If you run your own business — or are a gig worker or independent contractor — and you want to buy a home or refinance, it could be more challenging for you to secure financing. The reason? It can be harder to prove how much income you have without a steady paycheck or W-2. That’s why most lenders have stricter rules for self-employed borrowers.
Just because you work for yourself doesn’t mean you’re guaranteed to have a hard time getting a mortgage, however. If you supply the right documentation to verify your income, do your homework and know what to expect, you can get approved for a loan.
Is it difficult to get a mortgage when self-employed?
It’s a common misconception that it’s always more difficult for self-employed applicants to get a loan than regular salaried or hourly workers with a W-2 from their employer, says Paul Buege, president and COO of Inlanta Mortgage in Pewaukee, Wisconsin.
“In all cases,” Buege says, “the basic criteria to get approved are the same: You need to have a good credit history, sufficient liquid available assets and a history of stable employment.”
Challenges can crop up, however, if you’ve only been working for yourself for a short time or make less money than lenders prefer.
“Self-employed individuals often take full advantage of the legal tax deductions and write-offs that are allowed by the IRS; unfortunately, this means that they often show a low net income — or even a loss — on their tax returns,” explains Eric Jeanette, president of Dream Home Financing and FHA Lenders, based in Adelphia, New Jersey. “That can make it tougher to qualify for a mortgage.”
Before the 2008 crisis, this would’ve been less of a problem, as loans that required no documentation or stated income were readily available to borrowers. Today, lenders scrutinize income and other financial qualifications much more thoroughly, particularly in the last few months due to the coronavirus downturn.
“Since self-employed people have non-traditional income structures, they may be required to show additional income documents when applying for the mortgage,” says Alan Rosenbaum, founder and CEO of GuardHill Financial Corp. in New York City.
Complicating matters is that the rules for self-employed applicants can vary depending on the lender or loan type.
“This makes the process confusing, especially if you are shopping around and applying with multiple lenders,” says Anna DeSimone, a New York City-based personal finance expert and author of “Housing Finance 2020,” adding “it lengthens the time you may have to spend trying to get approved for a loan.”
What mortgage lenders are looking for
If you’re self-employed, the loan approval process will be somewhat similar to that of a W-2 salaried applicant. You’ll need to provide certain documentation to verify your employment income and prove to the lender that you’re a good fit for a mortgage.
What documentation will I need to show lenders?
When applying for a mortgage, expect lenders to request and review the following employment and income documents:
- A copy of your business license
- Proof of business insurance (if applicable)
- A letter from a CPA verifying that you’ve been in business for at least two years
- Two years of federal income tax returns (personal and business)
- Recent business bank statements
- A year-to-date profit-and-loss statement that shows revenues, expenses and net income
- An itemized list of unpaid accounts receivable
Rosenbaum notes that some loan programs simplify this process by merely requiring you to provide business bank statements and documentation of any other income streams, such as rental income, pension payments and Social Security income.
“Mortgage applications with a 25 percent or greater share in a business or partnership are considered self-employed,” DeSimone says. “Also, loan qualification is based on your taxable income shown on your personal 1040 federal tax returns.”
Good news: If you’ve owned your business for more than five years, business tax returns are not required on loans purchased by Fannie Mae and Freddie Mac, DeSimone says — “but if your business is less than two years old, prepare to provide previous employment information plus business tax returns, a CPA letter or financial statements.”
Additionally, be aware that loan applications for all types of self-employment are underwritten using a process DeSimone calls “add-backs,” whereby certain non-cash business expenses (like depreciation) are added back to your net income.
“The list of qualified add-backs is extensive and can make a difference in you qualifying or not,” DeSimone says.
How to improve your chances of getting a mortgage
There are several ways to boost your odds of getting approved for a mortgage as a self-employed borrower.
Improve your credit score
Focus on improving your credit score and credit history. This requires making bill payments on time, paying down debt, correcting any errors or red flags on your credit reports and sticking to the limits on your revolving credit accounts.
Lower your debt-to-income ratio
Another way to increase your likelihood of funding is to lower your debt-to-income (DTI) ratio to 43 percent or less. This can be done by avoiding taking on any new debt, lowering your existing debt and paying it off more quickly than scheduled, and earning extra money.
Make a larger down payment
Forking over a higher down payment than the minimum required can help, too.
“Down payment requirements for a bank statement loan were as low as 10 percent before COVID-19 hit,” Jeanette says. “But now, many lenders require 20 percent or more.”
Shop around for the right lender for you
Shopping around among different lenders and programs can yield the best opportunities. Enlisting a skilled mortgage professional can also up your chances.
“Work with an experienced loan officer who understands self-employed business records and documentation,” Buege says. “This person can help you present your business earnings and liabilities in a clear and understandable way that facilitates the approval process.”
What kind of loan can I qualify for?
Fortunately, self-employed borrowers are eligible for virtually all of the same mortgage types available to others. That means you can qualify for a conventional loan from a variety of lenders.
“You should be eligible for all available options, including both conforming mortgage programs by Fannie Mae, Freddie Mac, FHA and others, as well as non-conforming loans if necessary,” DeSimone says.
What if I don’t qualify for a mortgage?
If you don’t get approved for a conventional mortgage, you can try applying for a non-conforming loan offered by select lenders.
“But these often come at a higher cost to the consumer, and not everyone can qualify,” says Buege, who adds that non-conforming loans can charge a higher interest rate and closing costs and stipulate less favorable repayment terms.
Alternatively, you could pursue a personal loan, although the maximum amount you can borrow likely won’t cover the cost of the home purchase.
If you’re trying to refinance and get denied, you could try applying for a home equity loan or home equity line of credit (HELOC) if you’ve built up enough equity in your property and meet the qualifications.
Next steps: How to get the lowest mortgage rate
To qualify for the lowest mortgage interest rate possible as self-employed borrower, follow these tips:
- Improve your credit score and correct any errors on your credit reports. “Aim for a credit score over 720,” Jeanette says.
- Offer the largest down payment you can afford (ideally one higher than the minimum required by the lender).
- Research several different lenders and rates carefully to find the best terms.
- Opt for a loan with a shorter-term. A 20- or 15-year fixed-rate mortgage may come with a lower interest rate.
- Consider paying upfront discount points, which can lower your rate.