Love being your own boss? Unfortunately, you might not love the process of applying for a mortgage when you’re self-employed.
Of course, you won’t be alone. With the increased unemployed youths in Kenya, the number of self-employed workers in the country will climb to a high. Nonetheless, this growing group faces a few extra obstacles attaining a mortgage over full-time employees.
Related: Mortgage Mistakes You Must Avoid At All Costs
The good news? By knowing the mistakes, you can avoid a ton of home loan hurdles and headaches.
1. Your income is high but unpredictable
As they do with typical home buyers, lenders will check to see if your income is high enough to pay for the mortgage. Self-employed borrowers, however, must also show that that income is fairly steady without wild changes that might restrict their ability to pay a monthly mortgage.
To prove the stability and viability of your business, you’ll have to provide at least two years’ worth of tax returns. (If you’re newly self-employed, some lenders will accept only one year of self-employment tax returns if you can also provide tax documents from an employer in the same field and your current income is at least as much as you earned from your previous employer.) Though some income inconstancy is acceptable, your business should be making steady or increasing revenue each year.
To validate your business income, many lenders will also require you to provide a profit and loss statement. The warning? If your business carries debt and you pay those debts out of a personal checking account. Or charge them to personal credit cards, the business debt is going to negatively affect your debt-to-income ratio qualifications.
What is the debt to income ratio?
The debt-to-income ratio is what you owe in obligations like credit card payments, student loans, car loans, instalment loans, car loans, personal debts, alimony, or child support, divided by your monthly income.
As a general rule, if you want to qualify for a mortgage, your debt-to-income ratio cannot exceed 36% of your gross monthly income. For example, let’s say you’re paying Kes 500,000 to debts and pulling in Kes 600,000 in taxable income. Divide Kes 500,000 by Kes 600,000, and you get a debt-to-income ratio of 0.083, or 8.3%.
However, that’s your debt-to-income ratio without a monthly mortgage payment. If you factor in a monthly mortgage payment of, say, Kes 100,000, your debt-to-income ratio increases to 25%. A higher debt-to-income ratio could mean you’ll pay a higher interest rate, or you could be denied a mortgage altogether.
The challenge for self-employed workers is that mortgage lenders will consider only their taxable income when assessing. So, if your company makes Kes 500,000 a month in gross revenue, your taxable income might be only Kes 400,000 if, say, your company has Kes 100,000 in work expenses.
2. You mix business with pleasure on one bank account
Like other borrowers, you’ll need a strong credit score to qualify for a conventional loan when you’re self-employed. Though a perfect credit score is 850, all scores above 759 are considered to be in the best credit score range, since this means you’ve shown an excellent ability to pay off your past debts.
Borrowers with outstanding credit qualify for the lowest interest rates.
But know this: Using personal credit cards to pay for business expenses can hurt your credit score if you’re carrying a large balance from month to month, or you’re missing payments. Even just one missed payment can cause a drop in your score.
The moral of the story: “Don’t mix business expenses with personal ones”.
3. You don’t have all your documents in order
In addition to requesting documents that show proof of your income, lenders will also be looking at your savings, financial assets, and monthly debt obligations to make sure that you have the means to take on a mortgage comfortably.
Here’s the documents you’ll have to provide:
- A quarterly statement, or statements for the past 60 days, of all of your asset accounts, which include your checking and savings, as well as any investment accounts (e.g., other stocks or bonds)
- Any other current real estate holdings
- Residential history for the past two years, including landlord contact information if you rented
- Proof of funds (e.g., bank account statement) for the down payment (If the cash is a gift from your parents, you need to provide a letter that clearly states the money is a gift and not a loan.)
Keeping up-to-date records of your business accounts is crucial, but having a tax preparer review these documents before you submit them to mortgage lenders can help you spot any inaccuracies. That could make the difference between getting approved or rejected for a mortgage since even small mistakes can hurt your application.
