Qualifying for a Mortgage When You’re Self-Employed

When John Kennedy observed that “life is unfair,” at a press conference in 1962 he wasn’t referring to the challenges self-employed workers would face getting a mortgage fifty years later—but he would have been right.

If you are one of the 14.6 million people in the US[1] who make a living working for yourself—about 10 percent of the total workforce—you don’t fit neatly into the profile of borrowers whose income can be easily documented for a mortgage application.

Tax returns don’t tell the whole story

It’s not impossible to get a mortgage if you are your own boss, but you’ve got to jump through some extra hoops to qualify.  That’s because self-employed borrowers typically have to provide two years’ worth of tax returns, which lenders will want to obtain directly from the IRS.

Yet tax returns often don’t accurately reflect their take-home pay.  Self-employed people typically take advantage of a slew of tax deductions related to their businesses, from retirement plans to home offices.  These reduce their taxable income, but they also reduce their adjusted gross income, which is what lenders look at for proof of income.

In some cases, mortgage lenders will allow certain deductions to be added back to the income such as depletion, depreciation or a large, nonrecurring item.

Plan ahead if you can

One solution is to plan ahead and write off fewer expenses for the two years leading up to applying for a mortgage, a strategy that could either cost you significantly at tax time or require you to refile you taxes after your mortgage is approved.

Another suggestion is to separate your personal funds from your business by using a credit card devoted to your business expenses, then convince a lender that the debt isn’t against you because it belongs to the business.  Finding the right lender could still be difficult, and you could still miss some of the most popular deductions, such as home businesses and cars used for business.

Timing is also important.  Self-employed workers typically have highly volatile businesses.  By using income averaging over 24 months, borrowers can avoid declines in income from one year to the next.

Reduce debt to improve your chances

The reason lenders want to see your income is because they need it to determine whether you have enough income to make you monthly debt obligations, a calculation expressed as your debt to income ratio. The median DTI for recurring debt on closed conventional purchase loans today is about 35 percent for recurring debt payments.[2]

By reducing or eliminating your recurrent debt payments, such as your car or student loans, you can reduce your DTI ratio, which will help you qualify for a larger mortgage.

source: totalmortgage.com

So you want to go freelance? Here are some tips

MANILA, Philippines - Ditching the office, the monotony and especially your boss, in favor of going freelance may seem like a good idea when you're tired and frustrated.

But that freedom comes with a price and if you're not careful with handling your own money, you may find yourself begging for the consistency and safety of being a regular employee.

On ANC's "On the Money," chairman and chief executive officer of Personal Finance Advisers Corp. Efren Cruz, shared some tips on what you will need in order to successfully make that leap towards self-employment.

Save up
According to Cruz, one has to ensure that he has enough funds for what he called, "the permanent working capital," which includes both household expenses and business expenses.

"It is like the blood that runs through your veins," said Cruz.

He also warned that those who would like to become their own boss should be able to pay for these expenses, especially the ones for employees and supplies, without relying on revenues, which are inconsistent in nature.

"In case they don't come on time [revenues], you should also have a sort of emergency fund for your household needs and for your business," Cruz suggested.

Borrow just enough

But what if you don't have enough money just yet, but you can't stand working for your boss anymore?

Cruz quipped that borrowing the funds needed for your freelance business from banks would just result in you "working for them and not for yourself"

"At most, borrow 50% of the capital you need," he said.

Question your "must-spend"

Without the help of regular income, freelancers should be able to cut down their expenses with respect to their earnings.

Cruz suggested that freelancers divide their expenses into a "must-spend" and a "may-spend," then compute the earnings they need in order to pay for these expenses plus taxes.

"If you think you can't earn that or are not earning that, then just go back to your expenses," he said.

"It's easier to cut the may-spend but if it still doesn't work out, then you have to question your beliefs in the must-spend," Cruz added.

Reinvest earnings

And because people can't possibly do their freelance work forever, Cruz advised them to keep the "cash-flow" moving.

"Whatever earnings you have, reinvest it. You don't have to reinvest it in the business itself, you can find other businesses or you can find investment securities to make sure that your money keeps on working till the day you die," he said.

But warned that the funds that are going to be used for investments should be from unrestricted earnings.

"The funds shouldn't come from debt."

Don't forget taxes

According to Cruz, one of the common mistakes that freelancers make whenever they start out is that they tend to leave taxes out of their computations.

"If you are selling to corporations, they would normally withhold taxes from you...But many people believe that since taxes are withheld, [they] already paid their taxes," Cruz said.

Freelancers that are earning more than P720,000 in a year should pay the Bureau of Internal Revenue a professional tax of 15%.

"You pay your taxes quarterly," reminded Cruz.

And lastly, say goodbye to company benefits

Be prepared to lose company benefits like free transportation, uniforms, paid vacations and sick leaves because as Cruz said, "these are all gone when you're self-employed."

source: www.abs-cbnnews.com