Since the beginning of 2020, self-employment has risen significantly. With the pandemic raging, businesses shut down (temporarily or permanently), and suddenly a lot of workers had little to no idea of what the future looked like. For some, self-employment was an opportunity. For others, a necessity.
To give some perspective, in 2019, there were about 3.5 million new business applications filed in the U.S. By 2021, that number spiked to a record-breaking 5.5 million per year, a 57% increase.
Many of these new entrepreneurs work from home, providing services to businesses and clients, while others set up digital storefronts or brick-and-mortar shops to sell products.
The job environment has changed
Unsurprisingly, Millennials and Gen Z are already more likely to be self-employed. This trend began before the pandemic. Of course, they absolutely have the skills and work ethic to succeed in more traditional jobs, but many are understandably disillusioned with the corporate life and have chosen to forge their own path.
In the past, the path from school to retirement was simple: you graduated, got a low-level job at a local company, and stuck with it. Over the years you worked your way up the career ladder, eventually retiring with a gold watch and a pension.
These days, the economics are different. It’s less common for people to have a single full-time job. And fewer of those full-time jobs have unions or offer pensions. And while wages haven’t kept up with inflation, the price of housing, food, fuel, and other necessary expenses have continued to climb.
With less long-term stability, and steady upticks in cost of living, it's understandable that so many people have decided to become freelancers, contractors, and business owners. It not only gives people more control over their potential income, but also more freedom and flexibility in their schedules and the kind of work they are doing.
If you’re shopping for a home
If you’re a freelancer or self-employed individual, you may also be looking to buy a home. That’s a great step toward equity and building towards your future. Just know that going through the process may look a little different for you than it will for someone simply working a job.
While working with a banker to buy a home, a more traditional employee can usually hand over a few years’ worth of W-2 forms to prove reliable, adequate income to qualify for a mortgage. In contrast, self-employed workers may have the income necessary to afford a house, but it’s not always a steady stream of dollars, and the tracking paperwork is different.
What counts as self-employment?
According to the Legal Information Institute at Cornell, a self-employed individual is “a person who owns and operates a business by themselves or as a partner and derives income by conducting profitable operations of that business, rather than receiving a salary as an employee.”
In short, this means you are your own boss. However, for the purpose of mortgages, things get more specific. Here are a few more criteria that may put you in the self-employed category, even if that’s not necessarily how you see yourself:
You are part or majority owner in a business.
You do not receive W-2 tax forms.
You receive 1099 tax forms.
You are a contractor or freelancer.
At least 25% of your income is from self-employment.
Most of your income is from dividends and interest.
Now, with all that said, let’s look at why being self-employed could mean you start at a disadvantage when shopping for a home loan.
How to prepare your paperwork
While you may have to jump through a few more hoops to get a loan as a self-employed person, preparing the paperwork ahead of time, and understanding your finances, can go a long way toward improving your chances of getting the mortgage you are seeking.
Calculate your debt-to-Income ratio.
Ideally, you want this to be under 45%. A high DTI may bring your credit score down and affect how much you’re approved to borrow, or whether you qualify at all. To improve your DTI before home shopping, refrain from borrowing money. That means no new car loans, credit cards, lines of credit, etc.
Your debt-to-income ratio is easy to calculate.
First, add up all of your regular monthly bills. That may include rent, vehicles, alimony or child support, student loans, credit cards, and so on.
Once you have that number, divide that total by your gross (not net!) monthly income, which is your income before taxes are taken out.
The number you’re left with is your DTI. The lower your DTI, the less risky you are to lenders.
Gather all the necessary documents.
Have as many documents as possible in hand when you first visit a mortgage banker. This will help them get a more complete picture of your finances and the kind of mortgage you can afford.
Start with these, if you have them:
Two years of personal tax returns.
Two years of business tax returns (schedule K-1, 1120, 1120S, 1065).
Two months of bank statements.
Two months of investment accounts (401k, etc.).
Year to date Profit & Loss statement for your business.
Balance sheet for your business.
CPA letter stating you are still a business.
Ask the mortgage lender what you may need.
Pay attention to your credit score.
If you’re in the mid-700s or higher, you’ll likely qualify for the best rates. If you're under that, talk with your banker about loan options, and other activities you can do that can help raise your credit score.
Additional Advice for Business Owners
If you’re a business owner, or a partner in a business, here are a few things to keep in mind before visiting with your banker:
Make sure your business is registered with your Secretary of State’s office and shore up any certifications or licensures you need.
Change how you’re paid.
Pay yourself a W-2 wage rather than an owner’s draw. Keep in mind that whether you can do this depends on your business structure.
Lower your debt load.
Above, we mentioned that avoiding new loans can help. If you’re a sole proprietor, you should also do what you can to pay off any vehicles, personal loans, credit cards, and other expenses in order to show higher overall cash flow.
Your business structure can affect your eligibility.
If you have been self-employed for a long time, but only recently set up an S-Corp, then you may end up having to wait to buy a home. Lenders will often make you wait a couple years before you're allowed to report income from S-corps or partnerships in order to be eligible for a loan.
What Mortgage Loan Types Exist?
Because programs and requirements may change, it’s best to talk things over with your lender to get the latest information and advice. But here are a few of the more common loans that may fit your needs.
Conventional loans can be a good fit if you already have a strong credit rating, a sizable down payment saved up, and you can demonstrate an income level that supports the kind of home you want to buy. A conventional loan may also help you avoid mortgage insurance.
If you have a lower credit score, or can only afford a smaller down payment, you should look into securing a Federal Housing Association (FHA) loan. Keep in mind that FHA is simply an insurer, not a lender. Their job is to help buyers who wouldn’t be approved under more conventional loans. Go here to learn more about FHA loan limits
If you live in a rural area, or you have served in the military, ask about USDA and VA loans. The US Dept of Veterans Affairs works with private lenders like Starion to provide less expensive loans to veterans. The USDA is a similar program but developed for rural folks. USDA loans require mortgage insurance, but the VA loans do not.
When You’re Ready to Get Started
Getting a home loan as a freelancer, contract worker, business owner or partner requires a little extra work. Follow the tips and tricks we outlined above, and you’ll be several steps ahead when it’s time to sit down with your Starion Bank mortgage banker and secure financing for your dream home.
Schedule your appointment today!