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Erik J. Martin
Erik J. Martin is a Chicago area-based freelance writer/editor whose articles have been featured in AARP The Magazine, Reader's Digest, The Costco Connection, The Motley Fool and other publications. He often writes on topics related to real estate, business, technology, health care, insurance and entertainment.
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If you run your own business — or are a gig worker, freelancer or independent contractor — financing a home could prove challenging. One of the first things lenders look for is a steady, verifiable income. Without a regular paycheck or W-2 statement, it can be harder to prove how much you make, and how reliably you make it. But just because you work for yourself doesn’t mean you’re guaranteed to have a hard time getting a mortgage. Here’s what to know about getting approved for a loan when you’re self-employed.
Yes, it is possible to qualify for a mortgage while self-employed. However, in some cases, you may need to put in a little extra work.
It’s a common misconception that it’s always more difficult for self-employed applicants to get a loan than regular salaried or hourly workers with a W-2 from their employer, says Paul Buege, operations officer at Guild Mortgage in Wisconsin.
“In all cases,” says Buege, “the basic criteria to get approved are the same: You need to have a good credit history, sufficient liquid available assets and a history of stable employment.”
Challenges can crop up, however, when you’re self-employed buying a house if you’ve only been working for yourself for a short time or make less money than lenders prefer — even if it’s just on paper. “Self-employed individuals often take full advantage of the legal tax deductions and write-offs that are allowed by the IRS; unfortunately, this means that they often show a low net income — or even a loss — on their tax returns,” says Eric Jeanette, president of Dream Home Financing and FHA Lenders, based in Adelphia, New Jersey. “That can make it tougher to qualify for a mortgage.”
Complicating matters is that the rules for self-employed applicants can vary depending on the lender or loan type.
“This makes the process confusing, especially if you are shopping around and applying with multiple lenders,” says Anna DeSimone, a New York City-based personal finance expert and author of “Housing Finance 2020.” Often, “it lengthens the time you may have to spend trying to get approved for a loan.”
If you’re self-employed, the loan approval process will be somewhat similar to that of a W-2 salaried applicant: You’ll need to provide certain documentation to verify your income and prove to the lender that you’re a creditworthy fit for a mortgage.
If you own a business or have one partner, you will be considered self-employed. “A loan qualification is based on your taxable income shown on your personal 1040 federal tax returns,” says DeSimone. If earned income is verified by 1099 forms, rather than W2s, you’re likely to be considered a freelancer rather than a salaried worker bee.
The same goes if your return includes Schedule C, which is used “to report income or loss from a business you operated or a profession you practiced as a sole proprietor, to quote the IRS. “Mortgage applicants with a 25 percent or greater share in a business or partnership are considered self-employed,” says DeSimone. Here are other factors that qualify you as self-employed:
Even when you have a second, part-time job with a W2, a lender will likely place more weight on your own gig — if it’s your primary income source.
Depending on the nature of your work, your problem may not be so much the amount of your income as the reliability of it. While you’re not required to submit a full business plan, it may be helpful to prepare some documents that show the health of your industry and explain why your services are (and are likely to stay) in demand. Supply reports or tax returns that prove revenue growth and provide links to a professional website that helps an underwriter understand you’re serious and successful in your field.
If you have any contracts or written agreements indicating that you’re on retainer or guaranteed compensation for a period, include those. These details may convince a lender that you can make those monthly mortgage payments.
Providing the lender with any of the below items can help show your job is secure:
Your lender will need to see proof of income, just like they would for a salaried employee. It’s just that you may have to jump through more hoops to provide that proof. “Since self-employed people have non-traditional income structures, they may be required to show additional income documents when applying for the mortgage,” says Alan Rosenbaum, founder and CEO of GuardHill Financial Corp. in New York City.
The sort of documents you might need include:
Employment verification
Income documentation
When searching for the best mortgage lenders for self-employed people, you may want to seek a loan officer who has experience underwriting a self-employment mortgage. These officers may fight harder for your approval and be able to explain your qualifications to the underwriting department. Lenders who offer FHA loans may also be a better fit than traditional loans because they are guaranteed by the government and lessen the lender’s risk.
A mortgage broker might be able to steer you toward lenders who specialize in self-employment mortgages.
Fortunately, self-employed borrowers are eligible for virtually all of the same mortgage types available to others. That means you can qualify for a conventional loan from various private lenders or a government-backed loan.
“You should be eligible for all available options, including both conforming mortgage programs by Fannie Mae, Freddie Mac, FHA and others, as well as non-conforming loans if necessary,” says DeSimone.
Here’s a closer look at each:
There are several ways to boost your odds of getting approved for a mortgage as a self-employed borrower.
Focus on improving your credit score and credit history. This requires making bill payments on time, paying down debt, correcting any errors or red flags on your credit reports and sticking to the limits on your revolving credit accounts.
Another way to increase your likelihood of funding is to lower your debt-to-income (DTI) ratio to 43 percent or less. This can be done by avoiding taking on any new debt, lowering your existing debt and paying it off faster than scheduled and earning extra money.
Forking over a higher down payment than the minimum needed can help, too. “Down payment requirements for a bank statement loan were as low as 10 percent before COVID-19 hit,” says Jeanette. “But now, many lenders require 20 percent or more.”
Shopping around among different lenders and programs can yield the best opportunities to secure home loans for self-employed individuals. Focus on lenders that do business with independent contractors or sole proprietors.“
Work with an experienced loan officer who understands self-employed business records and documentation,” says Buege. “This person can help you present your business earnings and liabilities in a clear and understandable way that facilitates the approval process.”
Enlisting a skilled mortgage broker (again, one familiar with self-employed applicants) can also up your chances.
If your self-employment income is insufficient to qualify for a mortgage, having a co-signer or a co-borrower can help you qualify for a mortgage or even a larger loan amount. Having either a co-signer or a co-borrower allows you to use their income and credit to qualify for a loan.
It’s important to note that co-signers are slightly different from co-borrowers. Both take on the debt as their own in addition to you. However, a co-borrower becomes a joint owner on the title, while a co-signer does not.
If you don’t get approved for a traditional mortgage, you can try applying for a non-conforming loan. “But these often come at a higher cost to the consumer, and not everyone can qualify,” says Buege, who adds that non-conforming loans can charge a higher interest rate and closing costs and impose less favorable repayment terms.
Alternatively, you could pursue a personal loan, although the maximum amount you can borrow likely won’t cover the cost of the home purchase.
If you’re trying to refinance and get denied, you could try applying for a home equity loan or home equity line of credit (HELOC) if you’ve built up enough equity in your property and meet the qualifications.
Lenders for self-employed mortgages will look at a borrower’s net business income to determine loan eligibility. This means they look at your gross income minus business expenses.
You can use tax returns to quickly calculate your gross and net income for previous years. Business owners may also find a recent income statement useful for proving your current income stream. Self-employed people may also be allowed to use rental income or government payments as a part of their overall income.
Also, keep in mind that loan applications for all types of self-employment are underwritten using a process DeSimone calls “add-backs,” whereby certain non-cash business expenses (like depreciation) are added back to your net income.
The short answer is yes, you can get a mortgage loan with less than two years of self-employment history. This situation may require more documentation to get a mortgage. Lenders typically want to see at least two years of self-employment before they will give you a mortgage.
However, your income isn’t the only factor they use to determine eligibility. Having a strong credit score can help boost your application. In addition, if you’ve become self-employed in an industry where you’ve previously worked, you can show continuity of career, even if you’ve been self-employed for less than two years.
Keeping business expenses separate from personal expenses can help keep your credit utilization score lower because you won’t put any potentially large business expenses on your personal credit accounts. A low credit utilization score is one factor that lenders look at when assessing you for a mortgage.
Arrow Right Contributor, Personal Finance
Erik J. Martin is a Chicago area-based freelance writer/editor whose articles have been featured in AARP The Magazine, Reader's Digest, The Costco Connection, The Motley Fool and other publications. He often writes on topics related to real estate, business, technology, health care, insurance and entertainment.
