Comprehensive Guide to Mortgage Loans for Self-Employed Individuals
Mortgage loans for self-employed are more challenging to come by than for the salaried borrower. Lenders have stricter requirements because you don’t work for a third party. In addition, they don’t have someone else to confirm your income with and verify that it will continue for the foreseeable future.
These factors make getting a mortgage loan when you’re self-employed more difficult, but not impossible, especially when you work with a reputable mortgage broker.
Understanding Mortgage Loans for Self-Employed Individuals
Before you apply for a mortgage, you must determine if you’re self-employed.
For some, it’s easy to determine; for others, it’s not as straightforward. If you agree with any of the following, you’ll need a self-employed mortgage:
- You own at least 25% of a business
- You receive a 1099 instead of a W-2
- Your ‘employer’ considers you a gig worker or independent contractor
- You classify yourself as a freelancer or consultant
If you’re ever in doubt, talk to your loan officer first. Be honest about the type of income you receive so you can apply for the right loan from the start.
Eligibility Criteria for Self-Employed Mortgage Loans
When you don’t work for a company but instead work for yourself, lenders must ensure your income is stable and your business is reliable.
Like when you work for someone else, they want a history of you operating your own business. Usually, a 2-year history is best, but if you have less time as a business owner, you might still qualify if you have a history in the same industry.
For example, say you opened an accounting firm but only owned the business for one year. If you worked as an accountant for a few years before opening your own firm, you have the experience to prove you can run the business.
If you worked as a teacher and then opened your accounting business, there isn’t any history to prove you can succeed, which may make it harder to get mortgage loans for the self-employed.
Documenting Your Self-Employment Income
The hardest part of owning a business is proving you qualify for a mortgage. Rather than providing pay stubs and W-2s, you’ll provide tax returns and letters from your CPA. Lenders need proof beyond a reasonable doubt that you are self-employed and the income you stated is legit.
To prove your steady and reliable income, you must provide:
- The last two years of personal tax returns
Your tax returns should show steady earnings. Lenders sometimes use a two-year average to account for the highs and lows your business may experience.
- IRS transcripts
Your lender may ask you to sign IRS Form 4506-T so they can access your transcripts and compare them to the tax returns you provided
- Letter from your CPA
Lenders usually require a letter from your CPA stating you are self-employed and verifying the income reported on your tax returns
What Lenders Look for in Self-Employed Income Documents
Mortgage loans for the self-employed work differently than those who work for someone. Rather than determining your gross income (income before taxes), lenders must use your adjusted gross income.
That’s where the problems lie for many borrowers. They take the allowed deductions on their tax returns. So while they can enjoy a lower or no tax liability if their business showed a loss, on paper, they don’t qualify for a mortgage.
The key is to work with a reputable mortgage broker who understands what lenders want from self-employed borrowers. Then, your loan officer can help you create a situation allowing lenders to approve your loan.
For example, you may qualify for a bank statement loan rather than a standard loan. The interest rate may be slightly higher for the non-conforming loan, but you can qualify using bank statements instead of tax returns. This works well for self-employed borrowers who show a loss on their tax returns.
Exploring Mortgage Loan Options for Self-Employed
The good news is that even though you are self-employed, several loan options are available, including the following.
Conventional loans are the most common option but have the strictest requirements. For example, self-employed borrowers must have a two-year history of self-employment, one year in self-employment, and at least two additional years working in a similar role.
To qualify, you must have at least a 620 credit score, a 5% down payment, and debts that don’t exceed 45% of your income. Some lenders, however, may require a higher down payment, such as 10% – 20%, because of your self-employment, especially if you have a lower credit score.
The FHA loan can be a good option if you don’t qualify for a conventional loan. With lower credit score requirements and higher debt-to-income ratio allowances, borrowers have an easier time qualifying.
FHA loans have more flexible underwriting requirements but still allow mortgage loans for the self-employed. To qualify for an FHA loan, you need at least a 580 credit score, debts that don’t exceed 50% of your income, and a 3.5% down payment.
Like conventional loans, FHA lenders require a two-year self-employment history or one year with at least two years of experience working for someone else.
VA loans are for veterans of the military and sometimes their surviving spouses. If you’re a self-employed veteran, a VA loan may offer the lowest rates and fees out of any other loan option.
You need an average 620 credit score and enough disposable income to cover your daily cost of living to qualify. The VA doesn’t require a down payment, and you need only a two-year history as a self-employed business owner or one year with relevant experience at another company.
Tips to Get Approved for a Loan as a Self-Employed Borrower
Getting approved for mortgage loans for the self-employed isn’t as hard as it seems. Here are some tips to improve your chances of approval.
Keep your Debts Low
Since you’re already a higher risk being a self-employed borrower, see what you can do about keeping your debts low. If you have consumer debts, try to pay them off before you apply for a mortgage. The fewer debts you have, the easier it is to qualify for a loan because you won’t need as much income to qualify.
Increase your Credit Score
Try maximizing your credit score as much as possible before applying for a self-employed mortgage. While you need an average 620 score for most programs, some lenders want a higher score to offset the risk of your self-employment.
The more stable your credit history, the easier it is to get approved. Make sure all your payments are current and your credit lines don’t have more than 30% of your credit line outstanding. If you have any collections or other negative issues, try correcting them before you apply for a mortgage.
Keep your Personal and Business Finances Separate
Your lender will ask for your income taxes, bank statements, and other proof of your income and assets. If you don’t separate your personal and business finances, it can be hard to differentiate, creating a nightmare when you apply for a mortgage.
Keeping your finances separate makes it easy to differentiate between the two and prove to the lender that you have the money to qualify for the loan.
Use a Co-Borrower
If you’re married and your spouse works, consider adding him/her to the loan. If your spouse has decent credit and doesn’t have a lot of outstanding debt, a stable income can help you qualify for the loan.
There are more mortgage loans for self-employed than most people realize. At Co/LAB Lending, we work with many lenders with various loan options. Whether you qualify for a conventional loan or need an alternative loan, such as a bank statement loan, our professionals can help you understand your options and qualify for a self-employed mortgage.
Contact us today to learn more about how we can get you the loan you need to buy the home of your dreams!
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