If you own a business, are a gig worker, an independent contractor, or a freelancer, qualifying for a mortgage can often be more difficult than W-2 employees. This is because proving a steady income can be challenging. For this reason, lenders have stricter requirements for self employed applicants.
While the application process for a self employed mortgage is similar to that for a traditional mortgage, you’ll need to provide more documentation to verify your income. Here are the top 10 strategies for the self employed buying a house to increase your chances of getting approved for a mortgage.
Who is Considered a Self Employed Borrower for Mortgage Lenders?
You don’t have to be a business owner to be self employed. A mortgage lender will consider you self employed if you meet any of the following:
- Have 25% or more ownership interest in a business
- You’re not a W-2 employee
- You receive 1099 tax forms
- You’re an independent contractor, gig worker, or a freelancer
- 25% or more of your income is from self employment
Is It Harder to Get a Mortgage If You Are Self Employed?
Securing a mortgage as a self employed individual can pose more challenges than for someone in a traditional employment situation. Lenders typically examine the stability and reliability of your income, which, for self employed individuals, requires extensive documentation.
Your credit score also holds significant weight with the lender. A high credit score can tip the scales in your favor by demonstrating a strong credit history. However, a lower score can mean steep borrowing costs or an automatic denial.
Disadvantages of Getting a Mortgage If You Are Self Employed
When you’re self employed, obtaining a mortgage can bring certain challenges that traditionally employed borrowers might not face. Here’s a closer look:
- Income Verification Challenges: Self employed individuals must provide two years of tax returns, which may show reduced income due to business deductions, complicating loan qualification.
- Variable Income: Fluctuating monthly earnings common in self employment can concern lenders who prefer stability for consistent mortgage payments.
- Debt-to-Income Ratio: Self employed applicants may have higher DTI ratios due to business or personal debts, necessitating extra documentation like profit and loss statements to prove financial health.
- Credit Score Importance: A lower credit score can lead to less favorable loan terms for self employed borrowers, emphasizing the need for excellent personal financial management.
- Tax Return Complications: Tax deductions that benefit self employed individuals by lowering tax liabilities can hurt you in the mortgage process, as lenders evaluate net income after write-offs.
What Kind of Loans Can Self Employed Borrowers Qualify for?
There are plenty of home loan options for self employed individuals. However, the eligibility process is slightly different for employed people.
Conventional Mortgages
Also referred to as conforming loans, conventional loans are available to all home buyers who meet the lending requirements. If you’re self employed, you may be eligible for a conventional mortgage insured by Fannie Mae and Freddie Mac.
Self employed borrowers must have been in business for at least two years. However, in some cases, you may be eligible with at least one year of self employment and a documentation history of at least two years of earning comparable income in the same role.
Other requirements include the following:
- A credit score of 620 or above
- 3% down payment
- Debt-to-income (DTI) ratio below 45%
Government-backed Mortgage
Insured by the federal government, these mortgage loans have less stringent requirements than conventional loans and are a great option for self employed people.
- FHA Loans: Guaranteed by the Federal Housing Administration, FHA loans are a good choice for those with a modest income. To be eligible, you must have no less than two years of self employment history (or at least one year and two years in a similar role), put down at least 3.5%, and have a minimum credit score of 580.
- VA Loans: VA home loans are zero down payment mortgages insured by the Department of Veteran Affairs. The loan program is for service members, veterans, and their surviving spouses. As a self employed home buyer, you must show at least two years of self employment history and verify your income. Other requirements vary by lender.
- USDA loans: The US Department of Agriculture guarantees USDA loans to help self employed achieve their dream of homeownership. To qualify for a USDA loan, you must have a low-to-moderate income and live in areas designated as rural by the USDA. Self employed workers need a two years history in their current role. Like VA loans, USDA loans require zero down payment.
Bank Statement Loans
A bank statement loan lets self employed applicants apply for a home loan using bank statements instead of W-2s, tax returns, or pay stubs to prove their income. Most lenders typically require 12 to 24 months’ worth of business bank statements.
Co-signer Loans
If qualifying for a self employed mortgage has proven difficult, consider finding someone like your spouse or family member to co-sign on your mortgage. A co-signer is someone who assumes responsibility for the home loan in case you default.
1099 Income Loan
If your income primarily comes from 1099 forms, a 1099 Income Loan might be available to you. Mortgage lenders will examine these documents alongside your credit history and debt-to-income ratio to determine your loan eligibility. Maintaining a solid credit score and a positive record of consistent earnings will enhance your chances of approval for this type of mortgage.
What Lenders Consider When You’re Self Employed
Lenders typically look at various factors when determining your eligibility for a self employed mortgage. This includes:
- Income stability: Lenders will look at your income to determine your ability to repay the loan. So, you’ll need to provide two years’ worth of tax returns.
- Credit score: Your credit score helps lenders evaluate your risk as a borrower. The higher your credit score, the better.
- Debt-to-income ratio: Your DTI ratio is the percentage of your monthly income you put toward your debt payments. Lenders usually want a DTI ratio of 43% or lower.
- Business financial strength: If you’re a business owner, lenders will want to look at your business financials, including profit and loss statements, balance sheets, and tax returns.
- Industry and business type: Lenders consider some industries less risky than others. That’s why they’ll look at the nature of your business and the industry you’re in.
Top Strategies for the Self Employed Buying a House
If you’re self employed and want to buy a home, you can qualify for a mortgage to finance your dream. However, the mortgage application process can be challenging. Here are strategies to employ to improve your mortgage approval odds.
1. Provide All Necessary Documentation
Lenders will want to review your employment and income documentation when applying for a self employed mortgage.
For self employment verification, you’ll need to provide the following:
- A copy of your business license
- Business insurance
- A letter from a certified personal accountant verifying that your business has been in operation for at least two years.
- Business name verification, such as doing business as (DBA)
For income documentation, your lender will require the following:
- Business and personal bank statements
- Profit and loss statements
- Two years of federal income tax returns (personal and business)
2. Establish a Stable/Strong Cash Flow
For most lenders, a stable or increasing cash flow means the borrower can make their mortgage payments. That’s why they’ll want to look at your two years tax returns. If your income fluctuates significantly from year to year, you may appear risky to lenders.
3. Make a Large Down Payment
When buying a house, you must put down a certain percentage of the home’s purchase price before closing on a mortgage. While most lenders require at least a 20% down payment for a self employed mortgage, offering a hefty down payment can increase your chances of getting approved.
One advantage of putting more money down is that you can avoid paying for Private Mortgage Insurance (PMI), which could add up to thousands of dollars.
4. Reduce Your Debt-to-Income Ratio
The debt-to-income (DTI) ratio is the percentage of your monthly income that goes toward paying debts. Lenders use your DTI ratio to determine how much home loan you can afford, so you want to reduce your DTI to at least 43% or less. You can do this by increasing your income, reducing your existing debt, and avoiding new debt.
5. Prepare Cash Reserves
Most self employed persons have irregular income, which can make it difficult to make monthly mortgage payments. As such, lenders want to see a cash reserve to ensure you won’t miss payments even when your business isn’t earning as much.
6. Improve Your Credit Score
Your credit score is another factor lenders look at when evaluating your ability to repay a loan. You’ll need a good track record of repaying debts, so improving your credit score before applying for a mortgage can boost your approval odds.
You can improve your credit score by:
- Paying bills on time
- Paying down debt
- Disputing errors on your credit report
- Lowering your credit utilization ratio
- Limiting your requests for new credit
7. Separate Business Expenses
Mixing your personal and business expenses can increase your DTI ratio, an important factor lenders look at when applying for a mortgage. So, keep your personal and business expenses separate to boost your chances of getting approved for a home loan. Separating business expenses will also make your mortgage application process much easier.
8. Get to be a Co-borrower/signer
Having someone who can take full responsibility for your mortgage if you default increases your eligibility for a self employed mortgage. Finding someone who can co-sign on your mortgage is difficult, but if you do, you’ll appear a less risky borrower in the eyes of lenders.
Just because you have a co-signer doesn’t mean you’re not responsible for your mortgage payments.
9. Opt for Government-backed Mortgages
Mortgage loans insured by the federal government usually have lenient requirements, thus best suited for self employed applicants. With an FHA home loan, for example, you’ll need to put down at least 3.5%, while some programs like VA loans and USDA loans require zero down payment.
10. Shop Around for Lenders Offering Non-QM Loans
The lender you choose could mean the difference between getting approved for a home loan and not. Non-QM Loans are home loans specifically designed for people who don’t meet the strict criteria and requirements of traditional loans, like the self employed. Ensure that you choose a lender offering a wide range of self employed mortgages nd other innovative home loan products that could get you one step closer to your dream of homeownership.
If you are self-employed and looking to buy a home, Angel Oak’s self-employed home loans are designed to provide flexibility for individuals who do not have traditional income documentation. Whether you are a freelancer, contractor, or small business owner, Angel Oak can help you secure a mortgage that fits your unique financial situation. Their team of experts understands the challenges self-employed individuals face and is dedicated to guiding you through obtaining a home loan.
With Angel Oak, you can benefit from their specialized knowledge and experience in non-traditional lending. Contact Angel Oak today by filling out this simple form to learn more about their self-employed home loan options.
How To Get Mortgages for Self Employed
When you’re ready to move forward, follow these steps:
- Step 1 – Check your credit report and dispute any inaccuracies that could be dragging your credit score down.
- Step 2 – Prepare personal and financial documentation you’ll need to apply for a mortgage.
- Step 3 – Get preapproved with at least three lenders and compare loan offers. (If you’re working with a mortgage broker, they will coordinate with lenders on your behalf).
- Step 4 – Formally apply with your chosen lender.
- Step 5 – Await a lending decision from the underwriting department and work with your loan officer or mortgage broker to seal the deal.
The Bottom Line: Get the Right Financing for Your Home As a Self Employed Borrower
When you’re self employed, finding the right financing for your home can be a unique challenge. Your business earnings are crucial in securing a home loan but may fluctuate, which requires a strong application to prove your financial stability. So, do your research to find a reputable lender that has extensive experience with self employed borrowers to give yourself a chance at a seamless mortgage process. Here’s what you need to focus on:
Frequently Asked Questions (FAQs)
Self employed individuals do not inherently pay higher mortgage rates. Still, the interest rate you’re offered can be influenced by various factors, including your credit history and the stability of your income. Lenders may look for a strong track record in your business and consistent income to mitigate risk. High risk may lead to higher rates, but if your financial profile is solid, you may qualify for the same rates as traditionally employed borrowers.
To prove self employment for a mortgage, you will typically need to provide documentation that verifies your income and the existence of your business. This often includes:
Tax Returns: Generally, you must provide the last two years’ personal and, if applicable, business tax returns.
Bank Statements: These may demonstrate the flow of money and the health of your business.
Additional Documentation: A profit and loss statement, business license, or letters from clients can also be helpful in substantiating your self employed status.
Maintaining a low debt-to-income (DTI) ratio and a high credit score can also strengthen your mortgage application.
