It’s a common myth that the self-employed cannot secure a mortgage. That’s not true today. Many lenders and/or mortgage programs make it easy for the self-employed to get a mortgage.
It all comes down to reliability and consistency. These are the same two factors lenders look at when you are self-employed. They need to know that your income is consistent and will remain consistent for the foreseeable future.
Keep reading to see what lenders look for if you are self-employed.
Tax Returns are a Must
First, you should know that lenders are going to look at your tax returns. Because you work for yourself, there isn’t an independent third party creating your W-2s. The lender needs to see your tax returns to see what your true income is in order to decide how much you can afford.
Lenders will usually ask for the last two years of tax returns. They will need all schedules so that they can see how much income you claimed, what expenses you wrote off, and your net income. Unlike when you work for someone else, your lender will need to use your net income rather than your gross income only because all of the expenses of owning a business are your responsibility.
Using tax returns also allows lenders to take a 2-year average of your income. When you are self-employed, you likely deal with highs and lows when it comes to your income. During the busy months, things are great financially. During the slow months, though, things can get a little tough. Lenders don’t want to qualify you on the high or the low income – they want an average so that you can always comfortably afford your mortgage.
Proof of Success
Lenders also want to see that you have what it takes to succeed in the industry that you’ve opened a business. If you opened a business in the industry you already worked for many years, you have the knowledge that is necessary to succeed.
If, however, you changed industries completely and have no experience in the new industry you’ve joined, you could be a higher risk for a lender. For example, let’s say you were a teacher but you decided to quit and open your own real estate company. The two industries don’t have anything to do with one another, so there’s nothing saying that you will succeed in the real estate business. This isn’t to say that you will fail, but it can be difficult for you to get started.
Enough of a History
Typically, lenders want to see you have at least two years of experience in self-employment. If you apply for a mortgage too soon after starting your business, there’s no history behind it to let the lender tell how you will do. Let’s say you apply after starting your business six months ago. There hasn’t even been a full year for the lender to see how your business does.
If you have two years of experience behind you, lenders can look back to see how you did and again, take that average of your income. This ensures that they don’t approve you during a time of high income or a period of low income. You’ll get the average, which should suit you well.
Some lenders do offer an exception to this rule, though. If you open a business in the same industry you’ve been in for many years, lenders often consider that your experience and allow you to apply for a mortgage sooner than 2 years of self-employment.
It’s no secret that self-employed borrowers are riskier than other borrowers. If you can come to the table with compensating factors, you’ll have a better chance of getting the loan. Compensating factors can come in many forms, but the most common include:
- High credit score
- Low debt ratio
- Many months of reserves (assets on hand)
- A co-borrower that isn’t self-employed
Any of these factors can help offset the riskiness that self-employment brings for a lender. In other words, they can increase your chances of approval.
Being self-employed doesn’t mean you can’t get a loan, but it might mean that it’s a little harder to get it. You may have to jump through a few more hoops, but as long as you are prepared, the process should go as smoothly as if you were employed by someone else.Click to See the Latest Mortgage Rates»