Buying a home can feel exciting. And, no matter who you are, getting a mortgage can feel stressful – especially when you’re self-employed.
Mortgage lenders examine your personal financial history and your business’s financial history as well. But you’re not alone.
As of July 2021, you and over 16 million people in the U.S. are self-employed with incorporated and unincorporated businesses, according to the U.S. Bureau of Labor Statistics.
No one is going to penalize you for your entrepreneurial spirit, but you will have to jump over a few more hurdles than a salaried or part-time employee to verify your income and qualify for a mortgage loan.
An employee who can whip out a W-2 and a stash of pay stubs to prove their income has it easy when it comes to demonstrating stable income, but a self-employed person has to be able to prove their income without the benefit of those documents.
It’s a hurdle to clear, but it doesn’t have to be an obstacle.
Your Business Is (Now) the Lender’s Business
The lender will be looking at your business to assess whether it’s been a viable source of income for you in the past – and if it will continue to be a viable source of income in the future.
Is your income coming in?
Consistency is key.
You may have heard that before, and when it comes to getting a mortgage as a self-employed borrower, it rings true.
The lender will inspect the financial records of your business to determine how it has provided you with money in the past, and the likelihood of it continuing to pay you in the future.
Most lenders will need to see at least 1 year’s worth of financial data, but preferably 2 years’ worth:
- Business active for 1 year: In addition to providing proof of income and business viability, you will need to include your most recent previous employment.
- Business active for 2 years: You won’t need to verify employment beyond your current business but will still need to provide documents proving your business’s profitability and your income.
Do you have the paperwork?
Remember when we said that being self-employed means having to clear a few more hurdles?
Here’s what we meant: Unlike employees who can verify their income and employment through their company, it falls on self-employed individuals to prove the stability of their income and their business.
So be prepared to provide documentation that proves the viability of your business and income:
- Proof of a personal business accountant (if applicable)
- Business tax returns
- Current contracts, client testimonials
- Any relevant business licenses (such as a DBA)
- Profit and loss statements (Schedule C, Form 1120-S, Schedule K-1)
Separating work and play: Business vs. Personal expenses
One of the perks of being self-employed is that you can write off business expenses and save money on taxes. That perk can become a liability when you’re trying to buy a home.
Lenders will look at your income after the write-offs. If you write off a lot of business expenses, it will make your taxable income appear lower — and it could lower your chances of getting a loan.
If you’re considering buying a house, write off fewer expenses for at least 1 – 2 years before you start home shopping, so you can show increased income.
Another good practice is to use separate credit cards for business and personal expenses, so you don’t inflate your credit utilization.
This Feels Personal: Get a Handle on Key Aspects of Your Personal Finances
As you probably could’ve guessed, your personal finances will play a key role in a lender’s decision to give you a mortgage.
Luckily, we’ve broken down three of the biggest variables a lender looks at before giving you a loan.
Put it all on the table: Listing your assets
To prove your “mortgage worthiness” you’ll have to make a list of all of the assets you currently hold.
That allows the lender to calculate your net worth (that’s your assets minus your liabilities). The higher your net worth, the greater chance you stand of getting a mortgage. Now, this is true whether you are self-employed or not, but it has extra importance if you’re self-employed.
Here are some examples of assets you’ll want to account for in your mortgage application:
- Checking and savings accounts
- Stocks, bonds, mutual funds
- 401(k) and other retirement accounts
- Real estate or property
- Other sources of income
Balancing your act: Debt-to-income (DTI) ratio
One of the first things a lender will look at for any loan applicant will be their debt-to-income ratio. It’s a way to compare how much you owe with how much you earn.
Being self-employed, you know your income can vary month-to-month. So, it’s important to show your lender your average DTI over the past 1 – 2 years.
Knowing your DTI before filling out a mortgage application will let you know if you can qualify for a loan. Lenders prefer a DTI of 36% or less for a conventional mortgage. For alternative loan options, like a Federal Housing Administration (FHA) loan, a DTI of up to 50% can be acceptable.
Up, up and away: The higher the credit score, the better
There are three things in life that are certain: iOS updates, another season of “The Simpsons” and your credit score affecting your mortgage loan prospects.
Your credit report gives lenders a snapshot of how much you owe compared to how much you can borrow. It also shows them how responsible you are about paying back debts.
While most lenders will consider a mortgage application with a credit score of 620 or higher, if you’re self-employed, you’ll probably want a score of 680 or higher.
Also, the better your credit score, the better the interest rate you can qualify for.
Show Me the Money: How a Larger Down Payment Can Help Secure a Mortgage
If you’re self-employed, the lender wants to feel confident that you have the resources to pay the loan back and make each monthly payment.
One of the best ways to ease any concerns a lender may have is to make a larger down payment (20% or more of your home’s purchase price).
It will give the lender added confidence that you’ll be able to pay the loan back and has the added benefit of reducing the overall amount you’ll need to borrow.
One Size Doesn’t Fit All: Explore All Your Mortgage Options
Despite your best effort, there is always a chance that a conventional mortgage application won’t be approved.
But don’t stress over it. Conventional mortgages aren’t the only game in town.
There are alternative home loan options:
- Federal Housing Administration (FHA) loans: designed to help low- to moderate-income buyers purchase a home
- Department of Veterans Affairs (VA) loans: mortgage offerings for U.S. military veterans
Beyond the variety of mortgage options available, you can also get a co-signer for your mortgage.
A co-signer can be a parent or relative in a stronger financial position. Make sure that you and your co-signer understand that if you default on the loan, the co-signer will be on the hook to pay it back.
If you’d rather focus on your business and not on researching mortgages, you may want to consider a mortgage broker. Look for brokers who have experience working with self-employed borrowers.
If You Build It, a Lender Will Come
Moral of the story: You can be self-employed AND get a mortgage. The key is to be prepared, especially when it comes to meeting the extra documentation requirements.
Before running to a lender and filling out a mortgage application, ask yourself these questions:
- Have I been in business for at least 1 year?
- Are my business and personal expenses separated?
- Do I have all the necessary documents to prove that my income and business are stable?
- Is my DTI 50% or lower?
- Do I have the preferred credit score?
If you answered no to any of these questions, you may want to speak to a lender about alternative loan options and strategies to improve your application in the future.
Remember, financial situations are fluid, where you are today is not where you may be tomorrow.
Bureau of Labor Statistics. “Data Retrieval: Labor Force Statistics (CPS).” Retrieved October 2021 from https://www.bls.gov/webapps/legacy/cpsatab9.htm#a9.xlsx.f.3