Buying a Home When Self-Employed
This is a topic that is near and dear to every real estate agent’s heart. Why? Because we have to go through the exact same process as our buyers when we want to buy our own homes or purchase investment properties. As agents, we love being self employed, and the income freedom/capabilities that come along with it. We admire people who want to take that step to pursue their dreams. However, it comes with its own set of challenges, besides the business aspect of things. One of the largest setbacks is the ability to easily purchase a home when you are self employed.
You are probably asking yourself “Well why, I make a lot more money than I did at my previous job” or “I still have a lot in savings for a downpayment, why should it matter?” There are a couple reasons why it is much harder to purchase a home, once you take that step towards your business dreams.
1. Taxes. This is the largest part of the struggle. When you are self employed, taxes don’t automatically get taken out of your wages the way they do at normal W2 jobs. You have to pay them separately. With that being said, you also get the ability to deduct or write off any business expenses you may have. Each year, we find ourselves looking for different tax deductions to lessen the blow of the large check we have to write to the government. Why wouldn’t you? Of course you want to look for these kinds of things to keep more money in your pocket. However, the more you write off, the more you lessen your taxable income. When you go to get approved by a lender, they base your approval on your taxable income, not your overall gross income. See where we are going with this? The more you deduct and lessen your tax burden, the more you are hurting yourself with your approval ability. It becomes this struggle of deciding how much to deduct, in order to purchase the home you want.
2.When you become self employed, you are now showing income that is not 100% steady. You have up months and down months, no way to show a consistent income. Because of this roller coaster in income, lenders have to have at least 2 YEARS of well established income in order to approve you. There is no way around this. Every lender needs to be able to show that you can constantly make income out of your business to approve you. With this, a lot of self employed people cannot make it work even in two years. The reasons for this vary but include not producing high enough income in the beginning, deducting too much in the first two years to lower tax burdens, etc. Most lenders predict it could be closer to 5 years before you can purchase a home once you decide to be self employed. Local lender, Erin Venneman with Yellowstone Bank can break it down better than we can, and she had this to say: “Self-employment is trickier than just your average W2 wage earner meaning the income when you’re self-employed isn’t guaranteed. When you own your own business, you not only take all the risks and carry all the expenses, you aren’t guaranteed to make money. To qualify a borrower when they’re self-employed, we need to show a two year history of income via federal tax returns.”
3. Lastly, even if you will make more money or have money saved up, the old saying goes “You need to spend money, to make money.” Starting your own business and becoming self employed costs more money than you expect. Even in an industry with lower start up costs, you still will be taking on more expenses all while not making steady income. In order to get going, many people take money from savings, take out new loans, or add to their credit card debt.
While this all may sound very doom and gloom, we didn’t say all of this to crush your home ownership dreams. There are many self employed individuals that own homes, and are still crushing their businesses. It is possible! Again, we are all for dreaming big, and achieving your goals. Start that small business, but use these steps to plan ahead if you also have the goal of owning your own home.
Step 1: Talk with your tax person (CPA)
You have to plan ahead a little more when purchasing a home if you are self employed, which means start immediately telling your tax person about your goals of home ownership. Over the next couple years, they can help you decide the best way to do your taxes to show the taxable income that you need. With this, you need to also make sure you are paying your taxes. That is a whole nother ball game, but lenders will not look your way at all to approve you if you do not have a payment plan for taxes or are behind on them. Work together with your accountant, make sure they know your goals in the future. Erin Venneman also added to this: “Tax advisors are there to help you stay compliant with all tax requirements and to help guide you through the smartest way to file so you don’t overpay or under-pay the IRS. To be approved or denied when looking at business tax returns, it comes down to how the tax advisor notes income. If you are freshly self-employed and working with a tax advisor, be sure to let them know that purchasing a home is your goal, and they should be able to file the returns to accommodate the banking requirements (if the income is sufficient that is, they can’t magically make the income appear if it isn’t there.)”
(P.S. The amount of taxable income will determine how much of a home you can afford. You might still be able to be approved after two years, but not for the price of home you would want or could actually afford if you just deducted a little less).
Step 2: Talk with a Lender
We know no one ever wants to do this step. It can feel scary to talk to a lender because they give the ultimate Yes or No when it comes to being able to buy a home. We always joke with people that this can be the scariest part of the transaction, but if you have the right lender (one you feel comfortable with) it doesn’t have to be. You have to have that 2 years of taxable income before they can do anything for you, however we think it is best to start that relationship early on. Reach out to a lender. Let them look at your situation. Let them help you plan towards home ownership. They can work together with your tax person in order to figure out the best path forward and get you into a home sooner. The earlier you can take this step and plan with a lender the better off you will be when buying a home. So reach out. Just do it.
Step 3: Always keep your goal of home ownership in mind
While you are waiting to be able to purchase a home, don’t lose sight of the big picture. It is so easy to get defeated when you learn that your home ownership goal could be far away. Do not let this bring you down. When you are thinking about buying that new car (that is a whole other post, for another time lol), keep in mind that you want a house, and know that new car will hold you back. When you are looking at furniture because you hate your couch, keep in mind that house you want, and know that this purchase will hold you back (you will want new furniture in your new home anyway). When you are wanting to write off every deduction in the book so you don’t have to give your money to the government, know that this will hold you back. Keep your home ownership goal in mind, and stick to it.
To add to the steps, Erin Venneman also added a couple more tips in order to help you really prepare to purchase a home when you are self employed. “First, work with good local advisors who understand the community, your business and support your goals. Second, no one likes to pay taxes, but to report minimal income on your tax returns and expect to be approved isn’t logical and you can’t have it both ways. Banks need to show solid and consistent income for self-employed borrowers, the same as we do for borrower’s who aren’t self-employed. Finally, it’s good to remember that most of the requirements aren’t coming from your local lenders, they are coming from the investors; Fannie Mae, Freddie Mac, etc. Most of the key requirements on all secondary mortgages are pushed on lenders by the government. (Gotta love the government!)” We know better than anyone that it truly does matter who helps you through this process. You need to have the right help, from great localized people to get you on the right path. Reach out and get help from people you trust and that understand the process of purchasing a home when you are self employed.
Home ownership when you are self employed is possible. You can make it happen. You had the courage to take the step and create your own business. You have the ability to make home ownership happen too, but the right steps have to be taken. If you need help getting in the right direction, recommendations for people to help you with this process, fill out the contact form below. We are happy to help you get on the path to home ownership and reaching your goals!