Getting a Mortgage Can Be More Difficult if You Are Self-Employed
Rita Lewis is 52 and has never owned a home.
After renting for many years in Capitol Heights, she is ready to change that. She has about $50,000 in savings and a credit score above 700. But there is one thing working against her: She is self-employed.
On paper, self-employed people can look risky to lenders, particularly now because of the credit crunch. In fact, they have never looked great on paper, partly because there is not enough of a paper trail on them. Lewis doesn't get W-2 forms. Her income varies from year to year. Deduct business expenses from it, which she and other self-employed people can do, and it looks like she doesn't make much money at all.
Lewis, who runs a day-care center from her home and also caters, is wondering how she can get a decent mortgage given all of these obstacles.
"I'm just ready to stop renting and I'm on the Internet every day looking at houses," she said. "The way prices have dropped is incredible."
Lewis is ready to buy a home now, said Marguerita M. Cheng, a certified financial planner at Ameriprise Financial Services in Bethesda.
She might have to make a substantial down payment of as much as 20 percent of the purchase price, which long ago was the norm but became an anomaly in the days of easy credit.
"Go to the lender with a complete business plan and a personal financial plan showing a realistic projection of your cash flows over the next five to 10 years. If you can impress the lender, your chances for a reasonable loan improve greatly," said Bruce K. Sneed, president of BK Financial Planning in Woodbridge.
Lewis will have to provide tax returns and supporting schedules for at least two years to verify her income, the advisers said. But if her income is high enough, she might qualify for what is known as a stated-income loan, whereby the lender does not verify her income, Cheng said. "Lenders are aware of the challenges of being self-employed," Cheng said. "They understand that people do have the benefit of being able to deduct expenses to reduce their taxable income."
Going with the stated income, however, comes with a tradeoff. "The rate may be 1 percent to 2 percent higher," Cheng said. "Since it is a buyer's market, I advise her to ask for assistance with closing costs. Don't be shy as it cannot hurt to ask. The worst response you hear is 'no.' "
Lewis should become pre-qualified for a loan so she knows what homes are within her price range. And she should ask herself: How much does she want her payment to be? How much can she afford? Why does she want this home? At her age, does she want to get into more debt?
Affording the home goes beyond the price. There will be other expenses. "My advice for her is to not commit her entire $50,000 as the down payment to purchase her property," Cheng said. "I would want her to have at least three to six months of expenses set aside as cash reserves for emergencies and opportunities. Since she is self-employed and has two home-based businesses, I would feel more comfortable with at least six months of expenses set aside. I would not want her to go in debt at the same time she becomes a homeowner."
Which means she should keep a cash reserve for unexpected immediate repairs, maintenance, real estate expenses, homeowner's insurance and other costs. "You don't have these expenses as a renter," Sneed said.
In the end, Lewis has to do her homework to avoid getting into an untenable situation. "My advice to Rita and other potential first-time home buyers is that when determining how much mortgage payment you can afford, remember that homeowner ownership does not just include your mortgage payment," Cheng said. "Be sure to consider the impact of condo fees, HOA fees, escrow items, such as real estate taxes and homeowner's insurance, and increased utilities on your monthly cash flow."