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A self-employed borrower may have a more difficult time proving their income than someone with a regular job.
Chuck Savage/Getty
It’s often harder for self-employed borrowers to get a mortgage because proving consistent income can be difficult.
Improving your credit, making a large down payment, and furnishing tax returns can help with approval.
Self-employed borrowers who don’t qualify for a conventional loan might consider a bank statement loan.
When you apply for a mortgage, your income will play a big role. After all, lenders need to see that your earnings can comfortably cover your new mortgage payment, as well as any other household debts and expenses.
Unfortunately, proving income isn’t as cut and dry for self-employed professionals as it is for traditional income earners — but it is possible. Here’s what you should know about the approval process, and what you can do to make it go more smoothly.
Why getting a mortgage is harder when self-employed
The biggest reason obtaining a mortgage is more difficult when you’re self-employed is that these workers often have inconsistent incomes. They also don’t have much of the typical documentation required for a loan (W-2s, pay stubs, etc.), and their employment can’t be verified as easily.
“Self-employed borrowers have to provide additional financial records like tax returns and information about their business,” says Matthew Locke, national mortgage sales manager at UMB Bank.
Often, those tax returns pose an issue, too — particularly if the borrower takes a lot of tax deductions. When this happens, their income appears much lower than it actually is. This can make it harder to qualify for a loan. Even if they do qualify, it could reduce the amount they’re eligible to borrow.
“It’s common practice to write off business expenses when you’re self-employed, but that reduces your business’s overall profits,” says Austin Horton, director of sales and business operations at Homie Loans. “This ends up lowering your total qualifying income when applying for a mortgage.”
Important: The phrase “self-employed” doesn’t just refer to people who own a business. If you’re a contractor, freelancer, or gig worker, then you’re considered self-employed, too.
While it can be harder to qualify for a mortgage as a self-employed person, experts say you won’t pay a higher interest rate — at least with a conventional or government-backed loan. If you’re unable to qualify for one of those, you could pay a higher rate with a non-qualified mortgage, or non-QM loan. These loans don’t adhere to certain regulations set out by the Consumer Financial Protection Bureau and the Dodd-Frank Act, giving lenders more freedom in who they can approve.
How self-employment income is calculated for a mortgage
With traditional income earners, mortgage lenders will ask for the borrower’s last two years of tax returns and W-2s, and their last two pay stubs to calculate the borrower’s income and how much they can comfortably repay.
Since self-employed borrowers don’t have traditional income documents, lenders will instead ask to see:
Any 1099s for contract workCopies of the last 12 to 24 months of business and personal bank statementsA year-to-date profit and loss statement for the business
Lenders usually want borrowers to have at least two years of self-employment experience, or at the very least, two years of proven experience in their current field.
“You might need to provide additional documentation about your business, depending on how you’ve structured the business ownership,” says Rob Heck, vice president of mortgage at Morty.
“Factors like how long you’ve been in business and how stable your business looks to your lender’s underwriters will matter, too,” he says. “If it sounds like a lot of documentation, remember: lenders aren’t in this to give you a hard time. They just want to verify that you have enough income coming in to cover your future monthly mortgage bill.”
Mortgage options for self-employed borrowers
Self-employed borrowers have the same loan options as traditionally employed people. The thing to keep in mind is that government- and agency-backed mortgages will require tax returns, so if your taxable income is too low to meet the loan’s requirements (or qualify you for a large enough loan), you’ll need to look at a non-QM loan.
One popular non-QM option is the bank statement loan, which uses only bank statements — not your tax returns — to assess your income.
“Self-employed borrowers with good to excellent credit, large down payments, and the income to afford a higher-priced home are oftentimes turned away from their bank or other financial institution simply because they can’t qualify using tax returns and that lender does not have another loan option to help them,” says Mac Cregger, a senior vice president and regional manager at Angel Oak Home Loans, a non-QM lender. “That same borrower can qualify very easily and quickly with a bank statement loan.”
Here’s a look at the four loan options you might use as a self-employed borrower:
Conventional loan: These mortgages typically require a credit score in the low-600s, and you can have a down payment as low as 3%. If you make a 20% down payment or more, you won’t need to pay for private mortgage insurance.VA loan: VA loans are mortgages for veterans, active duty military members, and military spouses. They require no down payment. While the VA does not set a specific credit score minimum, most lenders require at least a 620. FHA loan: These are mortgages that are backed by the Federal Housing Administration. They require a 3.5% down payment and have the lowest credit score requirements of all. If you have a 10% down payment, you may be able to get approved with a score as low as 500.Bank statement loan: Bank statement loans give lenders more leeway in who they can lend to and how they consider income, but it also makes them riskier. For this reason, they typically have higher interest rates.
Note: Just like you would with a traditional mortgage, be sure to shop around for a bank statement loan. You should compare several lenders on interest rates, fees, and loan structure to ensure you get the best deal.
7 tips for getting a mortgage when you’re self-employed
While the road to getting a mortgage can be more challenging for self-employed borrowers, it’s not impossible. Here are several ways you can improve your application.
1. Be prepared to open your books
Make your loan process easier by gathering your documents ahead of time.
You can usually expect to need 12 to 24 months of bank account statements (business and personal) and, potentially, a profit and loss statement for your business. If you have any 1099s from contracting work, your lender may want copies.
2. Reduce your debt-to-income ratio
Your debt-to-income ratio is how much of your monthly income goes toward debt payments, and it’s an important consideration for lenders. It tells them how much you can comfortably afford to spend each month on a mortgage.
The exact DTI you need varies by loan program, but generally speaking, the lower your DTI, the easier it will be to qualify. Additionally, a higher DTI will usually mean a higher interest rate, as it makes you a riskier borrower in the lender’s eyes.
To improve your chances, work on lowering your DTI. You can do this by paying down debts or increasing your income.
3. Improve your credit
Your credit is another big factor for lenders. Again, the minimum score you’ll need varies by loan program and lender. Higher scores mean lower interest rates, which can save you money in the long run.
“Having a high credit score may help as it shows that you are responsible with your finances,” Heck says. “Showing that you’ve successfully managed debt before — through credit cards, personal loans, or business loans — can also show lenders know you’re a trustworthy borrower.”
You should also pull your credit report. If you find any errors, dispute them with the credit bureau. Other ways to improve your score include paying down debt, increasing your credit limit, and making consistent on-time payments.
4. Make a larger down payment
While it’s not possible for everyone, making a larger down payment is another strategy to consider. When you make a bigger down payment, you reduce the amount of money you need to borrow.
Ideally, you should aim for at least a 20% down payment, as this will typically help you avoid mortgage insurance, which makes your monthly payment more expensive.
“Increasing your down payment can also help lower your loan-to-value ratio, and hence show lenders that you’re a lower-risk borrower,” Heck says. “As a person with a non-traditional source of income, you’ll have an easier time securing a mortgage if you have significant savings put away, or if you’re able to put at least the traditional 20% down.”
5. Get a mortgage preapproval
A preapproval is basically the first step in the mortgage process. You’ll provide some financial information to your choice of lenders and each one will determine if you’re a good candidate for a home loan.
It’s always smart to get preapproval for a mortgage before shopping for a home — but it’s particularly important for self-employed people. For one, it gives you an idea of what price range you should be shopping in. It also shows sellers that, despite your non-traditional employment, you’re likely to be approved for a loan and go through with the deal.
According to Locke, it can also help speed up your mortgage process.
“We recommend self-employed borrowers seek a preapproval up front before going under contract,” Locke says. “This would allow the lender additional time to review all tax returns and financial records relating to the business which can sometimes take longer for review than a normal W-2 borrower.”
6. Consider a joint mortgage
If including a spouse or partner on your mortgage is an option, that might be a route to explore, too. First, it adds more income to your application, which is critical if you’ve taken many tax deductions and have a low taxable income.
“If a spouse or co-buyer that is a W-2 worker has the same or better qualifications, it can strengthen your ability to qualify for a mortgage,” says David Hall, president and CEO of Hall Financial.
Additionally, if your partner has a salaried, W-2 income, it can also lower your risk. It shows lenders you have stable, consistent income with which to pay your mortgage. “It’s all about the amount of income compared to the amount of debt on the mortgage application,” Hall says.
7. Think before filing your taxes
Finally, if you regularly take self-employed tax deductions on your annual returns, think carefully before next year’s filing day. Skipping some of those deductions might help you more easily qualify for a loan and buy a house.
“Plan ahead,” Hall says. “If you think that you may buy a house in the coming year or two, take off some of your tax deductions to show a little more income.”