If you are self-employed, you have to meet different requirements than the standard borrower. You probably don’t have paystubs or W-2s to provide the lender with to verify your income. Instead, you have your own paperwork, probably completed by yourself to provide the lender. As you can probably see, this is a conflict of interest, forcing lenders to ask for other documents when you work for yourself.
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Keep reading to learn the top dos and don’ts of getting a mortgage when you work for yourself.
Do Keep Careful Records
If there’s one thing that can help you as a self-employed borrower, it’s records. The more records you have, the more proof you have that can afford a loan. Lenders often ask for the last two years of your tax returns, but if you have more to provide, it could work to your benefit.
If you have an accountant or tax professional taking care of your books, you could be in an even better position. They will have a year-to-date Profit and Loss or other financial paperwork your lender may need. What you are trying to prove is that you have a steady stream of income that the lender can see rather than just a total on your tax returns.
You want to paint the picture of reliability and consistency, which careful records can do for you.
Do Start Planning Early
As a self-employed borrower, you should try to plan for the purchase at least two years ahead of time. Lenders are going to need your tax returns for the last two years. If you write off a large number of expenses on your tax returns, your bottom line will be lower than you actually make. This will work against you when you try to qualify for a mortgage.
If you plan ahead, you can minimize your write-offs for the time being. Let your adjusted gross income be higher for those two years. Yes, you will pay more in taxes, but you will be rewarded by qualifying for the mortgage you need to buy your home. Once you are in the home, you can go back to your write-offs, lowering your tax liability and even enjoying the write-offs of owning a home.
Do Pay Off Debts
Self-employed borrowers are already a higher risk than the traditional borrower. In order to make up for this risk, you need compensating factors. A low debt ratio is one of the best compensating factors you can provide.
If you have the money to pay your debts off completely, you put yourself in a better position. Of course, if you don’t have the money to pay them off in full, at least pay your debts down. Lowering your credit card debt as much as you can will help your debt ratio. The lower the minimum monthly payment is the lower your debt ratio, which puts you in a better position.
Do Have a Large Down Payment
Again, because you pose a higher risk being self-employed, the more money you can put down on the home, the better. While you can borrow as much as 95% on a conventional loan and 97.5% on an FHA loan, it’s not recommended for someone working for themselves. The lender needs to know that you have a vested interest. This way they have more assurance that you will pay the loan back.
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There isn’t a specific minimum amount self-employed borrower’s need for a down payment. The more you can put down, the better your chances of approval, though. It goes back to the compensating factors. A higher down payment means less risk for the lender.
Don’t Damage Your Credit
Pay close attention to your credit score during the years leading up to your loan application. Opening your own business can be expensive and sometimes can damage your credit. Take your time building your business and only borrow what you can afford to pay back.
If you know you did damage to your credit score, try to get it back up again. Pay your bills on time, lower your outstanding debts, and don’t overextend yourself financially. You should also avoid applying for any new credit during the year or two leading up to the mortgage application. This will help increase your credit score and show the lender financial responsibility.
Don’t Deposit Large Amounts of Money
As a self-employed borrower, your lender is going to pay close attention to your bank statements. If you do make any large deposits, make sure you have proof of their origination. For example, if a vendor owed you a large amount of money and they finally paid you, don’t just deposit in your account and not keep a copy of the check from the vendor and the deposit ticket.
Lenders are going to see the large deposit, sending up a red flag. If you have proof and an explanation for the deposit, they may allow the use of the funds. If you cannot provide proof of the payment, the lender will likely exclude the funds from those you can use for the home purchase.
Don’t Become Self-Employed Right Before Applying for a Mortgage
If you are employed now but are thinking of jumping ship and opening your own business, don’t do it within two years of buying a home. Lenders want reliability and consistency, which they need two years of paperwork to determine.
Lenders need to see that you have the experience and knowledge to succeed in the business. If you start a business 6 months before you apply for a mortgage, the lender has no history to use when determining your consistency and reliability.
Two years is the ideal length of time you should be looking for self-employed for before applying for a mortgage, but if it’s slightly less, you can try if you have compensating factors as discussed above.
Getting a mortgage as a self-employed borrower isn’t impossible, but it does require more work. The better you set yourself up beforehand, the more likely it is that you will get the loan you want. Use these tips to help you situate yourself for success.