Can You Get a Mortgage if You’re Self-Employed?
If you’re self-employed want to buy a home, you can get a mortgage, but you’ll face a documentation burden.
Mortgage lenders routinely require proof of income for mortgage approval, which can be tricky when you don’t have a W-2 or recent paycheck.
Self-employed borrowers should be prepared to provide evidence of active income – simply put, the money you earn for your work.
Although mortgage lenders tightened credit standards during the coronavirus crisis, banks began easing standards for household loans in 2021, according to a Federal Reserve survey of senior loan officers. However, self-employed borrowers should expect a couple of extra application items for proving income stability given that 2020 was an odd year for businesses.
Is Getting a Mortgage Hard When You’re Self-Employed?
While self-employed borrowers are held to the same lending standards as W-2 workers, the mortgage process itself can be more challenging. Lenders will need to consider the stability viability of your business along with your income, since revenue can fluctuate.
In general, lenders are concerned whether all applicants, including self-employed workers, can consistently repay their loans. They’ll need to see that your income is high enough to pay for your mortgage, that it’s likely to remain high, that you have a good track record of repaying your debts.
Proving the stability of your business requires documentation, including evidence of work, payments activity supporting business operations, such as a business website. “Every customer is so uniquely qualified their businesses are so different, so each one needs to be looked at differently,” says Ashley Moore, community lending manager at JPMorgan Chase.
Generally, borrowers need at least two years of self-employment income to qualify for a mortgage, as per Fannie Mae Freddie Mac guidelines. In some cases, borrowers who are self-employed for just one year may still qualify if they meet other criteria, like working in the years prior in the same occupation with comparable or higher income.
How Do You Get Approved for a Mortgage if You’re Self-Employed?
Qualifying for a mortgage when you’re self-employed means showing the lender that you can make your payments for the entire length of the loan.
Here’s what lenders want to see from self-employed mortgage applicants:
Stable or Increasing Income
Some fluctuation is acceptable, but that’s why lenders like to see two full years of tax returns.
Lenders are looking for the worst-case scenario, so they will probably consider the lower of the two years when crunching their numbers. Be mindful that significant decreases in income from year to year could raise additional questions during underwriting because the lender may see that as a sign that your business is declining.
Of course, in light of the pandemic, income swings are to be expected. As such, Fannie Mae Freddie Mac issued updated guidance in 2020 for how lenders should determine income stability, given that many businesses experienced temporary downturns and/or unusual income patterns. Part of that includes a requirement for self-employed applicants to provide a year-to-date profit loss statement as well as business deposit account statements for the most recent months.
Ideally, you should have at least two years of self-employment income in the same industry. If you’re newly self-employed, some lenders will make an exception if you have one year of self-employment tax returns plus W-2s from an employer in the same field.
Still, a short history of self-employment may make it more difficult to assure lenders that your income will remain consistent.
You’ll need a track record of repaying your debts. Foreclosures, delinquencies, collections, repossessions bankruptcies increase risk for the lender.
Lenders will review the type, age, use, status limits of your revolving credit accounts as well as how often you applied for credit in the last year.
“There are a lot of different loan programs products that require different credit criteria, that’s going to look the same for a borrower whether they are self-employed or have a W-2,” says Moore.
Low Debt-to-Income Ratio
Lenders typically look for a debt-to-income ratio – the percentage of your monthly income you put toward paying your debt – of 43% or lower. If your debt payments are perceived as unmanageable for your income, you might not qualify for the amount you need to purchase a home or not receive an offer for a mortgage.
You’ll also want to be careful if you’re self-employed tend to deduct a fair amount of business expenses. This can hamper qualification because mortgage underwriters typically look at income after expenses.
“The problem that we run into is a self-employed borrower can write a lot of things off,” says Sean Cahan, president of Cornerstone First Mortgage in San Diego. So those savvy deduction moves that help at tax time could end up reducing your bottom line, which can then impact the debt-to-income ratio.
However, Cahan notes that loan officers who have experience working with this type of borrower should know how to interpret a tax return run the proper calculations in these cases. He recommends that self-employed people simply ask the loan officer to show them the actual worksheet the officer used to come up with the effective income amount. “If they don’t know how to break it down for you, move on to the next lender,” he says.
Your mortgage payment is due every month, even when work has dried up. Lenders may want to see that you have an emergency fund to get through months when you’re not earning as much. But again, that doesn’t mean self-employed borrowers are held to a higher threshold, says Cahan.
“Compensating factors are going to help any borrower,” says Moore.
Big Down Payment
A hefty down payment – some lenders now expect at least 20% – can offer more assurance to lenders. Otherwise, down payment requirements for self-employed workers with good credit enough income are usually no different from other borrowers.
However, a larger down payment can be helpful. “Putting more money down will help your DTI ratio,” says Cahan. But if the loan is not likely to be approved because of other challenges, a larger down payment probably won’t tip the scales to an approval.
What Are the Document Requirements for a Mortgage When You’re Self-Employed?
Because of economic uncertainty fueled by the coronavirus pandemic, lenders are taking extra steps to verify income. Many lenders will require income verification early in the mortgage timeline then again just before closing.
Although requirements will vary by lender, you should be prepared to submit:
- Government-issued identification
- Complete personal tax returns for two years
- Business tax returns for two years
- IRS Form 4506-T, which gives third parties permission to access your tax records
- Earnings statements
- Business personal bank statements
- Asset account statements, such as retirement or investment accounts
- Business name verification, such as a DBA, or “doing business as”
- Business license
- List of your debts expenses, both business personal
- Canceled checks for your rent or mortgage
- Any additional income, such as Social Security or disability
Some lenders require further documentation, such as statements from your accountant clients.
Before you submit your documents, be sure they are up to date organized. Lenders don’t want to have to go back to you for more recent statements. Make understanding your finances easy for the lender.
Mortgages backed by government-sponsored enterprises Fannie Mae Freddie Mac require verification of business operations. You may need to provide evidence of work, such as invoices, business payments or active websites.
These measures are normally required 120 days before closing on a mortgage. But self-employed borrowers now have to offer proof of steady income again as the closing date approaches.
How Can You Plan for a Mortgage When You’re Self-Employed?
If you’re self-employed considering a home purchase in the next few years, you can take several steps to make yourself a more attractive borrower:
Establish a track record of self-employment work. Maintain consistent work as much as possible. Try to time your mortgage application after two to three years of consistently strong earnings.
At that point, lenders are less likely to be concerned about income instability, you may qualify for a higher loan amount.
Improve your credit report. Check your credit report to identify any problems you may need to fix before a mortgage lender checks your credit. Lenders could reject your application or charge you a higher interest rate if you have a low credit score.
If you identify any errors, contact the credit bureau to correct them. Look for any other areas of concern, such as high credit limit use, work to improve them.
Do not apply for other loans or credit cards in the months leading up to your mortgage application, because a lot of new credit inquiries may harm your credit rating.
Pay down debt. You can boost your credit score by paying off some or all of your debt. This will also lower your debt-to-income ratio, which will make getting a mortgage easier.
Save as much as possible. Don’t drain your savings on the down payment. A healthy emergency fund can put lenders at ease; they like knowing that you can still make payments during work droughts or that you can afford surprise home repairs.
Maintain clean business records. Make it easier for lenders to understyour business income. Separate your business personal finances by using business checking savings accounts as well as credit cards.
Keep track of invoices monthly expenses, create an updated earnings statement at least quarterly. Be sure to retain your records when you file taxes each year.
Don’t believe the misconceptions. Though there may be more paperwork, lenders are very open to working with self-employed borrowers. “We look at each individual based on their entire financial picture,” says Moore.