Getting a Mortgage When You’re Self-Employed

We’re living in a gig-economy; the age of the freelancer. It has never been easier to earn money as a full-time freelancer or a side hustling contractor, and many skilled workers make a very good wage while working on their own time and from their own homes. 

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However, there are a few pitfalls with self-employment, including the fact that you don’t earn a stable, consistent income and therefore can’t prove your earnings as easily as a contracted employee.

If you’ve ever applied for a mortgage when you’re self-employed or have spoken with a financial advisor or mortgage broker, you’ll understand just how difficult it can be. It is still possible to get a mortgage when you’re self-employed, but you may need to work just a little bit harder.

What You Need for a Self-Employed Mortgage

A mortgage lender needs to be assured that you can make your mortgage payments on time, which generally means they will consider the same things for all applicants, including:

Credit Score

Your credit score is an integral part of the mortgage application process and this is true whether you’re applying for a conventional loan, FHA loan or any other type of mortgage loan. The higher your score is, the better your chances will be, and this is true whether you’re a contracted employee or are self-employed.

Generally speaking, a credit score above 700 will ensure you qualify for all types of mortgage and will give you a head-start in the home buying process. However, you may still qualify for most loan types with a score of more than 600.

Debt-to-Income Ratio (DTI)

Your debt-to-income ratio compares your debt payments to your income. The higher this ratio is, the less disposable income you have and the less room there is for another monthly payment.

To find your DTI, simply calculate all your monthly debt payments and calculate this as a percentage of your gross income. For instance, if you have a loan payment of $500, a credit card payment of $500 and a gross monthly income of $4,000, then your DTI is 25%.

Some lenders may look at your net income, but for the sake of simplicity just base it on your DTI, which is your total taxable income before tax deductions have been accounted for.

Income

Lenders request pay stubs, tax returns, and bank statements to see if you are earning a consistent income from regular work. Large gaps in your income resulting from little or no work may raise red flags for the lender, but if you have a consistent or steadily rising income then there shouldn’t be any issues.

You are required to submit at least two years of proven self-employment income and these will be examined to see if you’re making enough money to cover your mortgage payments. 

Documents

All the following documents need to be provided when you’re applying for a mortgage as a self-employed individual or small business owner:

  • Personal tax returns and business tax returns for the last two years
  • IRS Form 4506-T
  • Profit and loss statements
  • Personal and business bank statements
  • Business verification and business license
  • A list of all debts and details of monthly payments
  • Any mortgage or rent checks that have been canceled
  • All additional income, whether relating to savings, investments or social security

What You Don’t Need for a Self-Employed Mortgage

There a few misconceptions concerning the mortgage process and self-employed applicants. These are rooted in truth, at least to some extent, but they are often grossly exaggerated. For instance, it’s often claimed that:

You Will Pay a Higher Interest Rate

Mortgage lenders can be wary of self-employed applicants and this could lead to an increased interest rate. However, it all comes down to income and credit score and if both of these are stable there is no reason why a self-employed applicant should be quoted a higher interest rate.

After encountering some issues with traditional mortgage lenders, some self-employed borrowers may look for alternatives and this could result in greater fees and higher charges, thus perpetuating the myth that they will always pay more money.

You Need a Co-Signer

A co-signer can certainly help and may provide some assurances to the lender. However, a co-signer is not necessary for a self-employed home loan. As above, providing the borrower has a high credit score, a stable income, and a good debt-to-income ratio, they can get a mortgage on their own terms.

How to Improve Your Chances of Getting a Mortgage

There are a few things you can do to get the best mortgage rates and improve your chances of getting a mortgage, including:

Plan Ahead

Self-employed homebuyers should plan ahead, speaking with a financial advisor, broker or lender as soon as possible and discovering what they need to do. You can get a pre-approval if you’re ready; if not, discover what you’re lacking, fix those issues, and try again in a year or two.

Clear Debts

The more cash flow you have the more likely you are to be accepted, and as increasing your income isn’t that easy, you should focus instead on clearing your debts. The more of these that you repay, the better your credit score and debt-to-income ratio will be.

A significant proportion of your credit score is tied to something known as a credit utilization ratio, which compares available credit to used credit. The more balance left on your credit cards, the higher this ratio will be and the better your credit score will be as a result.

Having fewer loans on your credit report is also key, but be careful when you’re clearing credit card balances in full. If you cancel these accounts after they have cleared, you will hurt your credit utilization score.

Establish a Stable Income

A lender may be a little concerned if you go several months without making money and earn all your cash in just one or two months. It doesn’t matter if your annual income is the same; they want to know that you can meet those monthly payments consistently.

This isn’t easy if you’re a freelancer, but if you’re planning ahead you should try to stabilize your income. For instance, instead of taking a long vacation that leaves you out of action (and money) for a few weeks, take several shorter vacations. Instead of being paid in single, large lump sums once contracts have been finalized, request a weekly, bi-weekly or monthly payment.

Establish Some Cash Reserves

Lenders may feel a little better if you have cash reserves on hand. These reserves can bail you out if you ever fall behind on a mortgage payment. They’re not essential and even if a lender does consider them, there’s nothing to stop you blowing those cash reserves on a vacation as soon as the mortgage documents are signed. 

However, it’s further proof, if needed, that you are a legitimate and trustworthy borrower.

Make a Larger Down Payment

A larger down payment will reduce the loan amount required, thus limiting the liability and making you a better proposition to the lender. You’re also proving to the lender that you have the means to save and accumulate large sums of money.

A larger down payment also makes your real estate purchase more viable as an investment, as it reduces the total interest you pay over the term, which means the purchase price needs to grow by less for you to make a profit when it comes time to sell.

Bottom Line

Self-employed individuals can still apply for mortgages and are afforded many of the same benefits and options as salaried workers. 

Things can be a little more demanding at times and you may be forced to send more paperwork and submit to more tough checks, but providing you’re a viable borrower who can make monthly payments on time, lenders will be happy to give you the money you need.