Home Loans Are Just As Available To The Self-Employed
For many people, quitting your job to become your own boss is as much a part of the American dream as owning a home.
Fortunately, these two things are not mutually exclusive.
Buying or refinancing a home while self-employed is a lot like doing so as an employee. You must document your income and the amount of money you have in the bank.
A credit score is required, too, although you don’t have to have perfect credit.
It’s the income part of the application where most self-employed borrowers get hung up.
But if you learn a few basic lending guidelines for self-employed applicants, your loan process should go as smoothly as it would if you were the typical 9-to-5 worker.
Tax Returns: The Most Important Piece Of Your Application
Prior to the housing downturn, self-employed borrowers had a variety of loan options available to them.
You could prove your income just by showing 12 months of bank statements.
Sometimes, you didn’t need to show any proof of income at all.
This was not necessarily a bad thing. No-income-verification loans were created for self-employed borrowers with five businesses and six-inch-thick IRS tax returns.
No-doc loans streamlined the process for high-earning borrowers and lenders. This cut the cost and improved efficiency.
But these programs soon were rolled out to everyone, and abuse of the system followed. No-doc and low-doc loans were eventually used to inflate incomes of salaried employees. But that was not their original purpose.
Rarely will you find a lender offering no-income verification, or stated income loans today. Self-employed borrowers must prove their income with tax returns.
The problem is, tax returns often don’t paint a “real life” picture of your income.
Tax Returns Don’t Always Reflect “Felt” Income
Self-employed mortgage loans have gained a reputation of being difficult, or even impossible. This perception is often overblown.
It stems from the fact that a large number of self-employed borrowers don’t show enough income, at least according to a mortgage underwriter’s interpretation.
Self-employed borrowers write off as many expenses as possible so that they can get a break on their tax bill. This tactic is what often prevents them from qualifying for a mortgage.
For instance, you took in $60,000 last year. But you wrote off $20,000 in business expenses like mileage and equipment.
As the underwriter sees it, you only made $40,000 or about $3,300 per month. It “felt” like you made much more than that.
If you apply for a mortgage at $1,500 per month, you might not be approved. Your mortgage payment alone would require 45% of your “on paper” income, even if you know you can afford more.
You might also be inconsistent with income, either due to business fluctuations or how much you write off year over year. Lenders will look for significant fluctuations between years of taxable income and typically use the lower of the most recent two years.
Prepare to explain significantly lower income in the most recent year. The underwriter will need to verify it was a one-time event and not a downward trend in your business.
Despite challenges, getting approved for a mortgage loan as a self-employed borrower does not have to be difficult. The caveat is whether or not you can prove enough income, and for how long.
Plan Two Years In Advance For Your Mortgage
To qualify for a mortgage in the next couple of years, self-employed borrowers should speak with an accountant and a mortgage professional now. It’s important to know how much income will be necessary based on the price range of the home you’re trying to purchase or refinance.
Unlike salaried workers, self-employed business owners can alter how much they make on paper by writing off more or less in business expenses. A two-year strategy pays off when you eventually apply for a loan.
Generally, self-employment will not hinder your approval as long as you can document the following.
- Adequate income
- Proof of self-employment for at least two years
Some loan types such as FHA mortgages require only one year of self-employment, if you have been in the same line of work for at least two years. Check with your lender to see if you are eligible for an exception to the two-year guideline.
No Need To Fear The Extra Documentation
Self-employed individuals will have to provide more documentation than a salaried W-2 applicant. That’s just a fact.
But it doesn’t have to be intimidating. You have kept good records. It’s only a matter of making copies or creating a PDF version of all your income paperwork that is easily transferred to a lender.
From there, the lender organizes your paperwork and makes a case for your approval.
A list of documents you should gather is as follows.
- Two years of personal tax returns
- Two years of business tax returns including schedules K-1, 1120, 1120S
- Business license
- Year-to-date profit and loss statement
- Balance sheet
- Signed CPA letter stating you are still in business
Tax professionals are very accustomed to providing necessary documentation for a mortgage. Your CPA may even be able to email you all your required documentation the same day.
With documentation in hand, applying for your home purchase or refinance becomes very easy.
What Are Today’s Mortgage Rates For Self-Employed Applicants?
Understanding what a lender wants to see can definitely make life easier for self-employed borrowers. As long as the lender can verify the income needed to qualify for the loan, the lender will process and underwrite your loan just as though it were any other mortgage.
Get an interest rate quote for your home purchase or your refinance while rates are still low. All quotes come with access to your live mortgage credit scores. Your social security number isn’t required to start.