Jan Kennemer's Blog
While working from home and making your own schedule, either freelance or as a contract worker, allows for a particular type of freedom and control of schedules, a dress codes, income limitations, and your life, when it comes to qualifying for a mortgage, your 1099-MISC status comes with some drawbacks.
The so-called “gig-economy” places workers squarely in the “self-employed” column with its tax breaks that reduce the bottom line, letting you keep more of the money you work for. Unfortunately, the mortgage banking industry has not completely caught up to the new reality. The challenge is differing between “provable” income while retaining the tax advantages of self-employment.
Conventional Mortgage Lenders
Typically, the mortgage industry bases your credit-worthiness on provable income. Underwriters (the folks tasked with determining your creditworthiness) use W-2 forms and tax returns to qualify homebuyers for a conventional loan. Without these standard forms, proving your income is difficult for many self-employed would-be homeowners.
Conventional lenders follow a prescribed formula to prove income and credit-worthiness, so many mortgage underwriters merely look at your after-tax and post-deduction income. The result for 1099 workers is a lower provable income than the reality of most entrepreneurs or self-employed workers situation. Certain expenses such as one-time investments in equipment or product, and some depletions or deductions for your existing home, add back into your income on paper, but qualifying with 1099 income requires extra effort on your part.
Unconventional Mortgage Lenders
Conventional lenders offer conventional loans. These are loans qualified for selling on to FreddieMac or FannieMae. Alternative loans—those provided by smaller lenders and investors that hope to realize a better return than a conventional loan offers—might be a more likely option for the self-employed. These loans are not without some added risk. To make them attractive to investors, the interest rate on non-conforming loans typically is higher, and down-payment requirements might be higher as well. Some alternative mortgages with lower interest rates or lower down-payments might be available to self-employed borrowers with exceptionally great credit or an extensive portfolio.
Plan two years in advance: position yourself to qualify for a loan. Once you know where you stand, you can work to move into better condition to qualify. Organize your books and keep accurate financial records. You need to prove your income, so use an invoicing system to show receivables. Often, lenders want to look at two or more years of both tax returns and bank statements. They want to see an average over 24 months to determine your annual income and your ability to pay your mortgage. Keep profit and loss statements, expense reports and a balance sheet. If your accounting is complicated, get professional help. Utilizing a professional bookkeeper and CPA might just save you money and show you have solid business intent.
Save up a more substantial down payment: The more you put down, the less you need to borrow. Showing consistent savings also proves your ability to set money aside and prioritize savings and spending.
Improve your credit score: Sometimes it seems your credit score doesn’t make sense. After all, the calculations and formulas used remain a mystery. You can make significant strides in increasing your score though, by paying attention to two things: payment history and credit utilization.
- Payment history is just what it sounds like—the history of how you pay your bills. Avoid paying late and try to pay early. Your payment history makes up more than thirty-three percent of your total score.
- Credit utilization—the ration of how much credit you have available to how much you’ve used—is another large chunk of your score. If you have a credit card with $2500 available, and you’ve only used $250 (on average) you are using just ten percent of your available credit. On the other hand, if your card only has $250 available and you’ve used just $125 you have used half of the available credit. The higher the percent of your combined usage to your combined credit (all credit cards, personal loans, vehicle loans, etc.) the lower your score.
- The remaining parts of your credit score relate to the length of time you’ve had credit, how many accounts are new, how often you apply for credit and a mix of other bits of information. To help this area, avoid applying for credit cards, car loans or personal loans (furniture, appliances, etc.) for the two years leading up to when you apply for a mortgage. When you pay off a credit card, cut up the card or put it away, but avoid closing the account. Older accounts have a higher point value compared to newer ones, even if you aren’t currently using them.
Start now working on your credit and establishing the best accounting practices to prove your income. Speak with a mortgage lender for information on what it takes to pre-qualify for a loan in your situation.