Being self-employed has its challenges both in the office and when trying to get a mortgage. Even if you are making a decent living for yourself, your lack of a consistent salary could make it a little more difficult to secure a mortgage.
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This doesn’t mean it’s impossible. Even those with little self-employment history can get approved. While you used to need 2 years of self-employment history, no questions asked, today 1 year will suffice in certain instances.
Whether you are in the market to buy a home or refinance, the guidelines below will help you gain approval for your mortgage after working for yourself for just one year.
Showing a Decent History
It’s all about showing the lender that you have what it takes to succeed in the industry. This doesn’t have to mean two years of successful experience owning your own business. You can be self-employed for just one year and still show the stability. Here’s how.
It all comes down to your employment history. If you open a business in the industry that you worked in for many years before going off on your own, you have a better chance of approval. Lenders want to know that you have what it takes to succeed. Typically, that means experience. Let’s say you were a real estate agent for 5 years before you decided to go off and open your own real estate company. You have those 5 years of experience to back you up, helping you know what works and what doesn’t.
Now, if you worked as a carpenter for 5 years and then decided to open your own real estate company, that wouldn’t work. Lenders wouldn’t have your work history to fall back because they are not related. The only way a lender will take one year of self-employment is if you have the experience in the same industry during the years leading up to your self-employment.
Proving Self-Employed Income With Tax Returns
Keep in mind that your self-employment income will have to be reported on your tax returns before you can claim it, though. This would become an issue if you opened your business in February and then applied for a mortgage during March of the following year. You would not have tax returns that show a full year of self-employment. A lender must see a full 12 months of income in order to make a proper determination.
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Lenders need to see the full 12 months in order to determine the cycles your business goes through. Let’s say that you are busy from March – October, but the rest of the year is slow for you. A lender will need to see that full cycle in order to get an average of your income. They need to see the highs and lows of your income. They use this to come up with the mortgage payment that you can afford even when your income is on the lower end.
Your Tax Returns Tell a Story
Your tax returns are the vital piece of information lenders need when you are self-employed. Not only does it show your income for a full 12 months, it also shows your expenses. When you work for yourself, those expenses are important. A lender cannot use your gross income as they could when you are employed by someone. When you work for yourself, you are responsible for all expenses. This is reflected on your tax returns.
Your lender will ask for all of your schedules on your tax returns. These schedules will show the expenses you wrote off in order to reduce your tax liability. The only expense many lenders will add back to your income is depreciation. This expense doesn’t physically come out of your income, so lenders are able to give it back to you for qualifying purposes on paper.
Have Good Qualifying Factors
The key to getting a lender to let you use one year of self-employment income is to have good qualifying factors. In other words, you’ll need:
- A good credit score (680 or higher)
- A low debt ratio (aim for 28/36)
- A clean credit history (no late payments)
- Assets available for use if necessary
These qualifying factors are sometimes known as compensating factors. They compensate for the fact that you are self-employed and therefore a higher risk. Not all lenders think borrowers that work for themselves are high risk, but chances are that you’ll run into a few that think this way.
Making your loan application as attractive as possible gives you the greatest chance of loan approval. Look at your credit report before applying to see if there’s anything you need to fix. Try paying your debts down as much as possible and save as much money as you can. These steps will help you make the most of your chances of getting a loan as a self-employed borrower.
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