How To Qualify For A Self-Employed Mortgage Loan

Whether you’re traditionally employed or work for yourself, the process of shopping for a home can be just as exciting (and daunting). However, the home buying process is a bit more complex for self-employed individuals in the United States.

When you’re applying for a self-employed mortgage, you may be placed under stricter scrutiny than you would if you worked for a company. You must provide more financial documents and often a longer work history proving that you have the means to repay your loan.

If you’re self-employed and are considering buying a home, don’t be discouraged. Going into the process knowing what to expect can give you the confidence you need to see it through.

How To Get A Mortgage Loan If You’re Self-Employed

Qualifying for a mortgage when you’re self-employed may be more difficult, but it’s far from impossible. Keep reading to learn what steps you’ll need to take to get approved for a loan.

Determine Your Self-Employment Eligibility

As you’re preparing to buy a house, it’s important to determine if you’re considered self-employed before you begin the mortgage process. It’s possible to have some self-employment income without being held to the standards of a self-employed person during your mortgage application.

The simplest way to determine whether you’ll be considered self-employed when applying for a mortgage is whether you have self-employment income and plan to use that income to help you qualify for the loan.

If you own at least 25% of a business your income comes from that business, there’s no question that you’re self-employed. But if you earn the majority of your income from a traditional employer, earn only a small amount from self-employment and don’t need your self-employment income to qualify for the loan, you can just rely on the income from your job.

If you still aren’t sure if your lender will consider you to be self-employed, here are a few signs that you are:

• You own 25% or more of a business
• You receive 1099 tax forms
• You’re a freelancer or contractor

Assess Your Business And Personal Finances

Regardless of whether you’re traditionally employed or work for yourself, you should take a close look at your finances before you apply for a mortgage. It’s important to make sure you have a good credit score that will allow you to qualify for a loan and that your income is high enough to cover a mortgage payment.

But if you’re self-employed, you’ll also have to look at your business finances. After all, you can only continue to bring in the income needed to repay your loan if your business succeeds. It’s important that your business has a track record of sufficient revenue and that your expenses are low enough to pay yourself a decent paycheck.

Gather Necessary Documents

When you’re ready to begin the mortgage process, you’ll need to collect the personal and business financial information needed for your application. Here’s what lenders look for when a self-employed person applies for a mortgage:

Income Documentation

Lenders need verification that self-employed borrowers have a steady source of income. These are the documents that you may need to provide to a mortgage lender to verify stable and sufficient income:

• Personal and business tax returns from the past 2 years
• All tax schedule forms related to those business returns (Schedules C, E, F, K-1, etc.)
• Year-to-date profit and loss statements
• Business bank statements
• Recent business receipts or invoices
• IRS transcripts, such as Form 4506-C

Employment Verification

Along with providing documentation to prove your income, you may also need to provide proof of employment. The following are examples of valid employment verification documents that you may need:

• State or business licenses
• Proof of business insurance
• Customer service approval letter
• CPA or tax preparer letter
• Membership letter from a professional organization
• A Doing Business As (DBA)
• Enrolled agent letter
• Online third-party verification

How To Calculate Self-Employment Income For Mortgage Loans

Calculating your self-employment income can help you determine how much mortgage you can afford and how much you might be approved for.

Your self-employment income isn’t necessarily the amount your business earns. Instead, your self-employed income is your taxable income before business expenses and tax deductions.

Additionally, lenders don’t just look at the most recent tax year when calculating your income for mortgage approval purposes. Instead, they most often take an average of the past 2 tax years. So, if your income from the most recent year is considerably lower, you may find that you aren’t approved for quite as much as you hope to be.

Mortgage Loan Types For Self-Employed Individuals

Self-employed individuals are eligible for the same types of home loans as traditionally employed folks. Here are a few examples:

• Conventional loans: A conventional loan is the most common type of loan and includes any loan that isn’t backed by the federal government. Most conventional loans are subject to Fannie Mae and Freddie Mac requirements, which include a credit score of at least 620 and a down payment of at least 3%.
• FHA loans: An FHA loan is one that’s backed by the Federal Housing Administration. These loans have more flexible income and credit score requirements and can help borrowers with poor credit to buy homes.
• USDA loans: A USDA loan is one that’s backed by the U.S. Department of Agriculture. These loans are available to low and moderate-income borrowers in eligible rural areas and don’t require a down payment.
• VA loans: A VA loan is backed by the U.S. Department of Veterans Affairs to help military service members, veterans and qualifying surviving spouses buy homes at competitive interest rates and without down payments.

Tips To Be Better Qualified For A Self-Employed Mortgage

Collecting the necessary documentation is just one step in preparing for the mortgage application process. You’ll want your application to look its best, so here are some steps to improve your loan application and eligibility:

1. Decrease Your Debt-To-Income Ratio

Your debt-to-income ratio (DTI) is the ratio of how much money you spend on paying off debts versus how much money is coming in. To calculate it, you add up your monthly minimum debt payments and divide it by your monthly pretax income.

Someone with a low DTI is viewed as a less risky borrower. Meanwhile, someone with a high DTI might be a red flag to a lender.

There are two primary ways to lower your DTI: increase your income or pay off debt. For most mortgage loans, an ideal DTI percentage is 43% or lower.

Another way to lower your DTI is to increase the size of your down payment. The larger your down payment, the lower your loan amount. And the lower your loan amount, the lower your monthly payments and, therefore, your DTI.

2. Increase Your Credit Score

Your credit score is an important indicator to lenders that you’re a responsible borrower. They don’t want to risk a loan if there’s an unstable credit history. A higher credit score can result in better loan terms and availability of mortgage types.

The credit score needed to buy a house depends on the type of loan you’re applying for. You’ll need a credit score of at least 620 to get a conventional loan but may qualify for a government-backed loan with an even lower credit score.

There are several ways to increase your credit score to improve your chances of mortgage approval. Start by checking your credit report to check for errors. Removing those errors could immediately help boost your score. Other ways to increase your score include making all debt payments on time and reducing your credit utilization.

3. Separate Your Business Expenses

Mixing your personal and work life can present some additional challenges, especially when you’re applying for a mortgage. By intertwining your business and personal debts, you can actually increase your DTI and risk profile.

To increase your eligibility for getting approved for a home loan, work on separating your accounts and keeping funds used for quarterly taxes in a separate account from your down payment savings. Consistent and organized separation of business and personal finances will simplify the mortgage process for you and the potential lender.

4. Apply With A Co-Borrower

Applying for your mortgage with someone else, either a co-signer or co-borrower, can improve your chances of being approved for a mortgage if that person has eligible income and a good credit score. Just keep in mind that even if your co-borrower’s income improves your chances of approval or increases the amount you can qualify for, if they have less-than-ideal credit, it could increase your interest rate.

Finding The Best Mortgage Lenders For Self-Employed Borrowers

Regardless of your employment situation, it’s important to shop around to find the best mortgage lender for your situation. Generally speaking, most lenders will have the same minimum eligibility requirements for a mortgage. If you don’t meet those requirements, you’re unlikely to find a lender that will offer you a mortgage.

The good news is you don’t need to research special lenders for self-employed borrowers ­– you can use any standard mortgage lender. However, some lenders may still be more favorable to self-employed borrowers. Look for lenders that offer competitive interest rates and a responsive loan officer who can guide you through the application and approval process.

Alternative Loans For Self-Employed Borrowers

If you can’t get approved for a traditional mortgage, there are some alternatives to consider. A nonqualified mortgage is one of the most common alternatives to a traditional mortgage and helps borrowers buy homes when they otherwise cannot.

This type of loan may have features that don’t apply to qualified mortgages, including interest-only payments, balloon payments, high upfront costs and fees, long loan terms and credit scores or DTIs that don’t meet traditional requirements.

One type of nonqualified mortgage is a bank statement loan. A bank statement loan doesn’t require the financial requirements that apply to most mortgages. Instead of providing the typical tax and income documents, you can use your bank statements to provide your income. As long as you have income coming in, you may qualify for the loan.

Another option to consider is a personal loan. A personal loan is an unsecured loan that can be used for any purpose and may not have as strict eligibility requirements as a mortgage. You probably won’t be able to borrow enough with a personal loan to cover an entire home purchase but could use it as a supplemental loan or to cover other expenses to allocate more money toward your down payment.

FAQs On Mortgage Loans For Self-Employed Borrowers

Now that we’ve reviewed the necessary documentation and tips on how to get a self-employed mortgage loan, let’s answer some frequently asked questions about getting a mortgage as a self-employed borrower.

Is it harder to get approved for a mortgage while self-employed?

Self-employed borrowers are largely subject to the same requirements when applying for a mortgage, including minimum credit scores, maximum debt-to-income ratios and more. However, self-employed people may find the process more difficult because additional documentation is required to prove that they can repay the loan.

How much income history do I need for a self-employed mortgage?

You’ll generally need at least 2 years of tax returns from your business to qualify for a self-employed mortgage. A lender will usually take the average of the past 2 years of income from your business.

Do self-employed individuals pay higher mortgage rates?

Self-employed borrowers don’t automatically pay higher mortgage rates. Instead, the interest rate you’ll get on your loan will depend on your credit score, loan amount, down payment, loan term, loan type and other factors.

The Bottom Line: Preparing Documentation And Finances Can Ensure You Qualify For A Self-Employed Mortgage

At the end of the day, lenders want to verify that if they approve a loan, payments will be made on time for the duration of the loan. Self-employed borrowers, while dealing with specific challenges that most home buyers don’t run into, can still qualify for mortgages with the proper preparation and documentation.

By staying organized with your business records, you can start the mortgage process with ease. And once you have your documents gathered, there are more steps you can take to increase your eligibility, including decreasing your DTI, maintaining a solid credit score, separating your business expenses and even getting a co-signer or co-borrower for your loan.

If you’re self-employed and are ready to purchase a home, start the approval process with Rocket Mortgage^® today.