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Looking to become a homeowner? If you’re one of the 59 million Americans who freelance or are self-employed, you might have heard from friends and families about the impossibility of getting a mortgage loan.
Don’t believe a word of it!
However, you might experience a slight difficulty in documenting your income as a freelancer, gig worker, or self-employed compared to W-2 employees.
But there’s good news, too. There are several mortgage programs targeted at self-employed individuals. In this article, we’ll walk you through the process of getting a mortgage when you are self-employed.
Am I Self-Employed?
The term self-employed doesn’t equate to owning your home business when it comes to submitting mortgage applications and the mortgage industry. An online mortgage lender will likely consider you as self-employed if:
- You own 25% or more of a business
- You do not receive W-2 tax forms
- You receive 1099 tax forms
- You are a contractor or freelancer
- At least 25% of your income is from self-employment
- Most of your income is from dividends and interest
More importantly, if you’re a part-owner of a business but with a share size lower than 25%, you’re not considered self-employed for mortgage loan purposes.
How Is Self-Employed Income Calculated for A Mortgage?
When calculating self-employment income for a home loan, it is common for lenders to look at your income over the past two years and break it down by month.
For example, let’s say your tax returns for the past two years show an income of $100,000 and $85,000. Here’s how a lender would calculate your monthly ‘income’ for qualifying purposes.
- Year one: $100,000
- Year two: $85,000
- Average yearly income: $92,500 ($100K + $85K / 2)
- Monthly income: $7,708 ($92,500 / 12)
The above calculation reveals to the lender that you have around $7,708 per month to spend on your housing payments and other debt obligations.
>> More: How to Choose the Best Mortgage
What Do Lenders Want to See in Self-Employed Applicants?
Whether you’re self-employed or a W-2 employee, the mortgage approval process is quite similar in terms of lenders’ requirements.
However, for self-employed individuals, it is common for lenders to request and evaluate the following information:
- Two years of federal income tax returns (personal and business)
- Recent business bank statements
- A year-to-date profit-and-loss statement that shows revenues, expenses, and net income
- A copy of your business license
- A letter from a CPA verifying that you’ve been in business for at least two years
- Your credit score and credit history, including your three credit reports from Equifax, Experian, and TransUnion
- The location and nature of your self-employment
Depending on the loan program you apply for, you may need to provide your business bank statement and financial documentation for your other income sources.
How to Get a Self-Employed Mortgage
While lenders are open to approving mortgage applications submitted by self-employed applicants, two words always pop on their minds when they see one: high risk.
There’s a misconception among loan officers that self-employed individuals do not have a stable income compared to salaried individuals.
Because of this, it is common for lenders to hold self-employed borrowers to a higher lending requirement to secure a mortgage.
Here are six ways self-employed individuals can get one of the most significant loans they’ll ever need – the one that finances their next home purchase.
#1. Shop Around and Compare Lenders
One of the things we advise our readers is that they should never settle for the first mortgage offer that comes their way.
And if you’re a self-employed individual looking to get their first mortgage, you should shop around and compare lender requirements.
Not only does shopping around expose you to different mortgage programs, but it also helps you evaluate interest rates, lender fees and save you thousands of dollars in potential mortgage payments.
#2. Get Your Finances in Order
While it is common for several online mortgage ‘experts’ to advise self-employed borrowers to put forward a significant down paymentto reduce their perceived risk to lenders, this isn’t always the case. Lenders are more interested in seeing a solid credit score and stable income in addition to a sizeable down payment.
Before applying for a mortgage loan as a self-employed individual, you must work on your credit score and correct any errors on your credit report.
Most lenders will require a credit score of at least 620 and above. The average FICO credit score among mortgage borrowers in September 2020 was 767, according to Ellie Mae.
#3. Assess Your Business
Before applying for a mortgage, you should consider assessing the financial health of your business.
As a self-employed individual, your business is the source of your income, and lenders will want to find out if your business is healthy enough to cover the potential costs of the mortgage.
Before you start approaching lenders or submitting mortgage applications, you should ask yourself the following questions:
- How large are your existing business and personal debt obligations?
- Does your business generate enough cash flow regularly to cover potential mortgage payments and other debt payments easily?
- What monthly mortgage payment budget can your business support?
- Can you show at least two years of steady—or preferably growing—income from being self-employed?
- How much can you comfortably afford to use as a down payment and cover closing costs without affecting your business growth?
Answering the above questions will help you decide whether or not it is the right time to take out a mortgage.
Remember that most lenders will request proof of your business’s financial health when underwriting your mortgage.
Investing your time in tracking your business financial health can make a difference in the type of loan you qualify for, interest rate, and the loan amount you receive from a lender.
#4. Have a Low Debt-to-Income Ratio
Your debt-to-income ratio indicates how much of your monthly income goes towards the payment of your recurring debts. This number reveals to the lender whether or not you can afford a mortgage payment comfortably.
There are two main types of DTI ratios:
- Front-end ratio: This shows how much of your income you spend on your housing payment. Your housing payments include monthly mortgage payments, insurance premiums, property taxes, and HOA fees. For example, if your stable monthly income is $8,000, the new house payment will be $2,500, your front-end DTI will be 25% ($2,500 divided by $8,000).
- Back-end DTI: This shows how much you spend on all debts, including housing. Most lenders generally look for a back-end DTI ratio of 43% or less. If your stable monthly income a $6,000, and the new house payment is $1,500, but you also have $500 in recurring non-housing debt, your total DTI will be 33% ($2,000 divided by $6,000).
If you’re applying for a mortgage as a self-employed individual, it is common for lenders to include your business debts when calculating your total debt-to-income ratio.
So, you must reduce your business debts before applying for a mortgage loan.
#5. Save Up for a Big Down Payment
While it is possible for you to put down as little as 3% for some types of home loans, a higher down payment offers several benefits. These benefits include:
- It increases your chances of mortgage approval since a bigger down payment makes you appear less risky to lenders.
- You can easily avoid paying for mortgage insurance premiums if you put down 20% or above on a conventional loan.
- It is common for lenders to offer borrowers with a bigger down payment with some of the lowest interest rates.
If you’re having difficulty saving up for a bigger down payment, you can use down payment assistance programs.
Most down payment assistance programs are designed to help first-time homebuyers, but seasoned home buyers may qualify.
#6. Apply for Mortgage Preapproval
Before you begin your house hunting journey as a self-employed home buyer, you should approach a lender for a mortgage pre-approval letter.
Getting pre-approved for a mortgage means that a lender has checked your income, credit history and is willing to approve a specific loan amount.
More importantly, getting pre-approved for a particular amount of loan helps you find homes within your budget and proves to home sellers that you are serious with the purchase.
>> More: Read Our Guide on How to Buy a House
Tips and Tricks for Self-Employed Mortgage Loan Applicants
Below are some tips and tricks to help make your mortgage application smooth even as a self-employed mortgage applicant.
Be Patient and Review All Options
Due to the misconceptions flying over the internet regarding the difficulty in getting a mortgage when self-employed, it is common for applicants to opt for the first mortgage offer that comes their way.
As a first-time self-employed applicant, you should search across lenders and loan programs.
Being patient and reviewing all options may save you hundreds and even thousands of dollars that would have been spent on higher interest rates, monthly mortgage payments, and even lender fees.
Get Out of Debt Before You Apply
The number of debts you have can be the deciding factor on whether a lender approves or declines your loan application.
If you’re applying for a mortgage as a self-employed individual, you should consider paying down your credit card and business debts before you apply.
During a typical mortgage underwriting process, it is common for lenders to evaluate a borrower’s DTI ratio before approving their loan request.
The debt-to-income ratio is an important factor that can influence how much you’re approved to borrow.
The ratio is important to the best mortgage lenders because it determines if a borrower can comfortably pay back the loan.
More importantly, eliminating your debts right before submitting your mortgage application can send the wrong signal to a lender and even negatively impact your credit score.
It would help if you considered paying down your debts over three months before submitting your mortgage application.
Document and Verify Your Income
Documenting and verifying your income by submitting your income documents can increase your chances of qualifying for a home when self-employed.
Since self-employed income structure is different from salaried employees, the required documents are different. Expect your lender to request the following documents:
- Two years of personal tax returns
- Year-to-date profit and loss statements (P&L)
- Balance sheet
- Bank statement
If your income isn’t stable or regular, most lenders will request more than the standard two years of tax returns to prove your income stability.
It is common for underwriters to ask for up to five years of tax returns and a statement from your CPA to back your submitted income documents.
You should also be prepared to provide clarifications on any sudden decrease in your income to your lender.
What Documents Do Self-Employed Applicants Need When Applying for a Mortgage?
To start your mortgage application process as a self-employed applicant, you will need to provide your lender with some documents for verification.
Generally, lenders will want to see a history of stable self-employment income for at least two years.
Here are some examples of documents that a lender may request when applying for a mortgage as a self-employed.
These sets of documents are proof that you’re self-employed and actively working with clients. It could include documents, emails, or even letters from:
- Current clients
- A licensed certified personal accountant (CPA)
- A professional organization that can attest to your membership
- Any state or business license that you hold
- Evidence of insurance for your business
- A Doing Business As (DBA)
If you’re applying for a mortgage as a self-employed applicant, you’ll need to prove to lenders that you have a stable and reliable income flow to finance the costs of the monthly mortgage payments and closing costs.
Providing lenders with the necessary documents about your personal and business income will surely bring you one step closer to getting approved for a mortgage. Your lender will request to see the following documents:
- Personal tax returns (including W-2s if you’re paid through your corporation)
- Profit and loss forms, which could include a Schedule C, Form 1120S, or K-1, depending on your business structure
More importantly, if you have been self-employed for less than the required two-year period, then your lender will have to verify your most recent two years of employment (whether self-employment or non-self-employment).
In this case, your lender will evaluate your business training, skill, and certifications to determine whether or not you can manage your business.
What Mortgages Are Self-Employed Applicants Eligible For?
There have been several misconceptions on the internet about self-employed borrowers not being eligible for the same mortgage programs as salaried borrowers.
This is a far cry from the truth. Fortunately, self-employed borrowers virtually qualify for all the same types of mortgage programs available to salaried borrowers. The only difference is in the income and employment documentation your lender may require.
However, there are other mortgage options tailored to serve self-employed borrowers. These types of mortgage options require minimal income and employment documentation. They include:
Low-Doc and No-Doc loan
While these types of loans are harder to come by these days, it is still an excellent option if you’re self-employed or a gig worker.
A low document loan or no document loan allows individuals under self-employment to take out a mortgage without providing extensive or no income and employment documents.
A low-doc and no-doc loan typically come with very high-interest rates because of the enormous risks it presents to lenders.
Stated Income/stated asset mortgages
Also referred to as SISA loans. With this type of loan, your lender may ask that you state your assets and income instead of providing tax returns or base the loan solely on the available collateral.
Most lenders will request that you provide 12 to 24 months’ worth of bank statements so that they can calculate your monthly business income.
>> More: Explore Government Home Loan Options
Is It Harder to Get a Mortgage When You’re Self-Employed?
While self-employed mortgage applicants will need to present more documentation of their income and employment, it is not difficult to get a mortgage when you’re self-employed.
Mortgage lenders evaluate self-employed applicants the same way they would look at salaried employees.
All mortgage lenders want to see that you have a good credit score, low debt-to-income ratio, a stable income, and sizeable down payment.
However, mortgage lending requirements vary across lenders when applying for a home loan when under self-employment.
So, it is essential that you shop across lenders, understand the various conditions, and prepare all the necessary documentation.
Bottom Line: How to Get a Mortgage When You’re Self-Employed
As a self-employed mortgage applicant, you are bound to jump through additional hoops when looking to get a mortgage for your new home purchase.
To get a mortgage when you’re self-employed, you’ll need to document your income, employment, lower your debt, and explore self-employed-targeted mortgage programs.
More importantly, it would help to discuss your mortgage options with a financial expert and loan officer for proper guidance.