Being self-employed and getting a mortgage is complicated, but it’s also becoming more common. The US Bureau of Labor Statistics predicts a 7.9 percent increase in the number of self-employed people nationwide, an increase 0.5 percentage points above the predicted growth in traditional W-2 jobs.
For most people, having a W-2 is enough to show that they receive a regular salary and can expect to earn the same or more the following year. In order for you to prove the same thing as a self-employed person, you have to produce a much bigger pile of paperwork.
Also, unlike W-2 employees, as a self-employed professional, you have to prove that your business is stable. If your business income fluctuates, that could raise some red flags that you’ll need to explain to a lender.
Getting a mortgage when you’re self-employed can be difficult, but it’s not impossible! If you’re careful and methodical about it, you can still get that home loan.
Step 1: Qualify for a Mortgage: Stable Self-Employed Work History
Lenders like to see borrowers with a stable and reliable income. They tend to prefer when a self-employed borrower looking for a mortgage has been doing the same work for at least two years, and it’s best if your income during those two years has been steady or increasing.
The possible exception is if you recently went into business for yourself but were employed in the same field for several years beforehand. Some lenders will consider that whole narrative as one income history and will see your income as more reliable.
Tip: If your business is new and unpredictable, consider waiting until things have settled and you can produce evidence of two years’ stable income.
Step 2: Keep Records of Everything
Being self-employed and getting a mortgage is all about documenting your finances. Lenders can ask for proof of any financial claim. To make sure you’re ready, keep all of the paperwork you receive for your business, including Form 1099-MISCs.
Hold on to any business expense receipts, especially those from the kind of one-time expenses that advance your business. These costs can bring down your net income and make a lender worry, but it’s better if you can verify that the effect is actually positive.
Tip: If you don’t have verifiable income and debt records from a reliable source such as a bank, hire an accountant to create a record of your finances.
Step 3: Check Your Credit Score and Debt-To-Income Ratio
Whether you’re self-employed or not, mortgage lenders want to see a good credit score and a low debt-to-income ratio, also known as a DTI.
DTI and You
Your DTI, as the term suggests, is the percentage of your regular income that goes toward paying off debts. Regular expenses like utility bills and rent don’t count here. What does count is accrued debt like car loans, student loans, and credit card balances.
For example, say that each month you earn $5,000 and pay $400 toward your student loans, $250 toward your car, and $200 toward your credit card balances. Then your debt-to-income ratio would be $850 divided by $5,000, which comes out to 0.17 or 17 percent.
Lenders want you to have a DTI of 35 percent or below, so the above situation would be highly desirable. You might still be able to get a mortgage while self-employed with a DTI of up to 49 percent, but you’d be a riskier borrower and would probably have a higher interest rate.
Your Credit Score
Your personal credit score, also known as your FICO score, is between 300 and 850. The higher your score, the more qualified you are for a mortgage loan as a self-employed borrower, and the lower your interest rate will be. The best rates go to people with scores of 740 and higher, but most borrowers are in the 680 to 739 range and qualify for average market rates.
If your credit score drops below 680, your interest rate will start to increase above the average. Your down payment requirements may also be higher, particularly if you’re applying for a Federal Housing Administration loan.
Tip: If you took out a loan to start or grow your business, spend some time paying it off before you apply for a mortgage.
Step 4: Gather and Organize Your Documents
When you decide that it’s the right time to apply for a mortgage while self-employed, get all of your paperwork in one place. Different lenders may ask for different documents, but you will probably have to supply at least the following:
- Two years of personal and business tax returns
- Current profit and loss statements
- Bank statements for your business
- A business license and any registrations (such as a “doing business as” verification)
- A list of any personal recurring debts and supplemental income
- A completed IRS Form 4506-T, which allows the lender to receive a transcript of your taxes
This isn’t necessarily an exhaustive list, so be ready to produce any other financial documents that your lender might request. Keep all documents organized by category and date so a lender can easily see that you’ve included everything requested.
Consider Your Alternatives
When you’re responsible for the health of your business, stable personal finances aren’t always at the top of your priority list. You might even have tapped into your own money to help grow your business. Many people take out second mortgages for just that reason.
If you’re in that situation and are struggling with any part of the qualification process, “How do I get a mortgage if I’m self-employed?” might not be the right question.
Instead, consider other ways of converting your equity. A second mortgage adds to your debt and can make it harder for you to get loans in the future. A home equity line of credit (HELOC) poses a similar issue.
A sale-leaseback is a safer solution. If you’re self-employed and need a mortgage loan, you can go with an alternative solution like a sale-leaseback. You sell your home and rent it back. You get to convert your home equity to cash to use for anything you want—it’s yours, no strings attached—and you remain in your house as a tenant.
Getting a mortgage when you’re self-employed can be tricky. Talk to a financial consultant to learn more about your options and to see if a sale-leaseback might be a good option for you.