By Chandler Sullivan
July 26, 2022 | 7 Min. Read
Being self-employed is an accomplishment within itself, but it can come with its own obstacles to navigate. One of those obstacles being how it may be harder to secure a mortgage when you are self-employed. Although you fill out the same mortgage application and get evaluated on the same stats i.e. your credit score, your debt-income ratio and your assets, it is easier to get a mortgage when you are a W-2 employee. Why is that?
When it comes to mortgages or most loans, there needs to be substantial proof of steady income. When you work as a regular W-2 employee, lenders can go straight to your employer/employment record and verify your income. Can’t you prove your income as a self-employed individual? Of course. The downfall of being self-employed looking for a home loan is the extra documentation that will be needed to prove your steady and reliable income. This isn’t an impossible task. You just have to be prepared.
In short, yes it is a little harder to get a mortgage when you are a self-employed borrower. Lenders don’t always see self-employed individuals as the best borrowers. This is because lenders want to know you have enough reliable income to be able to pay your monthly mortgage payments. Some lenders may decide that it isn’t worth the hassle to consider you for a loan.
Additionally, when you are a business owner, you are eligible for deductions. While these business deductions help you reduce your taxable income, it also leads to a lower annual income recorded. This can cause lenders to question if there is enough money to afford a home or home loan in general. For first-time home buyers, this can be a disadvantage also as you may need to pay a larger down payment.
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Whether you are a new business owner or an experienced self-employed individual, you have to be extremely organized with keeping track of your income for tax purposes. This will help you when you are ready to apply for a mortgage.
All lenders will be looking for proof of the following things:
To start the home buying process, you will need to show self-employment history for at least two consecutive years. To show self-employment verification, you have the following options:
Lastly, you will need to have proof of steady, consistent income. The more income history you can provide, the more likely you are to be approved for a mortgage. The level of income should easily reflect the same or higher value you need to afford the loan. Your lender may ask to see the following documents:
Some lenders don’t work with self-employed individuals because of the increased underwriting. It is important to do your research to see who does work with self-employed borrowers. Only take advice from reliable sources and never pay to speak with anyone. You can call banks or credit unions and ask what their policies are.
Furthermore, you can work with a mortgage broker. They will help you understand the policies toward being a self-employed borrower. Talking with a mortgage broker and building a relationship may strengthen your ability to have your mortgage application move forward.
At Marine Credit Union, you can speak to one of our knowledgeable Home Loan Experts. Regardless of your circumstances, you can get your questions answered or get recommended resources for your specific circumstances.
Traditionally, you’ll need to provide two years of self-employed income history with tax returns. It would be even harder to get a mortgage with 1 year of self-employment as it doesn’t show steady & consistent income yet. Unless you can prove a substantial amount of savings or assets, with a great credit score, your best bet is to wait a little longer before applying for a mortgage. If for whatever reason you cannot wait to buy a house, you may need to consider getting a co-signer.
If you don’t end up qualifying for a conventional mortgage, there are still other loan options available.
Backed by the Federal Housing Administration, FHA mortgage loans have one of the lowest credit requirements. This loan is very attractive for first-time home buyers because FHA-backed loans don’t immediately require higher interest rates for bad credit. There are additional qualifications for FHA loans like, you can only use it for primary residence and the minimum percentage down.
These loans allow borrowers to apply for a loan without proving income with tax returns. Instead, lenders look at 1-2 years of bank statements to determine your eligibility and evaluate your business income.
A joint mortgage is when a self-employed individual has a co-borrower (different from co-signer) who is a W-2 employee, that will share ownership of the home. Typically this could be your spouse, partner or trusted friend.
A co-signer has the same idea as sharing responsibility, but unlike a co-borrower, they will not share ownership to your house. This is typically family members or friends willing to assume responsibility of making payments if your default on your loan.
For both of these options, the other person at fault will need to have good credit. A co-borrower will need to have moderate debt-to-income ratio to qualify with you as well.
Having good to excellent credit will make you an attractive borrower to lenders. The higher your credit score is, the easier it is to get approved on most loans with lower interest rates. You can improve your credit score over time with conscious, consistent efforts. Also, paying down overall debts you owe will be extremely beneficial. If you have bad credit, it is still possible to apply for a loan but your odds of approval may be harder.
Your debt-to-come ratio (DTI), is the percentage of gross monthly income that goes towards paying your monthly debts. When your DTI is low, it means you are a less risky borrower.
To calculate your DTI, divide your monthly recurring debt by your monthly income before taxes. Your normal grocery pills or small monthly bills don’t go into consideration for this calculation. If your DTI is more than 50%, it would be a good idea to reduce your debt before applying for a mortgage.
Being able to save is very important when it comes to self-employed borrowers. If you are able to put extra money away to save up for a down payment, it shows your efforts to be financially smart about your mortgage decisions. If you are able to pay a higher down payment, it can show lenders you are able and willing to take on risk but also the ability to save for loan payments.
It is a great idea to separate your business assets from your personal assets. Having a separate account for business expenses and setting up a sub-account for mortgage obligations and settlement fees will help you keep organized from spending within your personal savings account.
Self-employed individuals have options when it comes to mortgage loans. The application is the exact same as a W-2 employee but the process is a little lengthier. The major difference is having to provide documentation that proves employment and income history, within the last 2 consecutive years.
Regardless of employment status, consult with your local bank/credit union, financial consultant, or mortgage broker to see what the best options may be for you.