Financial Best Practices for Self-Employed Homebuyers

A Man Working in a Coffee Shop

Are you navigating the choppy waters of self-employment and setting your sights on the horizon of homeownership? It’s no secret that the journey can feel like you’re charting unknown territories. But fear not, intrepid explorer! With the right compass and map—in this case, financial best practices—you can find your way to the land of homeownership. This guide is your trusty sidekick, packed with insights and strategies tailored for the self-employed homebuyer. So, buckle up, and let’s embark on this adventure together!

Understanding Your Unique Position

First off, let’s get something straight. As a self-employed individual, you’re a bit of an enigma to lenders. Traditional employment offers a predictability that’s easy for lenders to understand. Your mission, should you choose to accept it, is to present your finances in a way that’s just as reassuring.

Keeping Your Financial House in Order

A. Meticulous Money Management

  • Keep Your Personal and Business Finances Separate: As tempting as it might be to mix the two, keeping them distinct makes your financial story clearer to lenders. That means having separate bank accounts and credit cards.
  • Maintain Flawless Financial Records: Think of your tax returns, bank statements, and business ledgers as the Holy Grail. These documents are crucial for proving your income. You’ll have to provide a Profit & Loss Statement when you apply for a mortgage and a good accounting program will easily provide that, if you’ve been maintaining your business financial records.

B. Building a Robust Savings Buffer

  • Save for a Rainy Day (and Then Some): Aim to have at least six months’ worth of living expenses stashed away. This reserve reassures lenders of your ability to weather financial storms.

C. Getting Debt Under Control

  • Tame the Debt Dragon: High levels of debt can spook lenders. Focus on reducing your debt-to-income (DTI) ratio by paying down high-interest and high-balance debts. Your DTI should be 35% or less and the lower it is, the better.
Woman Paying Her Bills at Her Kitchen Table

Woman Paying Her Bills at Her Kitchen Table

Polishing Your Credit Until It Shines

Your credit score is like your financial fingerprint to lenders. The higher it is, the more favorably they’ll view your loan application.

  • Regularly Check Your Credit Report: Keep an eye out for errors that could drag your score down. You can do this easily on websites like Credit Karma. Some banks and credit unions also offer the option to monitor your credit through their systems.
  • Pay Your Bills on Time, Every Time: This can’t be overstressed. On-time payments are the cornerstone of a stellar credit score. Struggling to do this? We have some tips.

Deciphering the Lender’s Code

Lenders aren’t trying to make your life difficult (even though it might feel that way). They just need assurance that lending to you isn’t a high-risk gamble.

  • Understand What Lenders Are Looking For: Stability, reliability, and predictability in your income are key. Be prepared to provide two years’ worth of financial records to prove it.
  • Examples of Documents They May Request:

    1. Tax Returns and Transcripts

    Lenders will typically ask for at least two years’ worth of personal and, if applicable, business tax returns. These documents are gold mines of information, revealing not just your income but also the health and stability of your business. They might also request a transcript directly from the IRS to ensure the tax returns haven’t been altered.

    2. Profit and Loss Statements

    A comprehensive profit and loss (P&L) statement can showcase the financial performance of your business over a specific period. It’s not uncommon for lenders to request a current, year-to-date P&L statement, especially if your most recent tax return doesn’t reflect your current earnings.

    3. Bank Statements

    Bank statements, both personal and business, serve as a real-time snapshot of your financial health. Lenders use these to verify the cash flow of your business and ensure that you have enough funds for a down payment and closing costs, as well as a cushion for future mortgage payments.

    4. 1099 Forms

    If you work as an independent contractor, 1099 forms from the last two years can provide evidence of consistent income. These forms are especially useful for lenders to assess if your income is stable and likely to continue.

    5. Business Verification

    Documents such as a business license or a statement from your accountant can help verify the existence and legitimacy of your business. Some lenders may also require a letter from your clients confirming an ongoing working relationship.

    6. Asset Documentation

    Assets can play a critical role in the approval process, especially if your income is difficult to prove or fluctuates. Documentation of investments, savings, or other assets can help reassure lenders of your financial stability beyond the income you generate from self-employment.

    7. Debt-to-Income Ratio

    While not a document per se, your debt-to-income (DTI) ratio is a crucial figure lenders will calculate and consider. You can prepare by understanding how your income and debts stack up and possibly working to pay down debts before applying for a mortgage.

    8. Credit Score and History

    Your credit score and history are critical to mortgage approval. While you don’t directly provide this, being proactive by checking your credit report for errors and ensuring you have a strong credit score is key.

    9. Proof of Insurance

    For certain types of loans, or if you’re buying a property that could be considered a higher risk, you might need to show proof of business insurance or a professional liability policy.

Mortgage Broker Talking on Speakerphone

Mortgage Broker Talking on Speakerphone

Choosing the Right Mortgage Product

Not all mortgages are created equal, especially for the self-employed. Some loan programs are more forgiving of fluctuating incomes and non-traditional employment.

  • Explore Government-Backed Loans: FHA, VA, and USDA loans can offer more flexible qualification criteria.
  • Consider Portfolio Lenders: These lenders have more flexibility in their loan criteria and might be more understanding of self-employed incomes.

Consulting with Financial and Mortgage Professionals

Don’t go it alone. A financial advisor can help you strategize and optimize your finances, while a mortgage broker specializes in finding the best loan for your situation.

The Final Stretch: Making Your Dream a Reality

Congratulations! You’ve navigated the treacherous waters of self-employed homeownership and are now sailing towards your dream home. Remember, the key to this journey is preparation, patience, and persistence. With the right financial practices in place, you’ll not only make yourself an attractive candidate to lenders but you’ll also secure a financial foundation for your future.

In Conclusion:

Buying a home as a self-employed individual requires a bit more footwork, but it’s far from impossible. By understanding your unique position, keeping your financial house in order, polishing your credit, deciphering lenders’ requirements, choosing the right mortgage product, and consulting with professionals, you can make your homeownership dreams a reality. So, what are you waiting for? Start charting your course today!

About the Author
Meghan Henderson
Meghan is the Marketing Specialist for The Cameron Team and a published author of two young adult books. She also creates digital and printable planners and trackers, as well as coloring pages for Larkspur & Tea.