It’s no secret that our gig economy is booming right now. Uber and Lyft have given contract work to hundreds of thousands of drivers in the United States. Creative freelancers can sell their own work on Etsy. And there are platforms like Upwork that enable individuals to be their own bosses.
While working for yourself brings autonomy, flexibility, and creative control, it can pose challenges when you want to buy a home. This is why getting a mortgage for contractors can be a little tough. So, we’re going to tell you everything you need to know about scoring a mortgage when you don’t have a standard 9 to 5 job.
Are you a contractor?
It seems like everyone and their mother are working for themselves these days. With our post-pandemic corporate culture shifting toward remote work and entrepreneurship, the contractors' market is thriving. But you can’t just call yourself a contractor if you fix your friend’s computer and have them Venmo you 50 bucks. So, what makes someone a legitimate contractor in the eyes of the IRS– and mortgage lenders?
A contractor is a self-employed person. Typically, contractors work for one company at a time to fill a particular role for a fixed period. They’re not formal employees, meaning they don’t get employee perks like health benefits and paid vacation. Contractors and freelancers (these terms are often used interchangeably) pay income tax via self-assessment. Thus, rather than receiving a W-2 from the company or person they work for, they receive a 1099.
What lenders look for with mortgages for contractors
The lending criteria for contractors is the same as it is for employees. Lenders look at your income, credit score, savings, monthly debt obligations, employment history, and any other relevant assets.
While lenders use the same criteria for freelancers as they do employees, it doesn’t mean it won’t be a little tougher for a freelancer to get a mortgage. This is mainly because of the varied income that goes hand-in-hand with being a contractor. Thus, lenders assess income differently for contractors than they do for employees.
How do lenders calculate income with a mortgage for contractors?
For a lender to determine how much you can afford to pay back each month, they need to thoroughly assess your income. The two most common ways lenders calculate a freelancer’s income is by the day rate or average earnings over a couple of years.
A lender may use the day rate you charge to work out how much money you’re likely to make. They’ll use your day rate and multiply it by the number of weeks you work, while assuming that you take holidays off.
Lenders may also calculate your income by finding your average earnings. Usually, they only go as far back as the last two years. Once they add up your total earnings over the last two years, they divide it by the number of years to determine your average annual income.
Why it’s harder for entrepreneurial types to buy a home
Can contractors get a mortgage? If you’re a contractor, you might have wondered this before. Because of the varied income that accompanies the flexible life of a freelancer, it can be harder to qualify for a loan to buy a house. This is because the housing industry’s automated underwriting processes are mostly catered to borrowers who receive steady pay stubs and annual W-2s. But this doesn’t mean if you work for yourself, you’ll have to jump through hoop after hoop to get a mortgage for contractors.
You just need to know how to prepare so you can be in the best position possible as a mortgage candidate when you sit down with a lender. So, let’s go over some tips to help you prepare for when the time comes, and you catch the homeowner bug.
Prove your income
The biggest hurdle when seeking a mortgage for contractors is sourcing sufficient evidence to prove the amount of money you take home from your work. This is due to the nature of contract work. It can be difficult to show a consistent flow of work over the past two years, especially if you’re just getting your feet wet as a freelancer. Plus, 1099s don’t always reflect your total income. Contractors often get paid in a variety of ways, such as by check, cash, PayPal, Venmo, and so forth. There are also many write-offs that a contractor can leverage during tax season. All of these reasons can make it difficult to show income history that meets standard mortgage underwriting rules.
Thus, whether you’re buying your first home or seeking a remortgage as a contractor, you must know how to prepare to make sure you have enough evidence to corroborate your true earnings.
Do your due diligence
Doing your homework to prove your income as a freelancer means gathering as much paperwork as you can to show the money you make from your profession. This includes all of your invoices, bank statements, 1099 tax returns, day rate, a contractor directors loan (if you’ve taken one out), and any other accounts that reveal your operating costs. It also helps to show your lender some proof of your expertise, like your qualifications, past work, and references.
Strive for a consistent working pattern
One of the most critical factors lenders look for when assessing a mortgage for contractors is a consistent working pattern. Unfortunately, consistency is very difficult to achieve for most freelancers. One month you might land a huge gig and feel enthusiastic and confident about your work; yet, another month you might have trouble booking anything and find yourself eating ramen noodles, and pop-tarts like you’re back in college.
So, if possible, try as hard as you can to avoid too many gaps in your work during the 12 months before you sit down with a lender. This will show the lender you make income consistently and have a good track record of managing money.
Credit score maintenance
Checking in on your credit score is important for anyone who wants to take out a mortgage, regardless of whether they’re a contractor or an employee. Thus, make sure you find out what your credit score is and take measures to improve it, if necessary before you apply. After all, contractor mortgages with bad credit aren’t given out generously.
Save money for a hefty deposit
A mortgage for contractors doesn’t require a higher down payment. That said, making a larger deposit is never a bad thing as long as you can comfortably afford it. Putting down a hefty deposit means you’ll own more property right away, you’ll be a lower-risk candidate, and thus, you’ll likely be rewarded with lower rates.
The contractor’s edge
Providing your lender with a large deposit is a smart way to play to the strengths of being a freelancer. Although contractors may have inconsistent income patterns, they may also have ample savings due to the higher rates they charge and the many tax write-offs available to them. So, a good tip is to build up enough savings for a large deposit to offset the perceived downsides of being a freelancer. A nice deposit can also convince your lender of your high earning power.
Get a joint mortgage
Choosing a joint mortgage for contractors can be a great way to score a home. With a joint mortgage, both your earnings and employment statuses will be taken into account. Thus, this can bolster your chances of getting approved if your partner is a full-time employee.
Use a guarantor
You can also use a guarantor when seeking a mortgage for contractors. If you have someone willing to provide the necessary security and a guarantee for your repayments, it can greatly enhance your application.
Are there contractor-friendly lenders?
If you’re a freelancer, it’s best to choose a flexible lender, like a contractor mortgage specialist, who understands your unique situation. Contractor mortgage lenders have the right knowledge and experience to help you achieve your goal of buying a home.
A final word
If you’ve broken free from the 9 to 5 life, you’re all too familiar with the freedom and flexibility that come with being your own boss. But, you likely also face many challenges, such as varying income, unpaid sick leave and vacation days, the stress of finding clients, and buying a home.
But, with the right preparation, getting approved for a mortgage for contractors doesn’t have to be a daunting task. Talk to one of our mortgage experts at NorthPort Funding today. We’ll take the time to listen to your financial scenario and help you choose the best path toward homeownership.