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The Self-Employment + Mortgage Approval Riddle

This comes as a surprise to many successful small business owners. 

The start-up phase is over, and you’re finally seeing a financial return on all of your hard work. You’ve doubled, tripled, even quadrupled the revenue, yet when you’re ready to buy a house you can’t get a loan.

Sometimes it feels like banks just like to hate on anyone who’s self-employed. And in the lending community, self-employment doesn’t only mean the gig worker or the independent contractor. It also means people like you — startup founders, e-commerce entrepreneurs, medical practice owners, and restaurant proprietors. According to most lenders, anyone who owns more than 25% of a company is considered self-employed.

But this designation isn’t all bad news.

Small business owners can grow a business and buy their dream home — or even an investment property — when they understand loan approval and plan ahead.

Self-Employment + Mortgage Approval Riddle

While lenders don’t really hate small business owners, it’s true they do prefer W-2 wage earners. That regular paycheck, along with a steady employment history, provides lenders with security.

When you combine the standard obstacles all borrowers face with credit scores and debt-to-income ratios, small businesses owners end up with a steeper hill to climb. They have to balance these variables with the self-employment designation and proof of income documentation banks require. Proving your income is different from how much money you have in the bank — and it’s this point of view that the self-employed find especially frustrating.

It may seem obvious but it’s worth pointing out: one of the most important things that profitable business owners need to do is show as much income as possible. And that means taking fewer deductions. While deductions helped reduce tax liability in the startup phase, they also reduced your company’s overall profit.

These calculations become extremely important when you’re trying to qualify for a mortgage because banks shrink that number even further when they subtract your monthly debt liability. If you live in a competitive housing market, that reality can be devastating — affecting everything from loan qualification to the amount banks are willing to lend.

With careful planning — financial experts recommend at least two years — you can take fewer deductions and report more earnings. In the short term you’ll pay more taxes, but in the long run home ownership will give you some tax advantages including mortgage interest write-offs and property tax deductions.

Self-Employment + Home Ownership Checklist 

As a business owner, it’s common for your income from your business entity and your personal finances to become intertwined. It’s important to work with your accounting advisor to establish clean financial records and to form a plan that considers both your business and personal income. As mentioned, most small business owners need at least two years of strong financial records before banks will consider them for loan approval. Wherever you are on this two year continuum, here’s a short list that can help you prepare.

  • Two years of personal tax returns
  • Two years of business tax returns including schedules K-1, 1120, the 1120S
  • Business license
  • Year-to-date profit and loss statement (P&L)
  • Balance sheet
  • Signed CPA letter stating you are still in business

Every business is unique, which means you may need a more comprehensive list. Knowing what you need before you need it is one of the ways you can best prepare.

How to Balance Business Growth & Home Ownership Plans

Self-employed individuals may not realize the impact of their business income or tax strategy until they start considering options for home ownership. To avoid surprises, start the process with your accounting or business advisor early, so you can balance the growth of your business with your lifestyle ambitions.