It is no small feat when it comes to keeping track of your work when you are self-employed. There are often more hurdles to leap when applying for a mortgage when you are self-employed than wage-earning employees do. The personal income of the self-employed can appear rather low, even when there is good cash flow coming in.
This can cause lenders to question if you are capable of paying off a loan when income may fluctuate. As with any home loan applicant, it will be important to document both your income and assets, to show an acceptable credit history along with a stable employment history. Bottom line, self-employed people have just as good of a chance of getting approved for a loan as wage-earning people are, while some are easier than others.
Here are the Basics About Getting a Home Loan in California
It is Not Recommended to Apply for a Loan if the Business is New
If your business is still in its infancy, it is recommended to bide your time before applying for a mortgage. Lenders usually request to see two years or more of steady self-employment. If you have expertise in the field you work in, with an additional year of experience to the one you have already worked in, there is a possibility that you can get by, just as long as you continue to earn what you are earning now.
Understand the Documentation Requirements
When applying for a mortgage, documentation requirements can vary, depending upon the type of mortgage you are seeking and your situation. You may need to show the following:
- Proof your business exists. For example, a business license, or a letter from a professional organization that can confirm your self-employment.
- Two-year minimum of personal tax returns.
- Two-year minimum of business tax returns.
- A canceled check was written to the IRS or a bank statement that shows paid taxes owed last year.
- Year-to-date profit and loss statement with business bank statements that show cash flow.
- Current balance sheet.
Get to Know Income Issues
The number one comfort lenders gain in lending out money is knowing that they will be paid back in full. Income requirements will differ according to the lender along with the type of loan, but there can be some common income issues.
Tax-Write Offs can be Detrimental in the Long-Run
Many of those that are self-employed will take all the legal tax-write-offs and deductions they can. But, they can significantly lower your income on paper, which is the income you need to show to be approved for a home loan. There are avenues to take to get around this issue with bank statement loans. These may enable you to qualify based on money that is constantly flowing into your bank account, rather than relying on your tax returns.
Prepare to Show Personal and Business Finances
If you are self-employed, a lender may ask you for your financial records, as well as explore the health of your business.
Sloppy Bookkeeping Can Come Back to Bite You
If you are not organized in maintaining your finances, you must get that in order before you try to apply for a home loan. A common mistake seen time and again is the mixing of business and personal income. To keep a neat bookkeeping system, document all of your income sources to prepare for the day a lender will ask you for the paperwork when you are applying for a loan.
Unsatisfactory Debt to Income Ratio can Sink your Loan
The lender will look at your income and the amount of debt you carry. Business and personal debt will be looked at closely. Debt to income ratio is an important factor in whether you can be approved for a mortgage. The requirement for this is a debt-to-income ratio of 43% or less. The bottom line, when applying for any type of loan, make sure you are cleared of debt.
Ensure Your Credit Score is Up to Snuff
In addition to your income and assets, your credit score and depending on what it is will be a huge deciding factor in if you will gain that loan that you are applying for. Typically, your FICO score will be considered, which ranges from 300-600. To understand credit scores, let us look at the break-down of credit scores:
- 800-850= Exceptional
- 740-799= Very Good
- 670-739= Good
- 580-669= Fair
- 500-579= Poor
- 500 Or Below= Very Poor
The average credit score of a person lies between 600-750. Depending on your type of mortgage and the approval you will need to get it will also vary on your credit score. If you have a credit score of 740, you will have clear sailing in acquiring a mortgage. Some loans will consider a FICO score of 580.
For more information on getting a home loan in California and all of your mortgage options in Mission Viejo please contact me anytime.
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