Photo: Robert Clark
For years, many Americans have bought into the persistent notion that it’s more difficult to get approved for a mortgage if you’re self-employed. But in reality, self-employed households have a higher rate of homeownership than salaried households and typically earn more annually.
The DC-based think tank the Urban Institute found in a new study that while more and more self-employed households are becoming homeowners, there are still many misconceptions lingering about self-employed earners throughout the real estate industry. And, homeownership for self-employed individuals is not without risks.
Here we’ve broken down a few of the most common homebuying challenges faced by self-employed Americans, and dispelled some of the misconceptions about self-employed households in the process.
1. Working with a financial expert is key
Typically, lenders will request self-employed prospective homebuyers show bank statements and tax returns for income history in lieu of W-2s and paystubs. And this is where many self-employed buyers make their first mistake. Write-offs are a common way to save money on taxes, but they can end up costing you a mortgage if the lender doesn’t see enough income.
“Buyers need to have their income taxes reviewed by a professional so it reflects the kind of income needed to buy the kind of home they want,” says Zack Tolmie, a home lending officer with Citibank.
Tolmie recommends self-employed prospective buyers begin the conversation with their financial advisor at least two years before they plan to buy, providing enough time for the paperwork to accurately reflect their income and correct any other potential mistakes that could derail the purchase.
“You don’t want to find out after you’ve made an offer that there are huge mistakes on your credit report, or similarly, not even know what your score is,” says Tolmie.
2. You have higher earning power than you think
A big misconception about self-employed earners is that they make less than salaried workers. But, on average, self-employed workers actually earn more.
According to the Urban Institute, the median annual salary for self-employed earners was about $71,000 in 2007, while their salaried counterparts earned around $55,000. While incomes for both household types fell during the recession, the decline for self-employed households was much steeper. Young self-employed workers suffered even more.
As of 2016, the income gap had lessened to only around $10,000 — with self-employed workers still earning more annually than salaried earners, on average.
And although self-employed buyers are still earning more, their income may be volatile. That’s why it’s so important to have a financial professional evaluate your finances before jumping into the market. Again, the financial paperwork needs to consistently reflect the income required to buy the home of your choice.
3. Navigate volatile income carefully
Unsurprisingly, self-employed households are more likely than salaried households to experience month-to-month income variations.
Over half of self-employed households (homeowners) between 30 and 44 years old reported some level of income fluctuations, compared to only a quarter of salaried households, according to the Urban Institute.
And, younger self-starters (18-29) are hit even harder — nearly 90 percent report some income volatility, compared to about 31 percent of salaried households.
The obvious downside of volatile income is the possibility of not earning enough in any given month to pay your housing costs — and other monthly obligations.
Often, first-time buyers will bite off more home than they can chew, and aren’t prepared to deal with all the hidden costs, which is especially concerning for those with volatile income.
“They don’t leave room for ongoing savings and they find themselves working just to pay the mortgage,” says Jodi Carter, a Certified Public Accountant in New York City.
4. It’s possible to buy without slipping further into debt
Self-employed earners are buying homes, but many are doing so without taking on mortgage debt.
In 2016, the two household groups had homeownership rates of 72.9 percent (self-employed) and 62.7 percent (salaried), respectively — a 10.2 percentage-point gap.
The homeownership rate fell for both self-employed and salaried households during the crisis, but self-employed households witnessed a bigger drop — around 7 percent, compared to about 2 percent in salaried households.
And, this drop occurred despite the higher median income seen in self-employed households.
According to the Urban Institute, self-employed households that purchased a home in 2016 were less likely to have a mortgage (67 percent) than salaried households that purchased a home in the same year (74 percent).
But before 2007, self-employed households who purchased a home were almost as likely to carry a mortgage as salaried household homebuyers — nearly 80 percent in each category.
Mortgage use among younger self-starters caught in the wake of the financial crisis has also declined.
Before 2007, mortgage use for 20 to 39-year-old self-employed households was only marginally less than for salaried households — both at almost 90 percent.
But by 2016, mortgage use for younger self-employed households had fallen to 80.6 percent. At the same time, mortgage use for younger salaried households sunk to 87.7 percent.