In order to get a mortgage, you need to show that you are not a high risk to lenders. This means good credit, stable income, and a good expense ratio. What if you are self-employed though? How does this relate to you?
Self-employed borrowers are at a bit of a disadvantage. They are automatically considered ‘high risk,’ because their income can be so erratic. The longer you are self-employed, the less risk you pose to a lender. However, you still need a high credit score, proof of stable income, and what a lender considers a good debt ratio.
Let’s look at the debt ratio further.
The Magic 43% Number
You’ll likely hear the number 43% pertaining to debt ratios quite often. That’s because it’s the magic number that allows a mortgage to be considered a Qualified Mortgage. Just what does that mean? It’s protection for the lender. It shows that the lender did its due diligence and did not give you a loan that made your total monthly debts exceed 43% of your gross monthly income.
Unfortunately, for some, that 43% is hard to hit. Luckily, not all lenders require only Qualified Mortgages. It’s not uncommon for self-employed borrowers to have a debt ratio as high as 45%, but that’s typically the maximum. It means that almost half of your income goes towards your monthly bills. That leaves only 55% of your income for daily living expenses and savings.
The Factors Other Than the Expense Ratio
Believe it or not, there are other factors lenders consider when deciding if you qualify for a self-employed mortgage. For starters, they look at the stability of your business. They look at:
- How long you have been in business?
- The stability of your income in that business (does it increase or decrease year over year)
- What is your experience in the business like?
The answers to these questions help a lender determine your income stability. Let’s say you have owned your business for 3 years. The first year you had a decent amount of income, but the year after that your income declined, and the year following that it declined again. This does not prove promising to a lender. They would much rather see increasing or at the very least, steady income to help ensure that you can afford a loan. Even with a 43% or lower expense ratio, if you have decreasing income, your chances of securing a mortgage are not very high.
Of course, lenders also look at your credit score. Your income shows how much you can afford, but your credit score shows your financial responsibility. What is your credit history like over the last 2 years? Do you have a lot of defaulted debts and late payments? If so, you prove risky to a lender. They want to see a pattern of paying bills on time and not overextending yourself financially.
Finally, lenders look at your assets. They want to know that you have another way to pay your mortgage should your income falter from your business. Let’s say you have a bad 3 months in your business. Do you have money to cover your mortgage payment set aside? Lenders call these reserves. They want to know how many months of your mortgage payment you can cover with your assets. This gives them peace of mind that you won’t default on your loan no matter what happens to your self-employed income.
It’s a Big Picture
Lenders look at all factors of your application as a big picture. They put all of the pieces together to determine your risk level. Just having a great expense ratio isn’t enough. You can have a low debt ratio and still have a low credit score and unstable income.
Instead, lenders want it all to come together. You might have a slightly higher expense ratio, but have a great credit score and steadily increasing income. If you can prove you have what it takes to survive in the industry you are in, a lender may grant an exception for your slightly higher debt ratio.
Just how high will a lender go? It depends on your situation. Again, looking at all of the factors, a lender will decide. Of course, no two lenders have the same requirements. Even two conventional or FHA lenders may have different requirements. They can add overlays onto what the program requires. One lender might not see a problem with taking a 45% debt ratio, while another may want nothing to do with it.
The key is to shop around and find the deal that works best for you. Don’t assume you need a specific expense ratio or you won’t get a loan. Make your other factors as attractive as possible. Increase your credit score, stabilize your income, and make sure your income steadily increases (not decreases). The combination of all of these factors can help you get the loan you need as a self-employed borrower.