It’s been almost nine months since I had a regular paycheck. Last year around this time, I was starting to make my plans for leaving my day job. One of my concerns was the possibility of qualifying for a mortgage with only self-employment income. Banks are still tight with their lending. Although mortgage rates are historically low, you have to be a special borrower to qualify. If your income isn’t shown on a W-2, and if there’s any risk that prevents you from showing a steady income from month to month, you won’t receive any preferential treatment.
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I’ve been working with my accountant to make sure this year’s business income will be shown on a W-2, having my business pay me a salary. The higher the salary, the more tax I’ll need to pay in the short-term, but it may be a small price to pay for qualifying for a lower mortgage interest rate, assuming I qualify at all. In an ideal world, I wouldn’t need a mortgage, but that’s not exactly a guaranteed assumption. I’d rather take the conservative approach and assume I’ll need or want a mortgage when I break down and buy a house.
For most freelancers, income is often shown on 1099 forms, not W-2 forms. 1099 income is viewed skeptically by banks.
Here are some suggestions for increasing the chances of qualifying for a mortgage when income is erratic or risky.
- Clean up your finances. Pay off credit card debt, get rid of car loans, and put money away into savings accounts. Always pay your bills on time and make sure you’re well versed in your financial condition. Being able to show you’re in control of your finances can help.
- Improve your credit. By cleaning up your finances, you should be improving your credit score over time. Look into some of the details that you know go into a credit score, like your utilization ratio and the length of your credit history. Make changes to maximize the positive aspects of credit that will increase your credit score. Don’t forget to check your credit score as you go through this process.
- Gather your documentation. The more proof you have, the more of a chance a bank will be willing to lend you money. At minimum, you should have your 1099 forms and your 1040 income tax returns. Any bank or brokerage statements that show you have substantial assets will help. Of course, this only helps if you do have substantial assets. (See the first point.) Any other documentation you have that indicates you will have the wherewithal to cover your monthly mortgage payments won’t hurt. Have a profit and loss statement ready for each of the last three years to coincide with your tax documentation.
- Shop around. You may not have much luck with the larger banks. They want low-risk borrowers, and because they have so many branches and are so well known, the largest banks can afford to be very selective. Look online for the best mortgage interest rates as a starting point, but don’t forget bout local banks and credit unions.
Avoid these headaches by buying a house with cash. If you save diligently, or if you have an incredibly successful freelance career or your own business, you might be able to pull off this feat. It’s a good way to “stick it” to the banks. You lose the benefit (and risk) of leverage, but that may not be important to you.
Updated October 21, 2015 and originally published August 30, 2011.