Buying a home when you’re self-employed — that is to say, you own at least 25% of your own business — isn’t quite as easy as it is when you’re drawing a regular paycheck from someone else’s bank account.
Regardless of where and what kind of home you’re looking to buy, if you need to take out a loan (the way most of us do), you’ll have to be more diligent than a typical home buyer. That’s because lenders will need to see more of your financial history to determine whether to approve your application.
Instead of W2 forms, which you won’t have, a bank will want to see two full years of your business tax documents.
Fortunately, though, the skills you’ll need are the same kind that you’ve got to have to run a successful small business: planning, organization, and financial savvy.
Keep business, personal finances separate.
Lenders will want to know you’ve got enough money for a down payment, but that will be difficult to tell if you’ve got all your money in one place — or if you keep moving it back and forth between your personal and business accounts.
If you make a habit of funneling personal money into your business, that will reduce your income level, which lenders use to qualify you for a loan. It will also make it look like you need personal funds to keep your business afloat, rather than it being self-sustaining (and, better yet, profitable).
Instead of just taking profits from your business for personal use whenever they’re available, pay yourself a regular salary. That will look good to lenders, too, and it will give them a way to judge how big a loan you’ll be able to afford.
Keeping your personal and business accounts separate is a good idea anyway, for tax purposes as well as for budgeting. If you plan to apply for a mortgage, that’s just one more reason to do so.
Reduce the size of your mortgage.
The bigger the down payment you can afford, the smaller the loan you’ll need to apply for — and the better your chances of getting approved. Paying more cash upfront can help you a lot in that regard.
Another way of reducing the size of your mortgage is to buy a fixer-upper. Instead of putting money into your home at the beginning, you can invest sweat equity and make renovations at your own pace, as you can afford them.
Buying a foreclosed home can be a good option. Then determine what it will cost to make the necessary upgrades. For instance, if you need a new roof, you can come up with a ballpark figure by using an online roofing calculator. Or, if you need to repaint, you can expect to spend between $2 and $6 per square foot, according to average paint job costs.
Make sure your credit’s in good shape.
Having good credit is an important way to show a mortgage lender you’re a good risk, and it will help you get the best possible interest rate for your loan. Order a free copy of your credit report online to see where you stand. Then, take steps to build (or rebuild) your credit before you apply for a loan by disputing any discrepancies, paying down debt, and catching up on missed payments.
“Why bother?” you ask.
Because solid credit can do more for your pocketbook than you might think. Say, for instance, you want to take out a $200,000 fixed-rate mortgage that’s spread out over 30 years. In the summer of 2020, you would have paid about 4.3% interest if your credit score was between 620 and 639, which would have averaged out to a monthly payment of $992. If your credit score was between 760 and 850, though, your interest would have dropped to 2.7% and your monthly payment would have been $814.
That might sound like decent savings, but you don’t get a picture of how much you’d have saved until you stretch that over the full term of the 30-year loan: Instead of paying nearly $157,000 in interest, you’d be on the hook for just over $93,000.
Trim your tax deductions.
Tax deductions can save you money on April 15, but they do so by reducing your official income. And since lenders use your income — and your debt-to-income ratio — in determining whether to grant you, too many deductions could sink your application.
This is one reason it pays to plan ahead if you’re self-employed when you’re thinking about buying a home: Lenders will look at two years’ worth of your tax records in determining whether to grant you a loan, so you’ll want to avoid taking too many deductions during that period.
Buying a home can be an adventure, but it’s filled with all sorts of questions you need to answer, such as what kind of mortgage you should get (there are six kinds to consider). And that’s on top of what you need to know as a self-employed business person. With the right planning and some financial due diligence, you can own the home you want as you continue to grow your business.
By Jessica Larson, SolopreneurJournal.com