Millennials and Gen Zers are more likely than any other generation to be self-employed in some capacity.
Your grandparents may have told you that by graduating high school, getting a job, working hard, and sticking to it, you could retire securely at a set age. You might even have some savings or investments to use toward traveling pursuits or new hobbies with some luck. But, of course, a side gig was rarely a part of the equation.
Nowadays, things are different. Today’s economic landscape makes a smooth ride to retirement less likely than older generations. Various economic factors make it challenging to gain a long-term corporate job. But, it seems that this generation of workers doesn’t mind. Many of them don’t want that anyway. In fact, a recent CareerBuilder survey found that Gen Zers stay at jobs for an average of about two years. In contrast, Baby Boomers stayed at each of their jobs for an average of eight years and three months.
According to a survey conducted by MBO Partners, Millenials and Gen Zers prefer to be self-employed. The survey found that in 2020, Millenials and Gen Zers comprised 68% of new independent workers. Now, thanks to Covid-19, the need for a side hustle or independent employment has exploded. Gig Economy Data Hub estimates that about a quarter of the American workforce participates in the gig economy somehow.
Unfortunately, self-employment can often complicate obtaining financing to buy a home. However, if you’re self-employed, the information below should help you prepare for mortgage financing.
Home Buying Challenges
The real estate market is a little chaotic right now, if you haven’t heard. Housing prices climbed sharply, partly because the pandemic made working from home more common and desirable. According to data collected by DQYDJ, the median price for a single-family home in January 2019 was just over $275,000. Now, at the start of 2022, federal census data shows the same number as $377,700 — a $102,700 increase. So how is the independent workforce paying for such high home prices?
It turns out many of them aren’t. According to Apartment List’s 2021 Millennial Homeownership Report, this generation isn’t optimistic about homeownership. The report shows that 18.2% of millennials don’t think they’ll ever be able to buy a home. In 2018 only 10.7% felt this way. As homes get more expensive, buyers must take out larger loans. Because of this, first-time buyers are repeatedly getting priced out of the market.
But Millenials and GenZers don’t have to feel this way. There’s a path to homeownership for everyone, regardless of employment or income status. In fact, our exploding gig economy might provide a faster way to get to a down payment. Robert Farrington, founder and CEO of The College Investor stated,
The gig economy has been a powerful force for people’s personal finances.”
Farrington also discussed that in many cases, workers leverage self-employment to achieve financial goals like paying off debt and saving faster than with traditional employment.
First-time home buyers should not be discouraged by the current housing market. However, if you’re self-employed, be prepared for a few extra hoops to go through when applying for a mortgage.
Mortgages for Self-Employed Buyers
Many potential home buyers are unaware of the wide variety of mortgage programs available. The right mortgage for you will depend on your particular situation. Following are different loan programs and ways to increase the likelihood of obtaining financing if you’re an independent contractor.
Conventional loans are usually best for those with a strong credit score and two years’ worth of tax returns. Lenders will base their evaluation of borrowers on their credit, income, and down payment amount. In addition, 15 or 30-year terms to repay the original loan and any accrued interest are standard.
Every situation is unique, but generally, the lower the credit score or income, the riskier a borrower is to lenders. As a result of this perceived level of risk, a bank will usually charge a higher interest rate. Borrowers have the option between two different types of rates for their loans. A fixed rate is often higher but doesn’t change with fluctuations in the market. Alternatively, adjustable-rate loans usually have a lower interest rate, but the rate will fluctuate with the market.
When you’re self-employed, demonstrating a reliable income stream that will allow you to make on-time payments can be a challenge. Independent contractors and freelancers don’t have W-2’s or pay stubs to prove their income. So, lenders will want to see at least two years of tax returns to show a consistent annual salary.
It can be tempting to add as many deductions as possible on your taxes when you’re self-employed. But, keep in mind that declaring a lower income will also make you less appealing to a potential lender. For this reason, if you’re a contract worker, be meticulous in your record-keeping. It’s also important to maintain separate accounts for business and personal expenses.
Being mindful of the income you declare on your tax return is not the only consideration. Self-employed individuals should try to come to the table with a larger down payment whenever possible.
While it is possible to qualify for a mortgage with only 3.5% down, the more money you put down, the more favorable your loan terms will be. For example, if you can put at least 20% down, your lender won’t require you to take out private mortgage insurance (PMI).
Federal Housing Association (FHA) loans
FHA loans are beneficial to buyers with a lower credit score or small down payment.
The FHA is a government agency that will insure loans given to homeowners who can’t qualify for a conventional loan due to limited savings or low credit scores. With an FHA-backed loan, lenders have protection, so they’re able to offer favorable terms to borrowers, including lower rates. So, the terms of an FHA loan can be beneficial to an independent worker who invested money into their business instead of saving for a home. You can put down as little as 3.5% to become a homeowner with an FHA loan. Also, borrowers with credit scores below the recommended 620 are often eligible for an FHA loan program.
It’s essential to find a local loan officer who has experience working with the self-employed so that they can find the right program for your situation.
Private money loans
Private money loans are a risk, but you can get money quickly
Often referred to as “hard money” loans, you don’t secure one with your creditworthiness or low debt to income ratio (DTI). Instead, you obtain a private loan by pledging an existing asset to guarantee your likelihood of repaying the loan.
Your DTI is important to lenders because they want to ensure you won’t be using all of your remaining income towards your mortgage payment. If your DTI is above 43%, it will be challenging to qualify for a loan from a traditional lender. However, if you already have assets to pledge to a private lender, you can probably obtain a hard money loan.
Because a private lender will be able to transfer funds to you much faster than it would take a bank to process a loan, access to hard money puts a homebuyer in a strong position in the eyes of a seller. So, the considerable risk involved with this type of loan is that if you default on your payments, the lender will repossess the asset you used as collateral.
V.A. loans and USDA loans
To be eligible for a V.A. loan, you must have served in the U.S. military or be a surviving spouse of someone who did. United States Department of Agriculture (USDA) loans are an excellent option for buying in rural areas.
V.A. loans exist to offer advantageous terms to borrowers who have or currently serve in the military. In collaboration with private lenders, the U.S. Department of Veterans Affairs provides loans that are more secure, less expensive, and usually don’t require a borrower to acquire a PMI policy since the V.A guarantees the loan. In some cases, a down payment might not be necessary.
A self-employed person could use a USDA loan to buy a home in a rural area. Similar to V.A. loans, USDA loans usually offer options to lower-income borrowers. However, they will still require the buyer to take out a mortgage insurance policy.
As with any loan program, finding a local lender with plenty of experience with the program you are applying for is essential.
The Bottom Line
Whether you have a side hustle to supplement your regular income or work full-time as a self-employed business owner, you should never feel that homeownership is outside of your reach.
Let’s chat so I can put you in touch with a lender that can help you find the best program for you. And if, for some reason, you don’t qualify for a loan at this time, I’ll be sure that you’re clear on the necessary steps to take so you get to a position where you will qualify. I’ll be there with you all along the way.