If you’re self-employed and want to buy a house in 2021, you really need to read this before you file your taxes.
Getting a home loan when you’re a self-employed person can be a bit of a tricky combo. And of course, COVID-19 has complicated things even more.
Before we get too far in the weeds in all of this, there are 3 super important takeaways you need to know about right up front:
1. Do NOT make any major purchases right now. Yes, this includes that sexy crushed velvet Joybird sofa that caught your eye. These things can wait until you have the key to your new home.
2. Before you file taxes this year, you really, REALLY need to talk to your lender and/or tax person/accountant. Once you’re done reading this, shoot them an email about your plans. (Seriously. Don’t put this off if you’re serious about buying a home this year.)
3. Typically, advice from seasoned professionals is free. Don’t be afraid to check in with the pros for info on the best course of action, and don’t ever be afraid to seek out a second opinion. (Taking the time to educate yourself now can save you money and heartbreak in the future. It’s worth it.)
Now that that’s out of the way, I’m going to walk you through exactly what you need to do if you’re self-employed and want to buy a home this year.
But let me kickstart this with a story.
I was once chatting with a dear friend, and she casually mentioned that she was on the verge of quitting her full-time job and starting a small business. Then she added that she wanted to buy her dream Portland house a few months later.
I kind of freaked out when I heard this:
“If you quit your job and start a business, you won’t be able to get a home loan as a self-employed professional for a minimum of two years… but because of COVID-19, this is most likely going to be a minimum of five years! If you try to get a mortgage while you’re self-employed, you’d be screwed.”
My friend’s jaw dropped. “Wtf should I do, then?”
“You buy a house in Portland right the fuck now, honey. If you quit your job and strike out on your own right now, you will literally lose your opportunity to be a homeowner this year. Suck it up for a few more months, and let’s find you a home, NOW.”
As you can tell, I have some strong opinions about how to go about being a business owner or an independent contractor and purchasing a house. I work with self-employed people all the time, and as a real estate agent, I’m self-employed myself. It’s the best decision I ever made, and the freedom and creativity that being an entrepreneur allows is unparalleled. That being said, running your own business can have serious drawbacks, and buying a home as a self-employed person is one of them. If you’ve made it this far in reading this you’ve heard a lot of urgency from me, but that’s only because I know how devastating it can be to have to put your dreams on hold for years. But don’t sweat it, you’ve got this!
Here’s what you need to do:
Step 1: Talk to your tax person.
Buying a home while you’re self-employed takes careful planning, foresight, and a smart tax person. You gotta have that taxable income, and a fair amount of it. Let your tax person know that you’re planning on buying a house this year, and they’ll be able to help you figure out what documentation you need, etc.
Aaaand it’s time for another story!
I know of a small business that takes in $200,000/year. However, this most recent year, they wrote off so many expenses that their personal income only shows that they made $12,000 this year. No bank is going to give you a loan if you say you make $12,000/year.
When you’re self-employed on a 1099, you have to make different decisions when you’re buying a house. You need to tell your tax person that you’re planning to buy a house this year, and you might need to not write off as many things this year. Yes, you’ll pay more income tax this way, but you’ll also be more likely to buy a house.
(Now, if you haven’t filed your taxes for a few years or are behind on paying them, that is a whole other can of worms. Believe me, a bank won’t give you a second glance for a home loan if you’ve been lax with your tax.)
Step 2: Talk to a lender to plan well in advance of what you actually plan to buy a home.
You usually need an average of at least two years of taxable income before a lender will even consider giving you a loan to buy a home (and this is why I freaked out on my friend when she was going to quit her job right before she bought her first house).
We all know that those first few years of starting a business can be brutal. And even if you kill it that first year and rake in tons of cash, you still don’t have the two years of self-employed tax history that lenders insist on. You’re right, it doesn’t seem fair, but that’s just the way it is, friends.
And of course, there are additional levels of complications thanks to COVID-19. Here’s what Jen Leon, one of my preferred PDX lenders, has to say about it:
“Every lender at this point in time is looking for a strong profit and loss statement, especially due to COVID. They want to ensure that earnings haven’t taken a backseat comparatively to previous tax returns that are filed. That’s been the biggest hiccup with self-employment – unfortunately every lender is going to use a conservative profit and loss with less income versus a strong tax return from 2019.”
And here’s some wise words from Adesina Cameron, another preferred local lender of mine, who can explain it all better than I can:
“It’s a smart idea for anyone to check in with a lender 2-3 years before they want to buy. But when you’re self employed, it’s critical that you work with a lender to have a plan to qualify for a mortgage. You want your lender and your tax person working together as a team to get you qualified. I often work with CPAs to make sure they understand how I calculate income BEFORE they file. Your CPA can share the draft taxes with your lender to see if letting go of a few deductions is worth it, because the tax savings is minimal, but the increased income is the difference in qualifying or not. During COVID-19, mortgages for the self employed have gotten even tougher. So if you keep sloppy books, or have been procrastinating in doing your 2020 bookkeeping, your lender will give you some encouragement and guidance to get your shit in order before they can pre-approve you.”
Step 3: Don’t write off every single business expense this year.
Your lender is going to be looking at TAXABLE income when they are qualifying you for a loan. The more you write off as expenses, the less your taxable income is. The problem is, when you become your own boss, you’re trying real hard to get every write-off possible in order to lessen your tax liability. As a result, your income will seem very, very low. And when you’re trying to impress your lender with how much you’re earning, you need the opposite to happen. You need your adjusted gross income to be nice and high!
Jen’s got a snippet of sage advice for self-employed folks out there:
“Love my self-employed clients, but I don’t love when they write off every donut purchase at Starbucks.”
Step 4: Pay your taxes.
The only thing guaranteed is death and taxes, right? Well, the taxes part is definitely essential in getting a loan to buy a home. Every single time you get paid, set aside a percentage that you and your tax person have agreed on so when tax time comes around, you’re prepared. This is big Virgo energy, and I promise you, it’s the easiest and least stressful way to go about it.
If you’re behind on your taxes, set up a payment plan with the IRS. Because in a lot of cases, if you’ve jumped through all the other hoops, you can still buy a house if you owe them $$$, just as long as you are currently on a payment plan. (Here’s a cheeky little trade secret for you: That’s how I managed to buy my first home. There are ways, y’all, you just gotta know how to find them, and you gotta plan ahead for them!)
“The best way to know if you have viable income is to have a lender review your tax returns and assess where income can be bolstered up and used to qualify for a home loan. This is ESPECIALLY critical BEFORE YOU FILE your tax returns to the IRS in a new year! This way, the tax return can be modified and adjusted before the IRS gets it. It may require you to pay more in taxes, but it can also mean homeownership.”
Got questions? Reach out and I’ll talk you through it, and if it’s beyond my expertise as a real estate agent I’ll happily refer you to one of my Portland, OR home loan nerds who can tell you all about getting a mortgage while self-employed.