Self-employed borrowers bring a unique challenge to mortgage lenders. They don’t have consistent income confirmed by a third party. Instead, they have income that they claim themselves. Even if the money is legitimate, lenders have to go above and beyond to ensure that you can afford the mortgage beyond a reasonable doubt.
The days of stating your income are gone. Instead, you have to prove your income with proven methods. If you are unable to prove your income, even if it’s valid, you won’t be able to qualify for a mortgage.
So just what do mortgage lenders look for in a self-employed borrower? Keep reading to find out.
Verifiable Tax Returns
A majority of the time, you need to provide your tax returns to verify your self-employed income. Even if you pay yourself with a W-2s, lenders need to see what you claim on your taxes. The adjusted gross income on your tax returns is what lenders will usually use for self-employed borrowers. This is because it takes into consideration any expenses you write off due to owning a business. This comes off your bottom line and lenders can only use the income you claim on your taxes.
In some cases, not all, you may also have to provide your business tax returns. This is necessary when a lender can’t differentiate between your individual income and your business income. It’s also the case if your business is a corporation. It’s best to keep the two completely separate to avoid the complexity that can occur when you apply for a mortgage.
One thing all lenders want to see out of self-employed borrowers is consistent income. In other words, they want to see you making around the same amount of money each month, or more. They don’t want to see declining income.
It’s understandable to have income that fluctuates throughout the year, but on a year-to-year basis, your income should be fairly stable. If there are great discrepancies in the income from year-to-year, expect a lender to ask questions. They will want to know what happened and if you have overcome the issue.
A Flourishing Industry
Expect lenders to look into the industry that your business operates in to make sure it’s in good condition. If you are in an industry that just doesn’t have the backing or a lot of businesses are falling out of, it could be a red flag for the lender.
You want to show that you are in a business that has a solid future. In other words, you want a business that has financial stability and that has high consumer demand. If it’s a business, no one has heard of and the demand is low, it may not fare as well in the eyes of the lender.
The Length of Self-Employment
Finally, lenders want to see borrowers that have been self-employed for a while. Typically, 2 years is the cutoff, but some lenders do cut some slack in this area. We don’t recommend applying for a mortgage 3-6 months after opening a business, but after one solid year, it may be a possibility.
In order for lenders to consider self-employment that has lasted less than 2 years, they want proof that you know the industry well. In other words, that you worked in the industry in the past. If you open a business that coincides with the employment you had before it, chances are that you have the knowledge necessary to succeed. If instead, you go into a completely different business where you don’t have a history or proof of education, you may have more trouble getting a loan.
Lenders don’t automatically shut down borrowers that are self-employed. You just need to be able to provide the lender with proof that you are a good risk. If the risk of default is high, a lender may not consider your application. It’s a good idea to have compensating factors to make up for your self-employment. This could include plenty of assets on hand, a low debt ratio, and a high down payment.