If you’re looking to help a 1099 contractor client secure a home loan, you first need to understand their unique financial situation. Though a 1099 client’s requirements for approval are similar to those of a traditional W-2 client, the process is often much more stringent. For example, your 1099 client will have to provide several years' worth of documentation (e.g., cash flow statements, tax documents, proof of employment stability). Loan officers must be knowledgeable about what these clients face and able to offer strategies to help them successfully navigate their mortgage loan journey.
Understanding the 1099 contractor landscape.
A 1099 contractor, also referred to as an independent contractor, is a type of self-employed worker who usually provides services to companies or clients on a contract basis. The “1099” refers to the IRS tax form that these workers must use to claim their earnings. Common professions where you may find 1099 contractors include freelance creatives (e.g., writers, artists, performers), doctors/dentists, and real estate agents.
As with any employment type, there are benefits and drawbacks to being a 1099 contractor. They often enjoy the flexibility of having control over their own schedule and projects. Depending on the profession, 1099 contractors also have the potential for higher earnings since they negotiate their own rates. They can also take advantage of various tax deductions related to business expenses, which can help reduce their taxable income.
There are a few disadvantages, as well. These workers typically do not receive benefits, such as health insurance and retirement plans, like W-2 employees do. They are also responsible for paying self-employment taxes including social security and Medicare. Perhaps the biggest drawback is that their income can sometimes be unstable as they can fluctuate between periods of being in high demand and periods with sparse opportunities.
Challenges 1099 contractors face in obtaining a home loan.
Obtaining a mortgage loan as a 1099 contractor can present several challenges compared to traditional W-2 employees. MLOs should be prepared to offer consultative guidance to their 1099 clients about these challenges during the mortgage application process.
Income Verification. A significant part of the mortgage process is providing documented proof of income. Since 1099 contractors do not get W-2, this can be complex because of income fluctuations year over year. Where traditional employees can submit W-2s and paycheck stubs, 1099 contractors will need tax returns, profit/loss statements, and bank statements to verify their income history.
Employment Verification. Lenders usually request at least two years of stable employment, so contractors who work on a project-by-project basis may have difficulty proving consistent employment. Because of this, lenders may want to see years of self-employment history to prove stability.
Debt-to-Income Ratio. A borrower’s DTI is usually considered by lenders to determine how much of a mortgage they can afford in consideration of their other bills. Sometimes, for contractors who have irregular income, DTI calculation can be tricky.
Increased Scrutiny. Part of the mortgage process is assessing risk, which includes the close analysis of a borrower’s financial profile by an underwriter. Contractors may face more stringent requirements, such as a higher credit score or interest rate, to make up for a perceived increased risk.
Loan Program Restrictions. Some loan programs, such as government-backed loans, may have income verification requirements that contractors will find challenging. For example, they may prioritize borrowers who have consistent income records.
How MLOs help their 1099 clients address home loan challenges.
Mortgage loan officers should be knowledgeable about the potential hurdles their 1099 contractor clients will face. By understanding the nuances of each of the following common challenges, MLOs will have an easier time tailoring their approach to provide the best service to their clients.
Income stability.
Due to the often cyclical nature of a 1099 contractor’s work, their income stability could pose a challenge in obtaining a home loan. Although their earnings per contract may be significant, lenders will look for years of consistent employment. So, loan officers should understand how the duration of their client’s employment will work for or against them in the mortgage process.
One way to address this challenge is to analyze the income and cash flow. By taking stock of the dips and peaks in income, MLOs can find the average income over a specific period of time to determine if the borrower will be able to pay the mortgage.
Taxation and recordkeeping.
Taxation and recordkeeping can be another hurdle for 1099 contractors. Not only do they have to keep up with their own tax obligations, but it can also be hard to keep track of what they owe, what they’ve paid, and other expenditures.
Mortgage loan officers should first acclimate themselves with the various tax situations that self-employed borrowers commonly face. In addition to miscellaneous tax forms, MLOs should have a good understanding of profit/loss statements, tax returns, and bank statements. Having a good grasp of the nuances of different tax situations their self-employed clients face can help them determine borrower eligibility.
Recordkeeping can be one of the most crucial factors in loan approval for contractors. Not only will having organized tax records demonstrate the consistent income stream that lenders require, it will create a sense of transparency and confidence in lenders. As loan officers, being proactive and helping your client to understand the necessity of diligent recordkeeping and reporting will go a long way toward a successful application.
Credit history and score.
Creditworthiness is a common requirement for borrowers; for 1099 contractors, this criterion comes with its own challenges. Oftentimes, self-employed professionals will have additional lines of credit to help cover business expenses. Depending on the type of business (e.g., sole proprietorship vs. LLC), those lines of credit could be in their own name. This means they may have higher credit utilization and additional outstanding debts that could affect their DTI ratio.
To address this challenge, first pull the prospective borrower’s credit report and look for any factors that may negatively affect their credit score. An experienced loan officer should be able to identify areas for improvement in accordance with the lender’s requirement for creditworthiness. This also gives you the opportunity to educate your clients on what needs to be cleaned up, general information about payment history, and how to rectify any delinquent items.
Loan officers can help their clients improve their credit score by offering credit-boosting strategies, credit education, and consistent follow-up. For example, teach clients about credit account diversification. Credit diversity accounts for around 10% of a person’s credit score. While it may not be the biggest factor in obtaining a mortgage loan, it can quickly increase your client’s credit score. A 1099 contractors should have a healthy balance of revolving credit (e.g., credit cards), installment loans (e.g., business or auto), and open credit (e.g., utility bills). Another way to help your clients with credit blemishes is by referring them to reputable credit counseling agencies that can assist in improving their score. These agencies can help prospective borrowers with managing debt and setting up a monthly budget.
To provide the best possible service, you should help monitor your client’s progress throughout their credit improvement journey. It’s important to remember that improving credit takes time. Be sure to communicate the need for patience and diligence to your clients.
Key takeaways
Loan officers face several challenges when assisting their 1099 contractor clients with obtaining a mortgage. Between income stability, credit concerns, and taxation, the journey to approval can be more stringent than applicants with traditional W-2 employment. However, homeownership is as beneficial for 1099 contractors as it is for other segments of workers, and may even offer these employees additional financial rewards such as the ability to lower the tax burdens inherent in self-employment.
FAQs
What are the requirements for a home loan as a 1099 contractor?
The requirements for a mortgage loan as a 1099 contractor are the same as they are for other buyers. Income, creditworthiness, and debt-to-income ratio are required for approval. However, they are more stringent than they would be with a traditional W-2 applicant, and often undergo more scrutiny.
How can I help my 1099 contractor client demonstrate income stability?
Length of self-employment, cash savings and reserves, length of contracts, and consistency of income over time are all good indicators of income stability that lenders look for during the mortgage loan process.
How can I help my 1099 contractor client improve their credit score?
For 1099 contractors who have less than favorable credit ratings, strategies such as credit counseling, paying off large balances, and making payments in a timely manner will help improve their score over time. A satisfactory history of credit diversification also helps.
How can I help my 1099 contractor client with their documentation process?
Loan officers serve to help facilitate a smoother process for contractors seeking a mortgage. They know what information will be most important to the process and can help clients sort through their tax records, access credit reports, and use profit/loss statements to determine their income and employment stability.
