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How to Qualify for a Self-Employed Mortgage Loan

There's a misconception that self-employed people don't have the steady income or tax records necessary to qualify for a mortgage. But that’s simply not the case. If you are self-employed, you can and should take advantage of the many home loan options available to you. 

It just takes some necessary paperwork and planning. This article presents a detailed guide to the steps you can take to be the perfect candidate for a self-employed mortgage loan. 

Do I need a self-employed mortgage loan?

Being your own boss is a freeing experience, allowing you to leave a mark in the world. Your endeavors may pay off, placing you in a position to buy a home. So why should you worry when filling in the mortgage application? The answer is: you shouldn’t.

Lenders don’t always view self-employed individuals as ideal borrowers. An employed borrower may only need to provide recent pay stubs, a couple of years’ worth of W-2s, and personal tax returns. All that means is that self-employed borrowers may need to present additional documentation, showing their income as a small business owner. 

Besides, most entrepreneurs deduct their business expenses while filing returns. While it may lower your taxable business income, it may also convey a lower annual income to the lenders — even when that’s not entirely accurate. 

However, there are still many options. Lenders provide numerous loan option packages targeting the self-employed. And there are tricks you can use to become an ideal candidate for a mortgage for self-employed individuals. 

Self-employed mortgage qualifications 

A couple meeting with loan officer

Most lenders qualify self-employed clients similarly to everyone else. You need to meet the same standards on debt-to-income ratio, credit history, down payments, and income as all mortgage applicants. The specific requirements may vary from one lender to another. 

Mortgage lenders typically define “self-employed” as an individual with an ownership interest of 25% or greater in a business. An individual who’s not a W-2 employee may also fall under the same classification. Generally, you must have at least two years of self-employment in the same business. 

If you do not have two years at the same business, there are ways to prove your income without using the two-year rule. Some lenders may accept a co-borrower who isn’t self-employed to provide the supplemental income. It’s essential to retain bank or account statements for your business and personal savings accounts. 
A record of the last 12 months is ideal. The amount in your savings and investment accounts can prove to the lender that you have enough funds for your down payment. You can also provide a letter from a licensed CPA or tax-preparer verifying your self-employment status. 

It’s a complex process, so you should speak to your loan officer to understand the documents necessary to qualify for a mortgage for self-employed individuals. 

Improve your qualification chances

Every mortgage lender puts in place specific risk-mitigation measures, leading to varying rules and policies for the self-employed. How can you increase your chances of qualifying for a self-employed mortgage loan? Keep reading to find out.

Lower your debt-to-income ratio 

Your debt-to-income ratio (DTI) measures the percentage of your monthly income that goes into offsetting your monthly bills. The DTI is a critical factor in the lender’s assessment of your financial ability to make prompt mortgage payments. 

In general, you'll need to have a debt-to-income ratio lower than or equal to 43%. A good rule of thumb is to keep your total monthly debt payments under 36% of your gross monthly income.

You can lower your DTI by increasing your income and reducing your debt. Mortgage underwriters typically look at income after expenses.

The most effective strategy is to pay off your debts. You can also opt to aggregate your credit to a lower interest rate, reducing the monthly payments to a comfortable level. If your debt-to-income ratio is higher than 50%, you should consider holding on to your application and paying off some of the credit first. 

Outline the different types of income for your business 

Your lender may require evidence of consistent and predictable income before approving the loan. Different types of self-employment income are eligible for mortgage approval, including gig work and side jobs, freelance work, contract jobs, and small business owners’ revenue. 

The lender can calculate the different types of income individually or lump them together. You can prepare financial documents beforehand that can help prove your income level. These may include:

  • Your latest balance sheets and profit-loss statements
  • The last two years of your personal tax filings 
  • The previous two years of your business tax filings

Your CPA can help you prepare these documents. You can also include other sources of income, including alimony and Social Security checks. Some lenders may also request Form 4506-T from the IRS to verify that the information provided matches the tax agency’s database. 

Significant decreases in your year-to-year returns can raise questions for most lenders. Prepare to answer and account for the deficits to the loan officer. 

If you have a large cash reserve in your business for the down payment, a CPA can help draft a letter that shows that the outflow of those funds will not affect your day-to-day business operations. 

Improve your credit scores 

You may need to print out a copy of your credit report to assess your credit history. Lenders use the FICO score to determine your willingness and ability to repay loans. 

Your credit report shows how well you've repaid loans in the past. A higher credit score can increase your likelihood of qualifying for a mortgage for self-employed individuals. Which may result in a lower interest rate on your mortgage. 

It is important to review the report for any erroneous inclusions if you wish to make improvements. Disputing the errors may improve your score. Additionally, you can promptly pay off any debt on credit cards, car loans, and student loans to boost your rating. 

You may also need to keep an eye on your credit utilization. Charging business expenses on your personal credit cards can increase your credit utilization rating, which can reflect negatively on your application. 
Keep your personal finance accounts separate from your business to provide a truthful, more-favorable outlook on your credit report.  

Provide proof of your length of self-employment 

Your tenure as a self-employed entrepreneur can also play a critical role in assessing your qualifications for the mortgage. Lenders prefer borrowers with at least two years of experience. You can provide the evidence and make the mortgage process easier by producing your business licenses or tax filings. 

Some lenders are open to accommodating borrowers in operation for fewer than two years if they provide professional credentials. Registrations with professional associations can boost the likelihood of your application approval. 

Save for a larger down payment

Your lender may require proof that you have enough funds for the down payments and a reserve to cover the first few months of mortgage payments. You can review your current financial position and adjust accordingly to save more for a higher down payment

You can indicate to a lender that you are willing to share the risk of a self-employed loan by putting in more money for the deal. The financier may offer a lower interest rate for the loan if you do. 

Alternatives: bank statement loans 

Finding a lender that provides conventional mortgage loans to self-employed individuals can be hectic. You can check out alternative loan programs such as bank statement loans. Using this model, the mortgage lender counts your business cash flow, not just income after expense deduction. 

If seeking this option, you should bring 12 to 24 months of bank statements, and the lender will look at the average cash flow every month. The amount generated is used to come up with your qualifying income. Unfortunately, these programs can attract higher interest rates. 

Getting a mortgage for self-employed individuals

Traditionally, self-employed borrowers have a tougher time qualifying for a loan than a traditional borrower who receives a W-2 from their employer. You can still be eligible for a mortgage loan as a self-employed person, but it takes planning. 

The steps above can help you present yourself as a favorable candidate for a self-employed mortgage loan. 
You can also consider alternative options such as bank statement loans. CrossCountry Mortgage provides a Signature Bank Statement offer, qualifying the income from your business deposits. Contact us today to learn more about the different home loan types.