Here’s what you should know as a self-employed mortgage borrower.
If you are self-employed and seeking a mortgage, you’re not alone. Self-employed mortgages are actually really common. A self-employed person can apply for the same types of loans full-time workers can. Borrowers who work for themselves can expect the same standards when it comes to credit, debt, down payments, and income and other applicants. Where things get tricky is when it comes to documenting and showing proof of your income.
Proving your cash flow to a mortgage lender can be more challenging for the self-employed compared to someone who can hand over a W-2. As long as you meet loan guidelines and can document steady cash flow, being self-employed should not prevent you from buying or refinancing a property.
Mortgage rules for self-employed borrowers
You will probably need to have two years of consistent self-employment before you can qualify for a mortgage loan. According to lenders, a self-employed borrower is someone who has ownership interest of 25% or more in a business, or someone who is not a W-2 employee.
In some cases, there are exceptions. You may qualify for a mortgage if you have one year of self-employment if you can show a two-year record in a similar line of work. However, you would need to document an equal or greater income in your new role compared to your previous position. Some lenders may qualify borrowers who have one year of related employment and one year of formal education or training.
You are not likely to qualify for a mortgage if you have been self-employed for less than a year.
Loan requirements
There are standard loan program requirements borrowers must meet in addition to employment history. These requirements vary depending on the loan type, but in general you can expect a lender to check the following in addition to your income and employment history:
- Credit score
- Debt-to-income ratio
- Liquid savings and assets
- Credit history
The type of property you want to purchase and intended use, whether it’s your primary residence or not, will also impact the types of home loans you qualify for and at what interest rate.
Which income types do mortgage companies consider?
Mortgage lenders consider income that is stable, consistent, and ongoing. That means that if you are a business owner, freelancer, contractor, seasonal worker, or gig worker – your income is suitable for mortgage qualification if it’s steady.
These income types are allowed as your sole income, but they can also be included as additional earnings on top of your primary income source. For example, you could include freelance work income in addition to income from your full-time job in your mortgage application. This could help you qualify for a higher mortgage and/or better rates.
If you are a seasonal worker, you may receive regular income from unemployment. In some cases, lenders will consider this income as well when reviewing your application.
A key factor for lenders is that your income is “ongoing.” This typically means income that is likely to continue for a period of at least three years after loan closing. Your loan officer will be looking for signs that your prospects look good for future business or earnings. If your income from a source is declining, that won’t improve your chances of loan approval.
While the loan officer will review your business for signs of stability, your industry can also play a factor in approval. If you are in a declining industry, that could negatively affect your loan.
Mortgage lenders will only consider taxable income. Underwriters will determine qualifying income by taking your taxable income and add back certain deductions. A business owner will typically take advantage of available deductions, but that can hurt your chances of obtaining a mortgage. The more you write-off, the less it looks like you earn monthly.
How to document self-employed income.
If you are self-employed, you need to keep tidy documentation of your income for tax purposes as well as borrowing. In most cases, you will need to provide the following to your mortgage lender:
- Balance sheet
- Yearly profit and loss statement
- Business license
- Two years of business tax returns
- Two years of personal income tax returns
If you have a CPA, accountant, or tax preparer, they can help you put these documents together for your loan. If you are applying for a jumbo loan, you will also need to ask your CPA for a signed letter stating you are in business.
If you run a sole proprietorship, you may not have to provide business tax returns. If you have been self-employed with the same company for over 5 years, you might only need to provide one year’s worth of tax returns. Lastly, if you are a self-employed borrower with a long history of paying themselves, you no longer need to provide access to the company income. However, you may still need to show that the company earns enough to back income withdrawals.
What about income inconsistencies?
If you earn income here and there from freelance work or side gigs, chances are your mortgage lender won’t count it.
However, many businesses have good and bad years, or good and better years. If you had a bad year, your lender may ask for more than two years’ worth of tax returns to prove you have the income needed to obtain the loan. You should also prepare to ask questions about any year over year decreases in income.
What are self-employed income calculations?
During the mortgage process, lenders will calculate your self-employed income by taking the average of your income over the past two years and breaking it down into how much you earn monthly. This calculation determines how much a month you can spend on housing and other costs.
How your debt-to-income ratio impacts your mortgage.
Underwriters don’t want to just see how much income you earn; they want to know how much of your earnings go towards debt repayment. Your debt-to-income ratio or DTI measures your current, revolving debt. That includes credit card debt, auto loans, student loans, and so on. A lender will subtract your current debt from your earnings to determine how much you would have left over each month for your mortgage. The ideal DTI is below 45%.
Your debt-to-income ratio impacts your ability to borrow, so it’s important to keep revolving debt low. If you are considering applying for a mortgage, and have a lot of credit card debt, you should create a plan for paying it down before you apply to ensure you can qualify for the loan amount you want and at a competitive interest rate.
Self-employed mortgage loans.
Traditional mortgages are available to self-employed borrowers. That includes government-backed FHA, VA, and USDA loans.
Conventional loans for self-employed borrowers.
A conventional loan is any mortgage loan that isn’t guaranteed or insured by the government, like the Federal Housing Administration (FHA), Department of Veterans Affairs, or Department of Agriculture loan programs. Conventional loans can be conforming or non-conforming.
Conforming loans are mortgages that can be bought by Fannie Mae or Freddie Mac, which make up the majority of U.S. mortgages. A self-employed borrower can qualify for Fannie Mae or Freddie Mac mortgage loans with a minimum of two years self-employment, or a minimum of one year self-employment and documented history of at least two years earning comparable income in a similar role. In addition, conforming loans require a credit score of at least 620, 3% down payment, typically a debt-to-income ratio under 45%, and a loan amount within conforming loan limits.
A non-conforming mortgage loan is one that cannot be sold by a bank to Fannie Mae or Freddie Mac. This typically occurs because the loan amount is too large.
FHA loans for self-employed borrowers.
An FHA mortgage loan is insured by the Federal Housing Administration. If you have a low credit score and are a first-time buyer, this could be the right option for you. You can typically qualify for an FHA loan with a credit score of 580 or higher, 3.5% down payment, DTI under 50%, plan to use the property as your primary residence, and have a loan amount within the FHA limit. As you can see, you can have a lower credit score and more debt with an FHA loan, but you will need to put down more of a down payment than a conventional, conforming loan.
An FHA loan requires a two-year self-employment history or one year with two years in a related role with similar earnings. In some cases, you could qualify with one year of self-employment, one year in a similar role, and one year of formal education or training.
VA loans for self-employed borrowers.
A VA loan is reserved for veterans, surviving spouses that qualify, and service members. They are guaranteed by the Department of Veterans Affairs.
Bank statement loans for self-employed individuals.
One way to get around the taxable income issue is to get a type of mortgage known as a bank statement loan. This type of loan allows you to qualify based on the money that goes into your bank account rather than what’s on your income tax returns.
Bank statement loans make it easier for borrowers to obtain higher mortgages, but bank statement loans are non-qualified mortgages, which means they lack some consumer protections offered by major loan programs. They also can come with higher interest rates. For that reason, many self-employed borrowers stick with traditional mortgages.
Best self-employed mortgage lender.
Masihi Financial Group is licensed to broker mortgage loans with the country’s top lenders. We help self-employed borrowers get matched with lenders and loan programs that meet their needs. We guide borrowers through the lending process, presenting all options clearly. We work with speed and efficiency, because we know how important a speedy mortgage loan process is when buying a home. Let us help you secure the mortgage you need for the home of your dreams. Contact us today.