If a lender had to describe the perfect borrower, chances are they wouldn’t say a self-employed borrower. Unfortunately, those who work for themselves pose a higher risk for lenders. That doesn’t mean they can’t get a mortgage. Is it more difficult? Maybe, but really it just means a little more time and patience. If you have the income to qualify, chances are there is a lender willing to give you a loan. You may have to shop around a little more, but the lenders are out there.
Things You Need if You are Self-Employed
If you are self-employed, prepare yourself for a more in-depth process. Having the following attributes can help you secure approval.
- High credit score – You already pose a risk by not having a salaried position. That’s strike 1 in the lender’s eyes. In order to make up for it, you need a high credit score. This shows lenders you are a responsible consumer. You don’t overextend yourself and you only take what you can handle. Because your credit score is comprised of so many aspects, it shows lenders that you do handle yourself well.
- Low debt ratio – Again, because you already pose a risk working for yourself, you need a low debt ratio. This shows lenders you don’t overspend. What’s the magic debt ratio? There is no specific answer. If you want a conventional loan, you should have ratios around 28/36. If you apply for an FHA or VA loan, they have slightly less strict guidelines. You may have a debt ratio as high as 43% and still qualify. In general, the lower the better, though.
- Reserves – Your income likely isn’t steady if you work for yourself. That could be the case for someone that works for a company as well, though. Because of the risk, though, you’ll need reserves. Shoot for 6 – 12 months at a minimum. This means 6 -12 months’ of mortgage payments in a savings or other liquid account. This shows lenders you can continue to pay your mortgage if your income stopped.
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Watch Your Tax Returns
One thing that can dampen your ability for loan approval is your tax returns. You work for yourself so of course, you want to take every credit you can. However, lenders only use the income you claim on your tax returns. It’s like a double-edged sword. You don’t want the higher tax liability, but it could leave you without mortgage approval.
If you have the time to plan, consider taking fewer deductions for a couple of years. The two years leading up to your mortgage application are the most important. Generally, lenders don’t go back any further than that. This may mean you pay more taxes for those few years, but it will help you get the home you want.
Watch Your Increases and Decreases
Another aspect of your income that lenders watch is its pattern. If you have 2 years in a row where your income decreased, a lender may be wary. This doesn’t mean if you have certain periods of the year that you do better than others that you are out of luck. It means if your tax returns overall show a decrease from year to year. This shows instability. Add this instability to the risk of you being self-employed and you are a high-risk borrower.
Try to apply for the mortgage when you have 2 years of increasing income. This shows success and probably continuance of your income. If you show any signs of weakness in your income, a lender may not let it slide.
New business owners are at high risk for being turned down unless they have experience in the industry. If you open a new business, make sure it’s in an industry you know and understand. Maybe you have a degree in that field or you worked in it before. Any experience you can show will reassure the lender that you have what it takes to succeed. If you jump from one industry to the other without any type of training or education, a lender may not want to take a risk on you.
Have a Third Party for Verifications
No matter how successful you are at your business, you need a 3rd party to verify every aspect of your business. Usually an accountant suffices. Someone that handles your payroll and other financials can verify what you say is true. The accountant can vouch for your Profit and Loss Statements and your tax returns. They can assure the lender that you make what you claim to make. Make sure your accountant isn’t a family member or someone with a vested interest in the business either. You need that degree of separation for the lender to take it seriously.
Other than the few things mentioned above, everything else about a self-employed mortgage remains the same as other mortgages. You must prove you can afford the loan and that you have a steady job. Your job is just different than those with a W-2. You may have to jump through a few more hoops, but they usually get you to your loan approval.
If you have a hard time with one lender, shop around for others. There are many portfolio lenders that offer special programs for those who work for themselves. You can also go mainstream and secure a conventional or government-backed loan. You have many options; you just need to see which one fits your needs the most!