Freelancers and independent contractors face extra scrutiny when applying for a mortgage. Lenders view 1099 income as less reliable than W2 wages. To convince lenders of their creditworthiness, self-employed borrowers must jump through additional hoops to verify their income.
How do independent contractors verify 1099 income?
For W2 employees, proving gainful employment is as simple as providing pay stubs. However, demonstrating creditworthiness is harder for self-employed home buyers.
- Lenders first verify that a business is open and operating. Verification of employment from a CPA and notarized client letters authenticate a business in the absence of a business license.
- Next, borrowers need to prove stable income using copies of business bank account statements, profit and loss statements, and tax returns.
- Loan-eligible income is typically calculated by averaging 24 months of net income excluding any depreciation expense. However, declining income or changes in tax status may affect how lenders treat self-employment income.
What are the top challenges for self-employed home buyers?
Documentation isn’t the only hoop to jump through. These are the challenges that most often hinder self-employed buyers.
- Mortgage lenders only count taxable income. While tax deductions save money in the short term, too many deductions shrink a buyer’s loan-eligible income and, in turn, their budget.
- Contract- and project-based work may appear unreliable to mortgage lenders. Registering a freelance business as a limited liability company (here is a service that can help) preempts faulty assumptions about 1099 income without affecting tax status.
- What about freelancers who earn income from multiple sources? Similar activities can be reported on a single Schedule C, but unrelated activities must be tracked and reported separately.
- No matter the source of 1099 income, good records are a must. Separate accounts for personal and business finances ensure lenders receive a clear and accurate financial profile.
How can freelancers plan ahead for mortgage approval?
Getting a great mortgage as a freelancer requires planning ahead, starting with these key steps.
- Save as much as possible. While mortgage programs like FHA loans help first-time buyers purchase with as little as 3.5% down, larger down payments improve creditworthiness and avoid PMI.
- Pay down debt and avoid opening new lines of credit. In addition to a lower debt-to-income ratio, paying off debt can raise credit scores by reducing credit utilization.
- Use tax strategies to maximize loan-eligible income, but be mindful of the Additional Medicare Tax due on self-employment income over certain thresholds.
- Consider a local mortgage lender like Evolve Home Loans. Local lenders have greater flexibility than big banks, making them an ideal fit for homebuyers who don’t fit the mold
It’s a misconception that it’s harder to get a mortgage when you’re self-employed. Freelancers and independent contractors face the same lending standards as anyone else. However, getting a mortgage with 1099 income does require extra paperwork and planning. If you intend to buy a home soon, get your finances ready now starting with a call to Evolve Home Loans in-house credit specialist at 480-GO-APPLY.