There’s a lot to be said for self-employment. You get to choose when, where, and how you work. You’re not limited by a salary, either — your earning potential is limited only by your work ethic, professional expertise, and business savvy.
However, being self-employed does make the process of applying for a mortgage or home equity line of credit (HELOC) more challenging. Lenders can be reluctant to lend to self-employed borrowers, but you can still prove your case. Keep reading to find mortgage tips and learn more about getting loans for self-employed workers.
HELOCs 101: What Are They for and How Do You Get One?
A HELOC is a common way of accessing your equity, which is the value of your home minus the balance on your mortgage. When you take out a HELOC, you borrow against your equity.
A HELOC is revolving credit. You get approved to borrow up to a certain amount and can make withdrawals as you will, up to that amount, for as long as you’re in what’s called the draw period.
The draw period on a HELOC usually lasts five to 10 years. After that, you’ll enter the repayment period. You’ll stop borrowing and instead make regular payments to rebuild your equity.
Why a HELOC?
People take out HELOCs for a variety of reasons:
- To make improvements or additions to a property
- To buy a second home
- To cover unexpected expenses like medical bills
- To fund a wedding or other life event
- To pay off a mortgage early
The benefit of using a HELOC in these situations is that the interest rate is usually lower than that of a personal loan or credit card. Also, because it’s revolving credit, you only pay interest on what you borrow.
How You Qualify
To qualify for a HELOC, you need to have:
- At least 15% to 20% equity in your home. In other words, your mortgage balance can’t total more than 80% to 85% of your home’s value.
- A history of on-time payments. That applies to your current mortgage and other debts.
- A credit score that’s equal to or above lender minimums. You’ll probably have some options as long as your score is in the mid-600s. The higher it is, the more choices you’ll have, and the lower your interest rates will be.
- Monthly debt payments totaling no more than 43% of your monthly gross income. Lenders call this your debt-to-income ratio.
- Enough income to afford the HELOC payments.
This last requirement can be tough for self-employed borrowers.
Getting a HELOC When You’re Self-Employed
HELOC lenders want borrowers to have steady incomes. When a self-employed person applies for a loan, they can’t submit a W-2 or pay stubs to prove that they earn a certain amount and will continue to earn that amount for the foreseeable future.
Self-employed professionals know that their income can be just as stable as that of employees — sometimes even more so because an employee depends on a single company and a self-employed person usually has multiple clients. However, lenders require more proof of stability.
To get a HELOC as a self-employed person, you may need to provide one or both of the following:
- Several years’ worth of tax returns or tax transcripts (official IRS documents with income information)
- Several weeks of bank statements
A HELOC is often easier than a personal loan for self-employed professionals since your home is your collateral. Of course, that does mean that the lender could take your home if you default on the loan.
Converting Equity Without Borrowing: The Sale-Leaseback Option
If you have trouble qualifying for a HELOC, you’ll probably also have trouble getting a lump-sum home equity loan. At that point, it might feel like your only choice is to sell your home and move out, but that’s not the case.
There’s also the option of selling your home to a company that will then rent it back to you. This is called a sale-leaseback program, and it allows you to convert your equity without borrowing or moving.
Not a Homeowner Yet? Getting a Mortgage While Self-Employed
Getting a mortgage as a self-employed person is much like getting a HELOC. You’ll have to submit alternate proof of income. In this case, though, you may only need to provide one tax return showing 12 months of self-employment income.
The catch is that you need to have two years of self-employment history. The exception is when you have previous experience in your field and you’re making as much while self-employed as you did when you were an employee. If that’s the case, you only need to prove one year of self-employment.
Tips for Qualifying
- If your business has had some “down” years recently, you’ll need to show that this is a normal pattern and you expect an upswing again. Offer up to five years of taxes — as many as it takes.
- Ask your accountant for a statement verifying that your business is in good shape.
- Raise your credit score as much as possible. Pay off card balances when you can. This will also decrease your debt-to-income ratio.
- To get a HELOC or mortgage as a self-employed borrower, you’ll need to use your tax and bank statements to prove that your income is stable.
- If you haven’t been self-employed for long or your income is unpredictable, ask your accountant to verify that your business is healthy.
- To convert your equity without borrowing, consider a sale-leaseback option. These let you stay in your home and avoid new debt.
Talk to a financial advisor to learn more mortgage tips for the self-employed.