Top Tips for Qualifying as a Self Employed Borrower
Despite often having higher incomes, putting more money down and buying bigger homes, on average a self-employed borrower receives 40% fewer mortgage quotes than those who work for someone else. Statistics like these can be discouraging for independent contractors and business owners, but working for yourself doesn’t mean homeownership is out of reach.
So, what’s the issue?
Lenders use the “three C’s” of underwriting (credit, capacity, and collateral) when assessing whether a borrower is approved for a mortgage. Self employment can present two main challenges when it comes to qualifying for a home loan – insufficient reported income and poor credit history. One of the benefits of working for yourself is actually the cause of many mortgage woes. Being able to take extensive deductions on your IRS returns is great at tax time, but when lenders see a low taxable income, they become concerned about your capacity to handle monthly mortgage payments. Bad credit also comes into play because many people co-mingle their business and personal expenses making it difficult for lenders to assess your individual credit history.
But it’s not all bad news: Despite these common challenges, there are ways to get around them and submit a strong mortgage application. Here are some tips for conquering the process when you’re self-employed.
Avoid these red flags: You may find it hard to qualify for a loan if you fall into one or more of these categories:
- Being self-employed for less than 2 years: Whether you work for yourself or someone else, lenders will want to see your last two years of W2s. If you haven’t been self-employed for all of that time, it’s hard to assess your expected income, and lenders are unlikely to approve you for a mortgage.
- Decreasing income year-over-year: Lenders will typically take the average of your earnings over the last 24 months to calculate your monthly income. But if these earning decreased significantly in the last year, they’ll throw out the first year of income and only take the second 12 months into account.
- Large periods without income: One of the biggest concerns about lending to someone without a consistent full-time job is that they’ll run out of work and stop bringing in money. If you’ve had periods of low or no income over the past two years, this could hurt your application.
- Major expenses on personal credit/accounts: Mixing business and personal finances can put you in a tight spot. If you used your personal funds for large business-related transactions in the last 2 years or if you’re carrying company debt on a personal card, it’s best to put-off your mortgage application.
Before you apply, plan ahead: By anticipating the information mortgage providers will request, you can make sure your financial profile is in good shape for approval:
- Spend longer preparing than most borrowers: Self employed borrowers will want to spend at least two years getting their finances in order before applying for a mortgage. During this time, make sure you’re deducting minimal expenses to maintain a solid net income, keeping good financial records for the business and yourself, and separating company and personal accounts. Selecting the right mortgage provider also counts – some will accept income from deposits instead of tax returns.
- Improve your DTI (debt-to-income ratio) by paying down debts: While your income alone is an important factor in your mortgage application, so is the amount of debt you hold compared to that income. If you don’t expect to move the needle on your income in the next two years, focus on paying down your debts (student loans, car loans, etc.) to improve your debt-to-income ratio. This could help your credit score too!
- Save up some cash: Some lenders will pay more attention to cash reserves if you’re self-employed. So after paying down your debts, make sure you have two or more months worth of mortgage payments saved up in the bank.
- Consider other strategies for making your application stronger: For all types of borrowers there are some tried and true ways to boost your chances of qualifying for a mortgage. Take steps to improve or repair your credit, explore options for increasing your down payment, or consider purchasing a cheaper home that requires a smaller loan.
All this being said, you don’t have to go through this alone. Sindeo Mortgage Advisors are experienced in helping independent contractors and business owners get approved for a home loan and can help you get the mortgage you deserve. Feel free to reach out to us with any questions or concerns and start exploring your options early.