“And what do you do for a living?” the loan officer asked, turning to me. “I’m a freelancer,” I answered him.
Whether you call yourself a sole proprietor, a term stolen straight from the IRS, a freelancer, an independent contractor, or self-employed, working without the safety net of a boss or a company boils down to one thing: an undependable source of income. I’d always been proud of the work I’d done freelancing, until time came to apply for a mortgage. As soon as I told the loan officer at our bank that I was a freelance writer, he immediately fired back with a barrage of questions:
- How many organizations do you do business with?
- How long have you been freelancing?
- What’s your average monthly income?
- What’s been your biggest grossing month? Your lowest?
- Has your client list been holding steady or growing over the past year?
While I’d kept meticulous records – including my tax returns, naturally – over the 18 months during which I’d been freelancing and was able to answer the mortgage broker’s questions, I felt scrutinized. I felt insecure. I felt overwhelmed. “Because of your unique situation,” he began, “we’ll have to refer your loan application to the underwriters for closer evaluation.”
Brilliant.
When I started researching how to freelance – before I even left my full-time job – I’d been warned that many financial institutions didn’t look highly upon freelancers with unstable income. Whether you’re applying for a mortgage, an auto loan, a personal loan, or anything in between, loan officers and underwriters are looking for one thing: consistency. Here’s how you can achieve the aura of stability in a very unstable career.
Keep Accurate Records
Each month, I submit invoices to five different individuals or organizations. Some of the invoices are for relatively small amounts of money – less than $100 each. My largest is often for several thousand dollars. When the checks arrive in the mail, they aren’t accompanied by a pay stub like my husband receives with his biweekly paycheck. Instead, they typically come with only a half sheet of paper attached to the check, outlining to which invoices they correspond. I make sure to staple those half sheets to my original invoice. Not only does this help me during tax time, but it also gives me a way to show proof of income at any point in the year.
Expand Your Client List
If you were working for a traditional employer, would you be content to linger in an entry-level position? Probably not. You couldn’t be content to linger with a painfully small client list either. Banks and credit unions want to see freelancers whose business is growing. An ideal loan candidate should show year-to-year, and preferably month-to-month, growth. There are plenty of ways to achieve this:
- Ask your current clients for referrals. Whether you’re a freelance writer, a general contractor, or a bookkeeper, your clients most likely know other individuals or businesses in the same industry who could use your services.
- Advertise. With a little computer programming knowledge and a few bucks a year, you can set up a basic web page to advertise your services. Or, even better, create a Facebook business page or a LinkedIn profile to help spread the word about your freelance work.
- Network with other professionals. If there’s one thing I’ve learned while freelancing, it’s that it can be lonely work – there’s no office, no coworkers, no boss with whom to interact. Networking can not only alleviate some of this loneliness, but it can also connect you to other freelancers in your industry who can connect you with potential clients.
Pay Yourself
This is actually a three-step process, all leading to the ultimate goal of paying yourself:
- Set a goal for your annual salary. Since freelance work usually pays per project, this can be difficult. My largest contractor tends to send me little to no work the last month of every quarter, so when I calculate my yearly income, I tend to look at it based on eight months instead of 12. This ensures that I under – rather than over – estimate my annual earnings, giving me crucial wiggle room.
- Budget your income. As a freelancer, taxes aren’t taken out of my paychecks. Instead, I set aside roughly a third of every dollar I make to pay my year-end tax bill. I have a friend – a fellow freelancer – who failed to do this her first year in the business, and she was hit by a four-digit tax bill in April. Ouch. Be sure to factor in other business and overhead expenses as well.
- Pay yourself. Once you’ve set money aside for your taxes and the cost of doing business, give yourself a salary. Try to keep this monthly paycheck as consistent as possible. Because I know I’ll bring in a solid income in April and May – but earn next to nothing in June – I’ll apportion my income from the first two months to pay my salary in the third.
Pay Down Your Debts
Lenders want to see a low debt-to-income, or DTI, ratio when they approve you for a loan. Most mortgage underwriters are looking for a DTI at or below 41 percent. If you end up with a surplus from your salary, use it to pay down existing debts. Start with high-interest debts, like a credit card balance or an auto loan. Leave low-interest debt, like a consolidated student loan, for last. By minimizing your debt, your income will appear bigger, even if it isn’t. It’s kind of like standing next to a short person; there’s nothing like hanging out around someone who’s 5′ 2″ to make your 5′ 4″ frame look dramatically taller.
Save & Invest
Some may argue that this should be a part of budgeting your income, and in many ways, I agree. When you’re first starting out freelancing, you may not feel capable of building your emergency fund or investing in your retirement account. As you get more comfortable as a freelancer, you may be able to put 10 percent of your pre-tax income into a Roth or traditional IRA before paying yourself. Either way, growing your nest egg is a crucial part of how to freelance. Not only is this important from a standpoint of personal security, but it’s also vital that lenders see a potential source for your down payment when they examine your finances. The larger your down payment, the smaller your loan – and the less monthly income you’ll need to gain the underwriters’ approval.
The Last Word
Even if you follow the above advice, you may still find yourself on the short end of the stick. But here’s the good news: even if the bank won’t recognize your freelance income, it still exists. You’ll still have that money to pay your bills, grow your investments, expand your savings.
Me? It’s been five business days and I’m still waiting for the bank’s final decision; my loan officer said it could take up to two weeks. So for now, I wait…
Whether you work as a freelancer or a traditional employee, what do you do to maximize your financial portfolio?
{ 11 comments… read them below or add one }
Dealing with banks is probably the #1 reason I haven’t tried to strike it out on my own as a freelancer. I know that’s a lame excuse but at this stage in our rental property business, we are heavily dependent on bank financing and it goes a lot smoother when you have a W2!
This is great advice. I work at a bank, and am guilty of being a person who plays 101 questions when a client states that they are self employed. The main reason is most of the self employed smaller businesses that I deal with claim no income or a loss. They generally tell us that their accountant told them to do it so they can save money. This causes a problem when they come in for a loan, as you have stated in this post. This should be a mandatory reading for anyone looking to start a business.
Awesome article. I think everyone is now scrutinized pretty heavily when it comes to getting a mortgage (which is about time) but freelancers have always been, unless their spouse works — in which case the usual route is to just disregard their income entirely if possible.
Great article. Branching out on your own is a difficult process, but if you’ll be doing something that you love or making more time for your family and yourself, the little headaches are worth it. And though the banks may scrutinize you more as a freelancer, a good accountant can make sure you always have your ducks in a row.
Canadian mortgage brokers, including non-financial insititutions like YMCA community centres, seem to be fine with a notice of tax assessment (NOA) for the past 2 years for those self-employed. Similarly, those with full-time employers however, may only be asked for their last 2 paystubs. It is unfair but I understand where the lenders are coming from.
Great article!
This is why I hate dealing with banks. Chances are that you are better with your money, but because of your “title” you are being looked at closely.
Great advice Elizabeth (I’ve been saying that a lot lately).
These are so great insights into the challenges associated with having unpredictable income. I like how you lay it out. I’m sure the banker is hopefully referring you to a manual underwriter, which is what it sounds like. If so, that’s how loans should be made ANYWAY. Good luck!!!
It is so sad that this is reality. It should have been the other way around. As an established freelancer with multiple customers, you have a much more secure base than someone working for a large corporation. Suppose you work 12 years for a big company and they have to cut costs. Suppose you get kicked out and maybe a one year salary (before taxes) in your pocket as “golden” handshake. How likely is it with unemployment over 8% that you find another job within a year with similar pay? Yes, some will, but many won’t. My prediction… it still will take many years, but at a certain moment the banks will welcome the established freelancers with open arms.
Very helpful advice. In my case, I was able to request for a certification from my long-time client to serve as evidence of my regular stable income. I really like the eight-month over-estimation method. I’ll also apply it from now on. Thanks.
Great post Elizabeth! Being on your own trade does come with such not so good things. But if you are an authority in the field that you are in I guess you can easily increase your client list by way of referral and in the end by the time you are face to face with other people your credibility speaks for themselves.
I am tied to two jobs, the traditional and virtual. I almost gave up the former to be a full time VA! Thanks to my spouse’s advice. I kept it.
Truly, if blessed with a generous employer, freelancing can be financially rewarding, however, when it comes to loan applications, freelancers are usually singled out because of the instability of the job. What I do to maximize my financial resources is follow this philosophy:
Earn More , Spend Less = Save More
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