If you're a 1099 employee, your lender considers you to be self-employed and evaluates your mortgage approval somewhat differently than they do for regular W-2 employees. From the prequalification to final underwriting processes, your lender will consider factors such as the length of your self-employment, your past few years of earnings, your credit profile and current debt levels to decide whether you can get the loan. If you're looking for an estimate of how much you can afford to spend on a new home, getting prequalified is a good step, and moving forward with preapproval will allow you to begin a more official application process.
Basics of Mortgage Prequalification
When you're considering buying a home, the first financial step you often take is to obtain a mortgage prequalification from your lender. By simply calling the bank or submitting a form online with basic information about your 1099 income, debt and assets, you can get a quick estimate of how much you could afford to borrow for a home. This step relies on the information you verbally report or type, so it often doesn't require a credit pull or submission of documents like tax returns or pay stubs. Because of this, getting a prequalification doesn't guarantee you'll be approved for a mortgage.
However, prequalification can help you decide whether now is a good time to buy a home as well as how much house you can afford. Your lender may also give you a prequalification letter that you can show a real estate agent, who can help you find something within that budget. This letter will usually state additional conditions that you'll have to meet if you want to get official approval. The prequalification process also provides an opportunity to ask the lender questions about the mortgage approval process, which is often more complex and comes with more documentation if you're a 1099 worker.
Prequalification Vs Preapproval
While getting prequalified can show you whether buying a home is within reach, the more official step is to seek a preapproval from your lender. This involves filling out a detailed application, having your credit checked, submitting official documentation and stating how much of a down payment you can afford. The lender will usually make a decision within a few days that will state your loan approval amount, estimated interest rate and potential closing costs. You can expect to receive a preapproval letter that your lender can forward to your real estate agent, giving you an advantage on the house hunt.
As long as your financial situation doesn't change, and the property passes inspection and appraisal requirements, a preapproval gives you and potential sellers peace of mind that your application will likely meet the underwriter's requirements. However, the preapproval is also no guarantee since you'll need to be able to submit any additional documentation and meet deadlines to complete the process. Also, the preapproval typically expires within 60 to 90 days, so if you don't find a house quickly enough, you may need to submit new documentation to the lender for renewal.
Getting Your Documentation Together
While you probably won't need to submit anything official for a prequalification, you still need to obtain important details about your income for the last two years, your monthly debt obligations and how much you have in cash and other assets. And when you move forward with preapproval as a 1099 employee, your lender will require certain documents that W-2 employees usually don't provide. The underwriting process often involves submitting additional documents as needed.
Some documentation you may need to provide your lender throughout the mortgage approval process include:
- Tax returns: If you're a sole proprietor, your lender will want to see your last two years of personal federal and state tax returns that show your 1099 income, including Schedule C and Schedule SE. If you're part of a partnership or run a corporation, you'll likely also need to present two years of business tax returns.
- Other proof of 1099 income: Your lender will want to see the Form 1099-MISC for each company for which you do work. If you don't receive this form due to not earning enough to meet the filing threshold, you may need to gather checks, bank statements and other proof of payment.
- Business financial statements: The lender may ask you to make a profit and loss statement, especially if your income has changed a lot since the last tax return. You may also need to show a recent income statement and balance sheet. Lenders may require you hire a professional accountant to audit these files for accuracy.
- Business license (if applicable): If your line of work requires a business license, permit or other credential, have it ready in case your lender asks for this as verification.
- W-2 forms and pay stubs (if you have another job): If you also work a regular employee job and just do 1099 work on the side, your lender will need a few of your recent pay stubs, including documentation that shows your year-to-date earnings. You'll also need to supply two years of W-2 forms from your employer.
- Bank account statements: Your bank account statements can serve as a way to prove your self-employment income as well as show the lender you have enough money saved for the down payment and closing costs. Your lender may request the balances of savings and checking accounts as well as retirement accounts and other investments.
- Credit card and loan statements: Your lender may ask for statements from creditors, but these documents help you anyway when adding up your monthly debts during the prequalification and preapproval steps.
- Gift letter (if applicable): If you'll get your down payment money as a gift from a family member, friend or acquaintance, your lender will probably ask for a letter from the donor to prove that you'll have these funds.
Preparing a Mortgage for 1099 Employees
Once you have your documentation together, you're ready to start the process of applying for your mortgage as a 1099 worker. Before you start filling out the application, though, you'll want to do a bit of research to find a lender who is convenient to you, offers attractive interest rates and offers any special programs that interest you, such as first-time homeowner programs and down payment assistance. You may also want to obtain your credit report from a source such as AnnualCreditReport.com or Credit Karma to make sure you have no negative marks that may work against you.
You'll also want to research loan programs and their requirements so that you can work with the lender to get the right loan for you. For example, if you have good credit and can afford a sizable down payment, you might seek a conventional loan since you can possibly avoid paying for private mortgage insurance. FHA loans for 1099 employees, however, can make sense when you have a lower credit score and are willing to pay more in fees in exchange for a lower down payment. If you're a veteran, you may find the Veterans Affairs loan with no down payment a good alternative.
Beginning the Application Process
With your preparation finished, reach out to your chosen lender to begin the prequalification and preapproval processes. You'll likely first chat on the phone or online to gather basic income, debt and asset information and estimate an approval amount. You can then expect to begin the preapproval process by completing an application that might ask for the following information:
- Personal and contact information for each borrower
- Current employment and self-employment income sources and amounts
- Any other income sources such as alimony, Social Security, disability or retirement income
- Financial assets such as bank accounts, investments and trusts
- Liabilities such as credit accounts, installment plans, non-real-estate leases and child support costs
- Existing property ownership information
- Purpose and type of the home loan, including intended property use
- Any planned rental income
- Any gifts you plan to use for the purchase
- Declarations about the property and your financial history
After filling out your application, you'll usually hear back with a preapproval decision within a few days. Once you do find a property and your offer gets accepted, you'll work with the lender throughout the underwriting process to finalize your mortgage application, supply documents such as additional proof of 1099 income, complete appraisals and inspections and answer any questions needed to close on the loan.
Approval Factors for 1099 Employees
Your lender will use the documentation you provide, requirements lists for the loan program you choose and underwriting factors to determine if you're ultimately approved for the mortgage and have a successful closing. Some common approval factors lenders look for when working with 1099 workers include:
- Credit score: Generally, lenders like to see credit scores of 620 or higher, and the higher your score, the better interest rate you can expect. The minimum score will also vary by loan program; 620 or higher is typical for conventional loans, but FHA loans can allow borrowers with scores as low as 500 to qualify for a home.
- Length and stability of self-employment income: This is one factor that can become a roadblock for applicants who are new to self-employment or just haven't shown steady income yet. The Fannie Mae employment history gap guidelines usually look for two years of documented steady income, whether you're working as a W-2 employee or 1099 contractor. If you've been self-employed less than two years, it can become trickier to qualify for a loan, but underwriting rules may allow for approval with less time if you can show you've worked in the same field before becoming a 1099 worker.
- Amount of income: Income determination also varies for 1099 workers. While a lender would just go by a yearly salary or hourly pay rate for a W-2 employee, they usually average your last two years of income from your tax returns to determine your self-employment income. This may present an obstacle if you made little money one year, if you claim a lot of expenses or if your income has risen substantially in the current year. In the case of large income variations, the lender may need to consider a recent profit and loss statement to ensure you're still seeing steady earnings.
- Front-end debt ratio: Your lender will divide your estimated monthly housing payment (mortgage, taxes, insurance and any association fees) by your computed income and the estimated monthly housing payment. The resulting ratio should be no higher than 28 percent (31 percent for FHA loans) to determine whether you can afford the loan you've requested.
- Back-end debt ratio: Your lender will also divide your housing payment and other total monthly debts (both personal and any shared business debts) by your computed income to get a picture of how much debt you carry relative to your earnings. This usually should not exceed 36 percent (43 percent for FHA loans), although lenders do have some freedom to allow for higher limits depending on your overall financial picture.
- Employment verification: Your loan's underwriter will specify how to verify your self-employment status. For example, Fannie Mae verification of employment guidelines allow lenders to use a business license, accountant statement or phone and address listing of your business as proof. A third party such as your accountant or a state business agency can also verbally verify this information.
- Specific loan program rules: Your lender will also have to make sure you meet other guidelines for your loan program. This can include minimum down payment amounts, income limits, home price limits and verification of veteran status in the case of VA loans.
- NerdWallet: Mortgage Prequalification Calculator
- The Lenders Network: 2019 Self Employed Mortgage Guide and FAQ
- Investopedia: Pre-Qualified vs. Pre-Approved: What’s the Difference?
- Upcounsel: 1099 Employee: Everything You Need to Know
- NerdWallet: Self-Employed? 8 Keys to Getting Approved for a Mortgage and Buying a Home
- The Mortgage Reports: Self-Employed Mortgage Borrower? Here Are the Rules
- Investopedia: 5 Things You Need to Be Pre-Approved for a Mortgage
- Fannie Mae: B3-3.2-01: Underwriting Factors and Documentation for a Self-Employed Borrower (12/04/2018)
Ashley Donohoe has written about business and technology topics since 2010. Having a Master of Business Administration degree and experience running a small business and doing tax returns, she is knowledgeable about the tax issues individuals and businesses face. Other places featuring her business writing include JobHero, LoveToKnow, Bizfluent, Chron, Zacks, PocketSense and Study.com.