Q: I saw your webinar recording, Five Options for Dealing with Debt, on the NAR website and loved it.
I have a family member who wants to buy a home this year, but here’s the situation:
The husband and wife have been working as business owners since 2020, and the wife also has another job, and she is a w-2 employee who started working last year in December 2022.
They both have credit card debts and make more than the minimum payments. I want to know if they qualify for a mortgage in this scenario.
Answer to your question:
Your relatives can still qualify for a mortgage — even with credit card debt — as long as they meet a lender’s requirements for DTI (debt to income ratio) and credit scores.
Furthermore, their status as entrepreneurs also does not preclude them from making the leap from renters to owners, so they will just need to supply more documentation.
Here’s an explanation of what they need to know about both of these circumstances to make their homeownership dreams a reality.
Debt, Credit, and Getting a Mortgage
Typically, banks want to see that borrowers have no more than 43% (and sometimes a maximum of 48%-50%) of income going toward total debt repayment.
This includes total housing costs (principal, interest, taxes, and insurance) PLUS other traditional credit obligations, like credit card payments, student loans, and auto loans.
They would also need an acceptable down payment (a minimum of 3.5% for an FHA loan or at least 5% down for a conventional loan), along with closing costs.
In summary, if their DTI is not too high, they have credit scores of at least 620 (and preferably 700 or more), and they can come up with a 3.5% to 5% down payment and closing costs, and they can get approved for a mortgage.
Lots of people obtain home loans even though they still have outstanding credit card bills, student loans, and other debt.
So just having debt is not a barrier to them becoming homeowners.
Paperwork Required from Entrepreneurs Seeking Mortgages
People who have regular 9-to-5 jobs, and those who are employees, need to supply W-2 forms and 1040 tax return information to lenders when applying for a mortgage.
For self-employed individuals like your relatives, the bank or financial institution will ask for two years of tax returns.
Your family members can give their 2022 and 2021 tax info. If they have not yet filed for the 2022 tax year or will be getting an extension, they can send the lender their 2021 and 2020 taxes.
Either way, the lender will take the average income from the two years as the income used to qualify them for the mortgage.
Note that small business owners typically try to write off all related business expenses. This ultimately lowers their net income.
Lenders will be looking at their adjusted gross income (which is roughly their net income).
Pro tip: sometimes entrepreneurs who know they will need a mortgage decide NOT to take every deduction or tax credit for which they would be eligible — to make their adjusted gross income higher.
So if your relatives have not yet filed their 2022 taxes, they should consider this strategy if they think they need to boost their AGI for mortgage qualification purposes in 2023 or 2024.
Lenders will also likely ask for their 1099 income statements received from any self-employment sources or clients.
Since the wife also began working in late December 2022, she may not have even received her first paycheck from her employer last year. Therefore, she wouldn’t have received a 2022 W-2 income statement.
Even if she did, the amount of income was likely negligible and probably wouldn’t make a big difference in their total 2022 income.
But going forward, her W-2 income may help them to qualify for a mortgage.
Again, lenders usually want to see two years of income. So assuming she keeps that full-time job, she should also give the lender her most recent pay stubs to show job continuity.
If she has an offer letter or contract from her employer, submit that too in order to show job stability to the lender.
Lastly, they should be prepared to give other routine mortgage documentation, like their last two months’ bank statements, copies of investment accounts, or any documents that reflect savings and assets.
It’s not always easy to get a home loan when you’re self-employed, but it can be done!
As I mentioned in the NAR webinar, I own my own business and have successfully secured numerous properties with bank financing over the years.
Ok, that’s everything.
Good luck to your family members, Alex!