Today there are many more self-employed people than ever before. While it’s a great feeling to work for yourself and create your own success, it does come with its hardships. Getting a mortgage could be one of those hardships; however, it’s easier today than it sounds.
The mortgage crisis seemed to cause a crackdown on those working for themselves simply because they didn’t have the paperwork salaried employees had. Luckily, there are ways you can still get a mortgage as long as you are diligent about your paperwork.
Keep reading to learn the simple rules you must abide by to get a mortgage if you are self-employed.
How Long Must you be Self-Employed?
There’s a myth surrounding self-employment. Many people think you have to own the business for at least two years before you can even apply for a loan. This used to be the case, but not today. Even Fannie Mae, an investor of conventional loans, allows borrowers owning their own business for just one year to qualify.
Here’s the catch. You must have experience in the industry. For example, let’s say you worked as an accountant for a company for five years. Then you decide to open your own business. You own it for one year and need a mortgage. You might get through the application process because you have the experience to back you up. It shows the lender that you have what it takes to succeed. While this is a new venture, you have the experience in the industry to make it work.
What Paperwork do you Need?
The paperwork is often the nightmare of getting a mortgage as a self-employed borrower. We recommend starting off keeping the right paperwork right away. This way when you decide to apply for a loan, you have everything ready. Basically, you’ll need:
- 2 years of tax returns including all schedules
- 1099 forms, if applicable
- Asset statements for the last 12 months
- Profit & Loss Statement
What About Income?
Here’s where things get tricky, though. What do your income taxes show? Is it the income you claimed on your application or does your accountant help you take a slew of deductions (legal of course)? It’s common to take those deductions as it reduces your tax liability. However, they can hurt you when you apply for a mortgage.
Lenders can only use the income you claim on your tax returns with the exception of depreciation. They can add that back because it’s not an expense you ‘pay.’ If your deductions are too high, they can reduce your qualifying income and reduce your ability to get approved.
You can avoid this scenario by watching your deductions in the year or two leading up to your mortgage application. If you plan ahead, you can minimize your deductions, taking them again after you close on your loan.
Keep in mind, lenders will also exclude any windfall amounts of money you receive. If you have some type of extraordinary income that only happens once or twice, chances are the lender will exclude it from your qualifying income. They are looking for income that is consistent and reliable for qualifying purposes.
What About Assets?
As a self-employed borrower, your assets play a large role in your approval. Without them, you may find yourself with a loan. They help offset the risk of default. Lenders count your assets based on the number of months you can cover your mortgage payment with them.
For example, let’s say you have $10,000 in liquid assets and your mortgage payment is $1,000. You have 10 months of reserves.
There’s no certain time period you need reserves for – it’s usually on a case-by-case basis. Generally, the lower your credit score and higher your debt ratio, the more assets the lender may require.
You’ll prove your assets with the last 12 months of bank statements. Lenders use these statements to confirm your income, look for windfalls, and look for anything else suspicious when processing your loan. They want to make sure everything you tell them about your business is true and that you actually bring in the amount of money you say you do.
What Credit Score do you Need?
Again, each loan program and lender varies regarding the self-employed borrower’s mortgage. In general, though, the higher your credit score, the greater your chances of approval. Owning your own business already puts you in a ‘risky’ category. It’s best if you maximize your credit score by paying your bills on time, minimizing your outstanding credit card balances, and keeping a good mix of credit vs installment loans.
You can check your credit here free once a year. You won’t get a credit score, but you can see the credit history that lenders will see. You’ll get a good idea if you have a score on the higher or lower end and can proceed from there.
As a self-employed borrower, you have a few more hoops to jump through than the standard borrower. Your mortgage application must show some ‘compensating factors’ for your risky income. High credit scores, low debt ratios, and plenty of assets are a great way to start. Talk with different lenders and inquire about different loan programs to see what is available to you out there.Click to See the Latest Mortgage Rates»