Can You Get a Mortgage When You're Self-Employed?
When someone applies for a mortgage, one of the first things the lender typically asks for is W-2s or pay stubs. This is challenging for people who are self-employed, but that doesn't mean they're unable to get a mortgage. Banks write mortgages for self-employed people every day, as long as they can provide the appropriate proof of employment and income. There are always several things to consider when applying for a mortgage, but people who run their own businesses have unique steps to take. Keep reading to find a step-by-step guide to getting a mortgage when you're self-employed.
What Do Mortgage Lenders Want To See From Self-Employed Applicants?
All mortgage applicants need to provide proof of income because lenders need to know there's limited risk to providing the borrower money. Specifically, they want assurance that income will be high enough and consistent enough to make regular payments. Tax documents, such as W-2 forms, are the easiest way to prove this, but other options are available too.
A History of Income
Lenders generally want to see two years of self-employment income in the same industry to see annual trends. Newly self-employed people can sometimes provide W-2s from one year prior, but it's only advantageous to the borrower if their self-employed income is the same or higher than the year before. Banks understand that there can be some fluctuation in self-employment income, but it may appear as a red flag if income trends downwards year over year.
Borrowers who can show significant cash reserves have a big advantage. It provides a resource to make the payment if income drops off at any point.
Credit scores impact all homebuyers, but they become even more critical when income is variable. Significant issues such as foreclosures, delinquencies, and bankruptcies increase the lender's risk and make them less inclined to offer a mortgage.
Stability of Business
Lenders want to know whether the borrower's business can make money now and continue to make money in the future. They'll look at the location, the financial strength of the business, and the prospects for the industry it competes in.
Debt-To-Income Ratio (DTI)
This is the ratio of monthly debt payments – mortgage, car loans, credit cards, and personal loans – to monthly income. Tools like the 28/36 rule of housing expenses provide a helpful framework for establishing a healthy debt-to-income ratio. This can create a problem for those who deduct depreciation or a portion of personal expenses. It decreases tax liability and makes monthly income look less than what the applicant has to spend.
What Documentation Do Self-Employed Mortgage Applicants Need?
Documentation that a mortgage lender asks for may include:
- Two years of personal tax returns
- Two years of business tax returns
- Business and personal bank statements
- Statements from other assets such as investment accounts and retirement accounts
- A list of both personal and business debts and expenses
- Any additional income such as social security, disability, or IRA withdrawals
How To Prepare To Apply for a Mortgage
Anyone who is self-employed and is even thinking about buying a home should adopt mortgage-friendly practices well before actually home-shopping. Examples of this are:
- Establish a track record of self-employment. As much as possible, work steadily and avoid gaps in earnings.
- Improve the credit score. Check the credit reports and correct any problems. Avoid new loans or cards as the mortgage application date draws close. Pay down debt as much as possible.
- Build cash reserves by saving money. This also allows for a larger down payment and a more favorable interest rate.
- Maintain clean business records. Keep business and personal expenses separate. Maintain separate credit cards. Paying for office equipment with a personal card could increase the utilization and lower the credit score.
A Mortgage Is In Reach For All
Mortgage lenders are incentivized to work with self-employed mortgage borrowers and understand how to evaluate self-employed people's income and financial status. It takes more preparation and documentation for a self-employed applicant, but plenty of banks are eager to work with them.