FHA mortgage qualifying gets tougher for the self-employed

August 17, 2020 - 7 min read

FHA is changing the rules for self-employed borrowers

COVID has made it tougher for lenders to verify that home buyers will have steady income.

That’s especially true for self-employed borrowers.

As a result, FHA has implemented new guidelines about qualifying with self-employed income.

And it’s not just FHA. Borrowers will likely have to meet higher standards on any type of loan.

But financing is still accessible. And with rates near record lows, it’s worth getting your extra paperwork in order and applying.

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New FHA rules for self-employed home buyers

On July 28, 2020, the FHA sent out a letter to all lenders that offer its loans.

It provided new, temporary guidance to lenders approving self-employed borrowers. Most importantly, the new standards include:

  1. Verifying continuing business operations for self-employed borrowers
  2. Rental income requirements for landlords

These FHA loan changes are set to last until at least November 30, 2020.

These new rules aim to ensure that borrowers will continue to be able to afford mortgage payments in these unprecedented and extraordinary times.

If you’re a self-employed person looking for an FHA mortgage, here’s what it means for you.

Verifying continuing income

Before it will give you a mortgage, a lender needs to know you’ll have continuing income and be able to make payments.

Lenders of FHA loans are given four ways to verify that the applicant’s business is continuing to operate.

Self-employed borrowers should be prepared to show one or more of these when applying for an FHA loan:

  1. Evidence of current work, like executed contracts or signed invoices that indicate the business is operating on the day the lender verifies self-employment
  2. Evidence of current business receipts within 10 days of the note date (payment for services performed). The note is created near the end of the loan process
  3. Lender certification that the business is open and operating. The lender will confirm through a phone call or other means
  4. Business website with activity showing current business operations, for instance, if timely appointments for estimates or services can be scheduled

Lenders only need one form of verification. But don’t be surprised if yours goes for two, three, or all four.

Of course, these standards only apply if you’re relying on income from your self-employed business to qualify for the mortgage.

If you have enough money coming in from other sources, your lender won’t usually need to verify the current state of your business’s operations.

Rental income requirements (for landlords)

Similarly, the following applies only if a landlord is using rental income to support an application for an FHA loan.

This applies to two types of buyers: 1) Those who are buying 2-4 unit homes who are qualifying with future rental income from the other units, and; 2) buyers who own rental properties and are using rental income to qualify for the new FHA loan.

The new standards are meant to reflect the uncertainty of rent payments during the pandemic.

Lenders can use one or more of these new methods to calculate rental income:

  1. Reduce the effective income associated with the calculation of rental income by 25%
  2. Verify 6 months PITI [principal, interest, taxes and insurance] reserves (this doesn’t apply to reverse mortgages)
  3. Verify the borrower has received the previous 2 months rental payments as evidenced by the borrower’s bank statements showing the deposit. (This option is applicable only for borrowers with a history of rental income)

These checks may also be necessary if you’re applying for a home equity conversion mortgage (a.k.a. a ‘reverse mortgage’) and are relying on rental income to support your application.

Updates to the FHA 203(k) rehab loan — easier to request extensions

There’s one bit of good news in the FHA letter. This applies to all borrowers using the FHA 203(k) rehab loan, which allows you to buy a home and rebuild or restore it.

Normally, funds for renovations are released from an escrow account, following an agreed-upon timetable for when stages of the work should be complete.

But the coronavirus has disrupted many of those timetables. And a lot of homeowners need extensions to keep their projects on track.

The FHA recognizes that. It now lets borrowers request an extension with an explanation for the delay from you, your contractor, or a consultant.

You will, however, be asked for a revised estimated completion date.

FHA mortgage rates mean this is still a good time to buy or refinance

By now, you may be wondering whether it’s still worth applying for an FHA loan, even with new hoops to jump through.

Our answer is, yes! If you qualify, it’s worth applying while FHA mortgage rates are so incredibly low.

On the day this was written, average mortgage rates set yet another all-time low. It was possible to get a 30-year, fixed-rate mortgage (FRM) backed by the FHA with a rate as low as 2.25% (3.226% APR), according to rates published by at least one lender in The Mortgage Reports’ network.

Last year, mortgage rates below 4% were “low.” Now, FHA rates are averaging below 2.5%.

Just to add some context, rates for all 30-year FRMs averaged 3.94% in 2019, according to Freddie Mac’s archives.

Last year, anything sub-4% was thought to be incredibly low. And now FHA rates have fallen below that by more than one full percentage point.

Of course, rates may be even lower (or higher) by the time you read this. So check today’s FHA and other rates now.

Check your FHA rates. Start here

Why it’s harder to get a mortgage when you’re self-employed

Why are mortgage lenders picking on the self-employed during COVID?

For an answer, we looked back to a June 17 article from MarketWatch. In that, Sanjiv Das, CEO of Caliber Home Loans, revealed some startling statistics about his customers’ forbearance needs. He wrote:

“Remarkably, self-employed individuals make up 42% of customers who seek forbearances — the largest group among our borrowers.” —Sanjiv Das, CEO, Caliber Home Loans

Of course, that article didn’t trigger higher hurdles for self-employed mortgage applicants all by itself.

But there’s reason to believe that most mortgage lenders are seeing similar figures. And, as a business person yourself, you can see why they’re bound to react strongly.

Just as a point of reference, in 2019, Pew Research Center reckoned that 10% of American workers were self-employed.

So they’re four times as likely as traditionally-employed people to be requesting forbearance, assuming Caliber’s figures are representative of most lenders’ experiences.

Are there new rules for non-FHA loans?

If you’re self-employed and are applying for a mortgage that’s not backed by the FHA, you may be feeling smug. None of the above applies to you.

Or does it? The rules might be slightly different, but lenders are being extra-tough on applicants across all types of mortgages.

In June 2020, The Mortgage Reports said:

“Both Fannie Mae and Freddie Mac [the agencies that regulate conventional loans] have announced new standards for self-employed borrowers. Virtually all lenders will soon follow.

“The new rules require self-employed borrowers to provide one or two new documents when applying for a mortgage: either an audited P&L statement, or an unaudited P&L statement along with 2 months’ business account statements.”

So the coronavirus is making it all but inevitable that self-employed people will have to work harder to get their applications approved, regardless of whether they’re getting FHA loans.

And business statements aren’t the only thing being scrutinized.

Higher credit scores all round

For example, credit score requirements are tight for all borrowers.

Regardless of whether you’re self-employed or the type of loan you want, you’ll likely need a higher FICO score to get a mortgage during the pandemic.

Ellie Mae’s latest mortgage Origination Insight Report — published in June 2020 — says the average FICO credit score across all mortgage loans closed that month was 751.

As recently as February 2020, the average score was just 738.

Tougher down payment and debt requirements

The same report showed a small increase in down payments over the same period.

  • In June 2020, the average loan-to-value ratio (LTV) was 73% — meaning the average down payment was 27%
  • In February 2020, that average LTV was 76% — so the average down payment was 24%

Likely, this is at least in part because lenders want to see bigger down payments offering more security.

Meanwhile, debt-to-income ratios (DTIs) were also stricter.

  • In June 2020, closed loans had an average DTI of 35%. That means borrowers’ monthly obligations (debt, alimony, and so on) plus their housing costs were 35% of their gross monthly incomes
  • Back in February, it seems lenders were more generous, allowing DTIs that averaged 37%

Of course, all those are just averages.

Plenty of applicants are still being approved with a 580 credit score (depending on the type of loan they want) and a low down payment.

Indeed, minimum down payments remain 3.5% for FHA loans, 3.0% for those from Fannie and Freddie, and zero for those eligible for VA and USDA loans.

And many will still be getting mortgages even though their DTIs are considerably higher than the average.

You can likely still be approved

The numbers above show a general tightening of lenders’ requirements. So you may find it a bit harder to get approved for any type of mortgage.

The best thing you can do in this situation is shop around for low rates and sympathetic lenders.

At today’s mortgage rates, it’s worth the extra effort to find a lender that can help you qualify.

Time to make a move? Let us find the right mortgage for you

Peter Warden
Authored By: Peter Warden
The Mortgage Reports Editor
Peter Warden has been writing for a decade about mortgages, personal finance, credit cards, and insurance. His work has appeared across a wide range of media. He lives in a small town with his partner of 25 years.