When John Kennedy observed that “life is unfair,” at a press conference in 1962 he wasn’t referring to the challenges self-employed workers would face getting a mortgage fifty years later—but he would have been right.
If you are one of the 14.6 million people in the US who make a living working for yourself—about 10 percent of the total workforce—you don’t fit neatly into the profile of borrowers whose income can be easily documented for a mortgage application.
Tax returns don’t tell the whole story
It’s not impossible to get a mortgage if you are your own boss, but you’ve got to jump through some extra hoops to qualify. That’s because self-employed borrowers typically have to provide two years’ worth of tax returns, which lenders will want to obtain directly from the IRS.
Yet tax returns often don’t accurately reflect their take-home pay. Self-employed people typically take advantage of a slew of tax deductions related to their businesses, from retirement plans to home offices. These reduce their taxable income, but they also reduce their adjusted gross income, which is what lenders look at for proof of income.
In some cases, mortgage lenders will allow certain deductions to be added back to the income such as depletion, depreciation or a large, nonrecurring item.
Plan ahead if you can
One solution is to plan ahead and write off fewer expenses for the two years leading up to applying for a mortgage, a strategy that could either cost you significantly at tax time or require you to refile you taxes after your mortgage is approved.
Another suggestion is to separate your personal funds from your business by using a credit card devoted to your business expenses, then convince a lender that the debt isn’t against you because it belongs to the business. Finding the right lender could still be difficult, and you could still miss some of the most popular deductions, such as home businesses and cars used for business.
Timing is also important. Self-employed workers typically have highly volatile businesses. By using income averaging over 24 months, borrowers can avoid declines in income from one year to the next.
Reduce debt to improve your chances
The reason lenders want to see your income is because they need it to determine whether you have enough income to make you monthly debt obligations, a calculation expressed as your debt to income ratio. The median DTI for recurring debt on closed conventional purchase loans today is about 35 percent for recurring debt payments.
By reducing or eliminating your recurrent debt payments, such as your car or student loans, you can reduce your DTI ratio, which will help you qualify for a larger mortgage.
 Ellie Mae Origination Insights Report, January 2016