Getting a mortgage should be exciting, because it signals a big life change. Often, people are obtaining a mortgage to purchase a home or to re-finance their homes for a new, large-scale project (funding college education or building a home addition, for instance). But getting a mortgage may actually be very stressful instead, particularly for self-employed professionals.
Mortgages are essentially loans. Commonly, mortgages are financed through banks. The applicant must show proof of income before the mortgage may be obtained…and this is where self-employed professionals run into trouble.
Self-employed professionals may not receive paychecks that show their earned income. In order to prove their net worth, independent workers must produce their income tax returns. But of course, there’s a twist. Because self-employed professionals rarely make the exact same amount of money from year to year, most lenders will ask to see at least two years’ worth of tax returns. This process is problematic for self-employed professionals for a specific reason: tax deductions.
Earned Income vs. Taxable Income
Employers and clients who hire freelancers, independent contractors and other self-employed professionals don’t take taxes out of the payments they make, and it’s the worker’s responsibility to claim their income at the end of the year. It’s standard practice for all business owners, even those who are in a business of one, to deduct expenses from their earnings. Home office costs, supply costs, travel time and many other expenses may be subtracted from the year’s earned income. Subtracting expense costs creates less taxable income, which can be a big life-saver every April when tax payments are due.
But, it can be a big problem for self-employed professionals who want to obtain a mortgage. Money lenders look at the net income, not the gross income, which means they’ll be basing their findings on the professional’s taxable income. Because of various deductions, the taxable income amount will be considerably smaller than gross income.
What About Credit?
Doesn’t the credit score play the biggest role in getting any kind of loan, even a home mortgage? Not for self-employed professionals. A high credit score certainly widens the door of discussion, but money lenders are primarily concerned with the applicant’s ability to pay back the loan. Making a large down payment will grease the wheels considerably, though not all self-employed professionals can afford to take this route. Adding a cosigner to the application may also increase the chances of getting approval.
KC Morgan - KC Morgan has been the featured writer in Self-Employment since 2006, using personal experience to create guides to being self-employed.
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