortgage.

Get Your Taxes Done By a Pro

Aside from looking at the numbers on your tax returns, mortgage lenders also concern themselves with who prepares your taxes. If you’re doing your own taxes at home with a tax software program (like TurboTax or Credit Karma), that could raise an eyebrow as to whether the numbers you’re reporting are legit. Having your taxes done by a CPA or another tax professional can be reassuring to a lender who’s concerned about the accuracy of your returns.

The Bottom Line

Why Buying a Home May Be Hard If You're Self-Employed

Being self-employed isn’t a deal breaker if you’re trying to buy a home. But owning your own business or operating as an independent contractor can make the home-buying process more challenging. Talking to a lender before you apply for a loan can give you insight into the kinds of hoops you’ll be expected to jump through and how likely you are to be approved for a mortgage.

You might also consider talking to a financial advisor about how buying a home will factor into your overall financial plan. You want to ensure that you can purchase a home without sacrificing your other financial goals. A matching tool like SmartAsset’s can help you find a person to work with to meet your needs. First you’ll answer a series of questions about your situation and goals. Then the program will narrow down your options from thousands of advisors to up to three fiduciaries who suit your needs. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while the program does much of the hard work for you.

Photo credit: ©iStock.com/Squaredpixels, ©iStock.com/Tempura, ©iStock.com/Steve Debenport

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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