Are you self-employed and looking to buy a home?
You may believe that it’s more difficult to get a mortgage when you are self-employed, but the basic criteria for approval are the same: Good credit history and a history of stable employment.
However, you may run into challenges if you’ve only been self-employed for a short period of time, or if you make less money on your personal income taxes than lenders prefer.
But it’s not impossible to get a mortgage when you are self-employed. Keep reading to find out how!
Challenges of Getting a Mortgage When Self-Employed
Before we get into how you can get a mortgage when you are self-employed, let’s look at some of the roadblocks you may face along the way.
Self-Employed Individuals Are Considered Risky
Self-employed individuals often don’t come across as ideal borrowers. Lenders see traditionally employed applicants as having a steady and easily verifiable income. As a self-employed borrower, you may need to provide additional paperwork to prove your income and show the lender that you have a reliable source of income.
Self-Employed Individuals Often Use Business Expenses to Reduce Taxable Income
One of the benefits of being self-employed is that you can use a lot of business expenses to reduce your taxable income. However, because self-employed individuals often take advantage of this it means that they often show a low net income (or even a loss) on their tax returns.
Higher Mortgage Interest Rates
Because self-employed borrowers are considered a high-risk, lenders will prepare for the possibility that you may not make your monthly mortgage payments. To offset this risk, lenders may charge higher interest rates.
There are two ways to mitigate this challenge: pay the higher interest rate and save on your taxes, or claim fewer expenses to increase your net income.
Keep in mind that even if you do go with a higher interest rate, you’re not stuck with it forever. As long as you make your mortgage payments on time, you can eventually qualify for lower rates.
How to Get a Mortgage When You Are Self-Employed
While it may seem difficult to get a mortgage when you are self-employed, it’s not impossible! Doing so simply requires that you jump a few more hoops than traditionally employed individuals.
Here are some ways you can improve your chances of getting a mortgage when you are self-employed:
1. Self-Employment History
With at least two years of self-employment history, you can show lenders that your income is stable and that you can afford to make payments on a mortgage.
If you haven’t been self-employed for at least two years, it may still be possible to get a mortgage. You may have to increase your down payment or find a lender who will consider your current self-employment history.
2. Improve Your Credit Score
Self-employed or not, a higher credit score will make you a more attractive candidate to lenders when applying for a mortgage. As someone who is self-employed, an impressive credit score will help remove obstacles that may get in the way of securing a mortgage for your new home.
Learn more about how mortgage professionals can help you improve your credit here!
3. Down Payment
As mentioned before, putting down a larger down payment can improve your chances of being approved for a mortgage as a self-employed individual.
This is because the higher the equity in the home, the less likely a borrower is to walk away from the mortgage. Lenders will see you as less of a risk if you put down more cash up-front when buying your new home.
Nowadays, a 20% down payment is recommended no matter your employment status. With a 20% down payment, there are alot more lender and product offerings availible as you longer have to go through a mortgage default insurer for your approval.
4. Minimize Your Debt
Having fewer monthly debt payments demonstrates to lenders that you have more available income to pay toward a mortgage. Work on improving your cash flow by paying down commercial debts such as credit cards and car loans before applying for a mortgage.
As a self-employed individual, you will have to provide more documentation during the mortgage process than someone who is traditionally employed. This includes proving your income through tax returns, profit and loss statements, and balance sheets.
Your lender may also require:
- A list of debts and monthly payments
- Bank statements
- A list of assets (savings accounts, investment accounts, etc.)
- Any additional sources of income (tax benefits, etc.)
- Proof of your employment (business license, letters from clients, etc.)
Having this documentation will improve your chances of being approved for a mortgage.
Mortgage Options for the Self-Employed
There are several borrowing options available for self-employed individuals:
- Prime Mortgage: This mortgage is based on your actual income over the past two years. This is a great option if you have good credit and manage your debt well.
- Stated Income: With this option, the lender takes a number between your gross and net incomes and formulates an “income reasonability” number to qualify you.
- Alternative Lenders: If you have bad credit or not enough income to qualify for a mortgage, you can look at alternative lenders. However, alt-lenders will charge more than typical mortgage lenders as well as fees to close the mortgage.
Getting a Mortgage Pre-approval
Before stressing out about getting a mortgage when you are self-employed, speak to one of our mortgage specialists about mortgage pre-approval.
Being pre-approved will help you understand what you qualify for or, if you don’t qualify, what steps you should take to improve your situation before applying again.
Pre-approvals also provide you with a list of required documentation so that you are fully prepared for your mortgage application.
With two or more years of verifiable income, a large downpayment, a good credit score, and enough cash flow, you can be on your way to owning your home as a self-employed individual!