How to Get a Self-Employed Mortgage

From a lender’s perspective, you may qualify as a self-employed borrower if you have at least 25% ownership in a business, be it a corporation or a partnership. In case of a sole proprietorship, you’ll need to show 100% ownership. Independent service providers and contractors fall under the self-employed bracket. You’ll also qualify as a self-employed borrower if you work for a business as a gig worker and receive Form 1099-MISC instead of Form W-2.

You may also fulfill this aspect of self-employed mortgage loan requirements if a major portion of your income comes from:

• Royalties
• Rent payments
• Interest/dividends

Home Loan Requirements for Self-Employed Borrowers

If you earn any income that comes with a Form 1099 MISC, you can be sure that a lender will view it as self-employment income. In this case, you’ll need to get through a few roadblocks before you may qualify for a mortgage. People who don’t plan to include their self-employment income in their mortgage applications need to realize that lenders will still look at their tax returns to determine how much money they make or lose. Further, if you plan to write off business losses against income, you run the risk of an underwriter subtracting the losses from your otherwise-qualifying income.

Just how much scrutiny your application receives depends on the mortgage provider you select, your income, as well as the type of business you run. Since there is no formal contract of employment to fall back on, lenders typically ask for proof of income to determine if a borrower can afford to make monthly payments. Asking for additional proof to ensure that there is stability in income is common, as is determining if you have adequate cash flow to deal with low-earning periods.

The Two-Year Requirement

Even before looking at your income, most lenders will want to determine if you’ve been self-employed for a minimum of two years. According to Freddie Mac, lenders might be able to justify providing mortgages to borrowers with at least 12-month self-employment work histories, provided they meet certain criteria. For instance, you may qualify if you’ve been self-employed for 12 months and held a job in the same field for at least two years prior to the switch.

Do You Receive Form W-2s?

If you receive Form W-2s, documenting your income for a mortgage application is fairly easy. All you need to do is provide copies of your W-2s for the preceding two years along with your preceding month’s paystubs which can be more than two if you’re paid weekly. You don’t need to provide tax returns unless you have considerable tax-deductible employee expenses or you earn a tidy sum as income from investments or commissions.

Self-employed borrowers with W-2s may also submit copies of their bank, retirement, and investment account statements. In this case, there is an increased possibility of approval if an underwriter finds your income to be adequate and your credit score to be satisfactory.

Self-employed individuals who don’t receive W-2s have to follow a more difficult path. While they need to provide copies of their personal accounts, they typically also need to submit their personal tax returns, business account statements, business tax returns, profit and loss statements, as well as year-to-date balance sheets.

Self-Employed Mortgage Documents

You may expect a lender to look at your income stability and the nature of your self-employment before making a decision. Applying for self-employed home loans requires that borrowers provide different types of documentation. It may include:

• Bank statements
• Personal and business tax returns (including schedules K-1, 1120, 1120S, and 1065)
• Profit and loss statements
• Balance sheet
• Relevant state or business license

Self-Employed Mortgage Loans – The Alternatives

Much like homebuyers who have regular jobs, self-employed mortgage seekers also get multiple options from which to choose. These include alternatives to traditional mortgages as well as conventional mortgages.

Non-Qualified Mortgages

It’s common for self-employed borrowers to ask, “What is a non-QM loan?” Simply put, non-qualified mortgages fall outside of the qualified mortgage (QM) bracket, and you may qualify for one by providing alternative forms of documentation.

Non-QM Loan Requirements

If you look at the qualified mortgage vs. non-qualified mortgage comparison, you’ll see that non-QMs tend to follow more flexible credit requirements. Besides, you may even qualify with a debt-to-income (DTI) ratio that’s over 43%. You typically need a credit score of over 600 to qualify, although this might increase to 660 for some non-QM loans. If you’re a foreign national, you may use the debt-service coverage ratio (DSCR) or standard documentation.

Are Non-QM Loans Safe?

Non-QM loan borrowers may have to make larger-than-usual down payments, and they typically end up paying higher fees and interest rates when compared to conventional mortgages. While non-QMs tend to come with higher risks than QMs, non-QM lenders have to abide by regulatory and underwriting guidelines. However, borrowers should ensure understanding the terms of their non-QMs and partner with reputable lenders.

Meadowbrook Financial offers among the best non-QM loans for people with fair/average credit, for those looking at larger-than-usual loan amounts, for investors, and for foreign nationals.

Conventional Loans

A majority of the mortgages issued in the U.S. classify as conventional conforming loans, guidelines for which are set by Freddie Mac and Fannie Mae. Lenders that provide conforming loans require self-employed applicants to show at least two years of self-employed work history. You typically need a credit score of over 620 to qualify for a conventional loan. The debt-to-income ratio for self-employed borrowers in this case needs to be 43% or lower.

VA Loans

The U.S. Department of Veteran Affairs backs VA loans. While you may apply as a military veteran, you can also apply if you’re still in military service, a surviving spouse, or a reservist. As a veteran, you don’t have to make any down payment. There is no prescribed minimum credit score requirement, which is why it may vary from one lender to the next.

Improving the Odds of Approval

Most lenders look at self-employed mortgage borrowers as high-risk propositions because of the preconceived notion that self-employed individuals can come with highly unpredictable income patterns. While people from this bracket find it harder than regular employees to get mortgages, following a few measures may help improve the odds of a successful application.

Scrutinize Your Finances

Take a close look at your personal and business finances to determine your existing financial situation even before you start looking at home loans for self-employed borrowers. Ideally, you should keep your individual and business accounts separate. This is because lenders can have a tough time distinguishing between the two if there’s any kind of overlap.

Whether you’ve filed your personal and business income separately or together, it’s crucial that you document all the sources of your income to build a stronger application for the underwriter. Keep in mind that while a lender would want to look at your personal finances, it would also want to determine how well your business is doing.

Here are some questions that can help you establish where you stand:

• How much do you currently owe toward personal and business debt?
• Do you make enough money through your business to cover your mortgage and other payments?
• How much can you afford to pay toward monthly mortgage payments?
• How much can you afford to pay to cover closing costs and as down payment?
• Do the preceding two years as a self-employed individual show steady or an increase in income?

Look at Your Credit Score

Your credit score plays a crucial role in whether or not you qualify for a mortgage and the terms that a self-employed mortgage lender offers. For instance, this factor has a significant effect on interest rates.

Lenders typically request your credit reports from all three credit bureaus, along with corresponding FICO Scores. This helps them evaluate the risk you pose as a borrower. Ranging from 300 to 850, the higher your credit score, the better the chances of approval. Besides, lenders tend to offer the lowest interest rates to applicants with exceptional credit scores.

It’s important that you look at your credit score before a lender does. This way, if you have less-than-perfect credit, you may work on improving it before applying for a mortgage. This step also helps you identify any possible errors in your credit reports that might cause your credit score to drop. If this is the case, you may contact the credit bureau in question to get the error fixed.

Inspect Your Debt-to-Income Ratio

Debt-to-income (DTI) ratio refers to the percentage of your gross monthly income that’s required to make your monthly debt repayments. For example, if your gross monthly income is $5,000 and your combined monthly debt payments amount to $2,000, your DTI ratio is 40%. Lenders pay close attention to the DTI ratios of self-employed mortgage seekers, and they view applicants with high DTI ratios as high-risk borrowers.

According to Fannie Mae, the maximum allowed DTI ratio for a manually underwritten mortgage is 36%. It can go up to 45% if a borrower fulfills credit score and other specific requirements. In addition, there can be exceptions in some cases such as cash-out refinance and high LTV refinance transactions. If your DTI exceeds 45%, consider bringing it down before you apply for a self-employed mortgage loan.

Offer to Make a Large Down Payment

Lenders view borrowers who start by having higher-than-usual equity in their homes as less likely to default on their mortgages. As a result, offer to make as large a down payment as possible without stretching your resources.

Have Significant Cash Reserves

If you’ve saved a substantial amount of money, it shows lenders you can continue making monthly payments even if you suffer a temporary financial setback. Ideally, you should be able to show enough cash reserves to cover 12 to 24 months of mortgage payments, insurance payments, property taxes, and the home’s regular upkeep.

Paying off as much of your consumer debt as possible before you apply for a mortgage is ideal. While this helps bring down your DTI ratio by reducing your monthly payments, the additional cash flow you have access to might also result in a lender offering you a higher loan amount.

Select a Suitable Lender

Not all mortgage providers view self-employed applicants in the same manner. For example, most big banks follow stringent eligibility criteria that might not work well for self-employed individuals. Specialized mortgage lenders, on the other hand, tend to offer self-employed people with good credit scores and adequate income a better opportunity to qualify for mortgages, be it in the form of non-QMs or QMs.

Conclusion

While the process and programs may be different that traditional mortgages, it is definitely possible for self-employee people to qualify for a mortgage. What’s important is for you to look at your existing financial situation and your ability to make payments going forward.

If you’re wondering how to calculate self-employed income for mortgagesor need help to determine which option might work best for you, consider speaking with a loan officerwho works with a reputed mortgage provider.