Lessons learned after applying for a mortage with self employment income
My wife and I recently applied for a mortgage for our first home. Since I am self employed, it was a lot more difficult than I anticipated even though I've owned my own business since 2008 and have been freelancing for almost 10 years.
Typically, banks require 2 years of documented self employment income for loans. I didn't think that would be a problem for me as I have documented 1099 income going back to 2005. However, most banks want to see a single source of income for those two years. If you're working as a sole proprietor and you file for an LLC, the clock starts over. If you close one LLC and open another, even if the business is exactly the same, the clock starts over.
Note: There are certain nuances I'm not sure about, such as renaming an LLC or changing your entity status (perhaps converting to a C Corp or an S Corp for tax purposes). If you are considering those, please consult with a mortgage broker about how that might impact your chances of getting approved.
In my case, I used to own an LLC with a business partner, but had to form a new single member LLC in order to land a contract that my partner was contractually obligated not to work on. In hindsight, the best thing for me to do would have been to remove my partner from the LLC and continue using the business for my own work. For various reasons that wasn't an option back then, but that is just one more reason why I'm of the opinion that every freelancer should have their own LLC rather than partnering with peers under a single entity.
My recommendation: If you are self employed and don't have an LLC, I would recommend filing one immediately even if you don't plan on applying for a loan any time soon.
I didn't think I'd be applying for a mortgage this summer. It's easy to think that big decisions like that are far off, but as freelancers we're already at a disadvantage. The best thing you can do for your future self is get your ducks in a row now.
Don't be too daunted by the prospect of forming an LLC. It's really not difficult; in Michigan, it's a single page document and costs $50. I'm sure other states are very similar.
Open a business checking account
Our lender was very happy to see that all of my business income was coming through a business checking account. Each ACH deposit has my business name on it, so it's very easy to provide a paper trail for my income. Even if clients write checks to you personally, deposit them in your business checking and then transfer to your personal checking.
Reduce your monthly debt obligations
I have a decent amount of student loans. I've been paying them off in order of interest rate, but until I actually pay a loan in full, my monthly minimum payments are the same. A small reduction in those minimum payments can actually significantly increase the amount of money I am approved for. It may have actually been smarter for me to pay off some of the smaller loans first, because lenders completely disregarded my total debt amounts and focused directly on the minimum payment amounts.
Pay off credit cards before billing cycle ends
Even though I pay off my credit cards in full every month, the amount due after each cycle, and more importantly the minimum payment, are still reported to the credit bureaus. I would recommend paying off credit cards a couple of days before the billing cycle ends (or paying multiple times a month) starting at least a few months before you plan on applying for a mortgage. Again, these things seem minor but any reduction in those minimum payments will be beneficial.
Start saving up cash as soon as possible
When applying for a mortgage, cash is king. It was kind of a last minute decision for us to start looking for a house, and prior to that we had been aggressively paying down debt so we had very little savings. Some lenders won't even accept cash for a down payment unless it's been sitting in your bank account for at least 3 months.