What to Know Before Buying Your First Home as a Freelancer
In 2017, my wife and I bought our first home in upstate New York using only my freelance income. I had recently quit my full-time job and had not yet set up a legal business entity, so…
I was not exactly an ideal candidate for a mortgage in the eyes of the bank, but we were still able to buy our first home without much difficulty — and you can too!
Even if you’ve always dreamed of owning a home, the process of actually buying one can seem intimidating and overwhelming. Combined with the unpredictable nature of freelancing and lack of a W-2, home ownership can seem… impossible.
That’s why I want to share what I learned during the transaction process and reassure you that it is possible to buy a home using your freelance income.
However, you need to understand the lending process and realize that financial institutions have not yet improved this process for the 60 million Americans who are freelancers (36% of the entire workforce).
My parents have been full-time realtors for most adult life, so I’ve picked up a few tips over the years on how to navigate the transaction process.
Most of this article will focus on the mortgage (lending) process because that’s the most mysterious and challenging part of buying a home for freelancers.
What’s in this article?
- Working With a Realtor
- Realtors vs Real Estate Agents
- The Mortgage (Lending) Process
- Pre-Approvals vs. Pre-Qualification
- Underwriting & Income History
- Local Banks
- Contingencies
- Loan Types
- Negotiating
- Budget
- Down Payments & Closing Costs
- Property Taxes & Home Owners Insurance
- Principal Payments vs. Interest
- Mortgage Interest Tax Deductions
Disclaimer: My research and experiences on this subject are not exhaustive. Other states and countries may have different rules, regulations, and laws. I’ve done my best to simplify what I learned along the way, but you should always do your own research, consult with a realtor and seek independent legal counsel.
Work With a Realtor
When you’re getting serious about buying a home, you need to find a realtor to work with. A realtor will help you navigate the home-buying process. They work on commission, meaning they don’t get paid until you close on your new home. That gives them a strong incentive to help you find your perfect home.
One thing most people don’t realize is that you can interview realtors and choose who you want to work with. As long as you don’t sign a buyer’s agreement, you’re also under no obligation to continue working with a realtor if they aren’t getting you results or if you don’t feel comfortable working with them anymore.
Note: You need to balance this with professionalism and respect. You shouldn’t just bounce from one realtor to another especially if they’re making a strong effort to help you find a home. The home-buying process is complex and takes time, so you need to be patient and trust the person you’ve decided to work with.
Unfortunately, my wife and I found ourselves in this situation. Our first realtor ended up being inattentive and unresponsive. It was obvious we weren’t a priority. It didn’t take us long to part ways and interview a new realtor. She was wonderful to work with. We got everything we wanted for only $10k over our original budget and in the exact town we wanted to live in!
Realtors vs. Real Estate Agents
Real-estate agents are also different from realtors. Anyone can be a real estate agent, but realtors are held to a higher standard. A realtor must be a member of the National Association of Realtors, which requires extra training, a valid real estate license, and an immaculate conduct record.
When choosing a realtor to work with, start by asking family, friends, and your professional connections for recommendations! You don’t just have to walk into a real estate office and work with whoever they pair you with and you should interview multiple realtors. In fact, you should interview accountants too. Don’t commit someone at random.
It’s perfectly acceptable to ask questions such as:
- How well do you know the area?
- Do you live nearby?
- How much experience do you have?
- Have you worked with first-time home buyers before?
It’s critical that you’re working with someone experienced, knowledgeable, trustworthy, and well-connected. This is the most significant and complex purchase you’ll ever make and it can be confusing and stressful. That’s why it’s imperative you work with someone you completely trust!
The Mortgage (Lending) Process
Most people can’t purchase a home entirely in cash, so you’ll need a bank loan, also known as a mortgage. The process of acquiring a mortgage is called the “lending” process.
It’s important to understand that you can’t get fully approved for a mortgage until after you make an offer on a home. That’s because the bank doesn’t know how much they need to let you borrow until they know the price of the home and how much money you’ll allocate for your down payment.
However, you can get pre-approved or pre-qualified.
Pre-Approvals & Pre-Qualification
Before you make an offer on a home, you’ll want to get pre-approved, which is different from a pre-qualification.
You can get pre-qualified online in minutes without ever talking to another human. Pre-qualifications carry little weight in the real estate world. However, a pre-approval letter is much more meaningful and your credit score will usually be a leading factor in obtaining one.
You may be able to temporarily lock in an interest rate and a specific loan amount with this letter as well. This indicates to the seller that you’ll likely be approved for a mortgage, which makes your offer less risky.
Pre-approval letters usually have an expiration date (typically 30-60 days), so plan accordingly and don’t obtain one until you’re ready to begin shopping seriously for a home. This will also minimize your credit inquiries. Running your credit too frequently can have a negative impact on your credit score.
Pro Tip: It’s paramount that you have a good credit score when applying for a mortgage. Banks use your credit score to set the interest rate on your mortgage. The lower your credit score, the higher your interest rate.
The offer you make on a home will be strongest with a pre-approval letter. This gives the seller more confidence when considering your offer.
Lastly, the bank will usually pre-approve you for much more than you can realistically afford. Just because you get pre-approved for $500,000 doesn’t mean you should go out and look for $500,000 homes. Always be sure you can afford the monthly payments and interest charges.
For example, I got approved for over $400k, but the bank didn’t consider my other monthly expenses. So my budget was actually closer to $200k. Spend some time talking with your bank and your realtor about what you can realistically afford based on your lifestyle.
Underwriting & Income History
Once you make an offer on a house, you’ll officially apply for a mortgage loan. If you’ve been pre-approved, this is where you’ll become fully approved.
A major part of the lending process is known as underwriting. During this process, the bank reviews your finances to assess your financial stability. This proves you’re capable of paying back the loan, with interest.
To prove your financial stability, the bank needs to see at least two years of income history — from the same job. In simple terms, the bank is trying to minimize its risk and liability. The less risky you are to a bank, the more likely you are to be approved.
For freelancers, that means having at least two years of full-time freelance income and corresponding tax returns.
A W-2 tax form is still the primary way banks verify candidacy for a mortgage.
If you’re already freelancing full-time and haven’t set up an S-Corp or other legal business entity, you won’t have a W-2 tax form to show the bank.
So what do you do?
The bank doesn’t care about the part-time freelance income you earned on nights and weekends or the high-paying salary job you recently quit. They need to see consistency in your tax returns and bank statements.
Reminder: You won’t get your tax return in January. You’ll more likely get it in the Spring, so plan accordingly. Just because you can celebrate 2 years of freelancing doesn’t mean you’ll also have the corresponding tax returns yet.
Keep in mind that you’ll be approved for a mortgage based on net income, not gross income. You can’t use gross income to pay the loan back. So, if you’re planning to purchase a home, consider taking fewer tax deductions and write-offs to increase your net income. That will make getting approved for a mortgage slightly easier.
Once you quit your job, your freelance income is all that matters in the eyes of the bank. That’s why you have to be strategic about the timing of your career transitions if you’re in the market for a new home.
If you’re freelancing full-time, it’s still possible for you to get a mortgage even without two full years of freelance income history.
However, it will certainly be more challenging and you may not get approved for a conventional mortgage. You’ll likely need to provide your monthly bank statements and you may get stuck with an unconventional mortgage with a high-interest rate.
One creative option is to set up a legal business entity such as an S Corp, put yourself on payroll using a platform such as Gusto, and then you’ll have a W-2 form to show the bank. You’ll save money in taxes and have more legal protection too.
Local Banks
If you have a turbulent employment or income history, you may be more likely to secure a mortgage through a local bank, not a national bank. Local banks tend to be more flexible with their mortgage requirements since they’re smaller and incentivized to take your business away from their national competitors.
When you obtain a pre-qualification letter, it’s important to obtain it:
- From the financial institution you’ll get the mortgage from
- In the location you’re buying in
For example, if you live in New York and want to buy a home in Tennessee, make sure you get pre-qualified from a local bank in Tennessee. Then be prepared to use that bank as your lender.
Don’t quit your day job and start freelancing full-time until after you’ve closed on your home. If you’re already freelancing full-time, consider waiting until you have at least two years of full-time freelance tax returns before applying for a mortgage.
Contingencies
Most freelancers will likely be first-time home buyers. While that can sometimes feel risky to sellers, a major benefit is that your offer will be non-contingent. In other words, you won’t need to sell your old house so you can afford to buy the new one.
More than likely, you’re moving from a rental unit, which also means you can be more flexible with your closing date. When you’re buying a home, the strongest offer you can make will be full-price and non-contingent with a flexible closing date.
This all gives you a strategic advantage when negotiating with the seller.
Loan Types
There are many types of mortgage loans you can use to finance your home. Because I didn’t have two years of consistent income history, we had a hard time qualifying for a conventional mortgage. Instead, we got a portfolio loan through a local bank.
A portfolio loan is a mortgage where the lender (local bank) originates and retains the loan instead of reselling it on the secondary mortgage market (how most mortgages work). It’s a useful home financing option for those who might not qualify for traditional mortgage loans due to their financial situation.
However, the portfolio loan had a 10-year balloon payment. That means at the end of 10 years, the bank reserves the right to ask me to pay the entire balance of my loan or risk losing my home. The bank assured me they’ve never had to enforce that on anyone, but it was unsettling.
That’s why I confirmed that I could refinance to a conventional mortgage at any time after closing. Three years later when the market dipped, I refinanced to a low-interest rate conventional mortgage to eliminate the risk of the balloon payment.
Negotiating
When you’re searching for a home, you’ll be seeing a “list price”. The list price is the amount of money the seller wants to receive for their home. In other words, this is how much they believe their home is worth.
As you can imagine, sometimes sellers set the price of their home too low or too high. Technically, you’re allowed to offer any price for the home, but this will affect the strength of your offer. If a home is listed at $200k, you can offer $180k or $220k.
But when it comes to negotiating, it’s not always about money. When my wife and I bought our first home, our offer was the lowest of 3 competing offers. The seller ultimately chose us because we had the most flexible closing date. They had children and were building their next home, so a non-contingent offer with a flexible closing date was more valuable to them than extra cash.
You can also negotiate things like furnishings, appliances, renovations or upgrades, and more. Work closely with your realtor to negotiate the best offer!
Budget
It would be wise to do some risk-assessment when establishing your budget as well.
Let’s say your budget is $200,000. You find the perfect house listed for $210,000. There could be several competing offers or there could be no competing offers. Your realtor will help you navigate the process of making a competitive offer, but generally speaking, you want your offer to be as strong as possible.
If there are competing offers, you might ask yourself, “should we offer more than the asking price?” The house is already $10,000 over our budget so this is a significant decision.
What’s important to remember here is that you’re not paying an extra $10,000+ in cash. Rather, it’s being added to a 15 or 30-year mortgage. That means it will have a relatively minor impact on your monthly mortgage payments. Here’s a simplified example for illustration purposes:
Example: There are 360 months in a 30-year mortgage. If you buy the house for $200,000, that works out to $555/mo. If you bought the house for $215,000, that works out to $597/mo — an increase of $42 per month on your principal payment (excluding interest adjustments).
Perhaps the greatest advice our realtor gave us when making our offer came in the form of a question:
“Will you be sad to lose the house for $210,000? For $212k? $215k? $220k?”.
That got me thinking about what I was willing to pay from a different perspective. I’d be upset if someone else bought the house for $212k. In other words, I’d be sad to lose the house for $2,000. But if $215k wasn’t good enough, then I could live with that. $15k over our original budget was more than I wanted to spend.
Best Seller!
Down Payment & Closing Costs
When you buy a house, you’ll need to make a down payment. The amount can vary greatly depending on what you can afford, but the larger your down payment, the better. A larger down payment will reduce the amount you need to borrow and you’ll ultimately pay less for your home over the life of the loan.
The ideal down payment is said to be 20% of the purchase price. So if your new home cost $200,000, your down payment would ideally be $40,000. However, most people (especially first-time home buyers), don’t have $40,000 cash to spend on a down payment.
Pro Tip: Even if you do, remember you can’t spend all of your savings on a down payment. You’ll need to furnish the house and pay your bills after moving in, so you need to keep some money in the bank!
You can make a smaller down payment (as low as 3%), but you might have to pay PMI (private mortgage insurance). Talk to your bank and realtor about your options.
In addition to your down payment, buyers also need to pay closing costs while sellers pay the realtor’s commission. Closing costs may include the following and can be 2-5% of the purchase price:
- Appraisal fee
- Application fee
- Home inspection fee
- Credit report and credit supplement fees
- Mortgage origination fee
- Lender’s policy title insurance
- Escrow fee
- Closing attorney fee (in some states)
- Courier fee
- Bank processing fee
- Recording fee
- Notary fee
- Loan discount points
- Homeowners association transfer fees
Property Taxes & Home Owners Insurance
“Property taxes” is actually a misnomer since this tax includes property and school taxes. Each year you’ll need to pay property taxes, even if you’ve completely paid off your home. You’ll also pay school taxes regardless of whether you have children. Most of the time, these taxes will be built into your monthly mortgage payment.
However, you can choose to detach your tax payments from your mortgage and make lump sum payments on your own twice a year. Property taxes will be due on different dates depending on the state you live in. School taxes are typically due at the beginning of the school year — around September 1st. In our town, property taxes are due in January.
If you choose to pay these taxes on your own, it will be your responsibility to save throughout the year and pay them on time. That takes tremendous discipline, so plan accordingly. For me, that was easier than paying more per month since my freelance income can fluctuate and be unpredictable.
You’ll also need to pay homeowners insurance. This can vary greatly based on your location, but should be less than 1% of the value of the home. If you’re paying more than that for homeowners insurance, shop around and try to find a better rate.
It took me two years to realize that my insurance company was charging me almost $800 per year because the prior owners had a fire at the house. The insurance company claimed the added insurance cost stays with the home, not with the owner. So I was paying for a mistake someone else made in a house they don’t live in anymore!
That is frustrating nonsense, so I demanded they recalculate my rate, which they ultimately did. You really have to pay attention and advocate for yourself during the home-buying process, but a good realtor will help you navigate it successfully.
Principal Payments vs. Interest
A $200k house can easily cost you $400k at the end of a 30-year loan, but most people don’t understand why. It’s easy to focus on the monthly payment, which can be deceiving. The total cost of the home at the end of a 30-year mortgage may need to be legally disclosed, but it’s rarely discussed.
With every loan, there are two key components: principal and interest charges. The “principal” is the base payment. The “interest” is an additional payment made to the bank. You can think about interest as the bank’s profit. It’s their reward for letting you borrow money.
These two amounts are always presented as a single number (your mortgage payment). So if your mortgage payment is $2,000 per month, some of that will go toward your principal balance and some will go towards the interest charges.
Example: Let’s say you buy a $200,000 house and put $20,000 down. You take out a loan at 6.5% interest. Your monthly payment will be about $1,200 per month excluding taxes and other fees. That house will cost you over $400,000 at the end of the 30-year mortgage!
It’s critical to understand that ONLY your principal payment will actually reduce the mortgage amount. It’s also critical to understand that banks automatically frontload your payments toward the interest, not the principal.
So for the first several years, your monthly payments will primarily cover interest charges. Over the life of the loan and as your interest is paid down, your payments will gradually start covering your principal balance.
Notice the green and blue lines in the graphic below:
Sometimes you’ll be able to specify how much goes toward your principal payment and your interest payment. At a minimum, you’ll be able to make extra payments specifically toward your principal balance. The sooner you can pay down the principal balance, the less interest you’ll pay over the life of the loan and the less you’ll ultimately pay for your home.
Again, when you start paying back your loan, your payments will be applied almost entirely toward the interest for the first several years. That’s because the bank wants to start getting their money back as quickly as possible.
Mortgage Interest Deduction
While that might not sound concerning at first, one benefit is that you can deduct most (or all) of your mortgage interest payments on your taxes. That means if you pay $5,000 in mortgage interest during your first year of home ownership, you can likely lower your taxable income by $5,000.
Check with your accountant to determine how much of your interest you can claim as a write-off. It might be all of it!
Disclaimer: My research and experiences on this subject are not exhaustive. Other states and countries may have different rules, regulations, and laws. I’ve done my best to simplify what I learned along the way, but you should always do your own research, consult with a realtor and seek independent legal counsel.
Summary
While the home-buying process can seem intimidating, stressful, and complex, I hope this article de-mystified key parts of the process to make it easier. Save as much money as you can, work with a realtor you trust and respect, time your move carefully, calculate your budget, and don’t spend all your money on the down payment and closing costs.
Timing is everything when you’re buying a home as a freelancer, so be patient and trust your realtor. Research the process and get prepared as much as possible before you start shopping seriously. If this guide helps you find your dream home or navigate the process more confidently, please let me know. I’d love to hear your story or see a picture of your new home!
Last updated on March 7th, 2023
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