Pros and Cons
There are so many great things about being self-employed. People who are self-employed enjoy a significant degree of freedom, while still making valuable contributions to our economy. Currently, there are more than 20 million people in the United States who qualify as “self-employed”, which represents about 12 percent of the working population.
However, despite the many perks that come with working for yourself, there are also a few drawbacks. One of the most commonly cited challenges of self-employment is qualifying for loans—including a mortgage.
Lender's Risk
A mortgage represents a large financial risk for the lender; if you begin missing mortgage payments (or stop paying altogether), the lender will likely end up enduring significant losses, even if they are able to eventually sell the house.
This is why lenders take the underwriting process so seriously. Their goal is to avoid issuing any disproportionately risky loans, including to those who are self-employed with a limited income history.
Fortunately, there are a few things self-employed people can do to increase their chances of obtaining a mortgage.
1. Create a Legal Business Entity
Increase Legitimacy
While many people who are self-employed operate as sole proprietors—which is a totally legal option—it might still be a good idea to create your own business entity, such as a limited liability company (LLC). Not only does this help increase the perceived legitimacy of your business but it also makes it much easier to separate your personal and business expenses. This helps improve your current debt to income (DTI) ratio, which, in turn, improves your ability to qualify for a home loan.
2. Get a Co-Signer (or Buy Together)
Borrowing as a Team
If you can get somebody other than yourself to appear on the mortgage—preferably somebody with a more “predictable” income—then your chances of qualifying for a mortgage will significantly improve. In most cases, the co-borrower will be your spouse or somebody else you have a legal relationship (including your parents). But even someone who is just a friend or associate could appear on the mortgage as well. Just be sure to clarify the risks and rights that come with borrowing as a team.
3. Provide Multiple Tax Returns
The More, The Better
The longer you can prove you’ve been successfully self-employed, the better your chances of qualifying for a mortgage will be. Ideally, you will be able to provide two or three years of tax returns to your lenders at the beginning of the process. In most cases, they will take an average of your income during these years and—as long as you are still generating income today—use this average while underwriting the loan. Generally speaking, having three years of a $50,000 income will be considered safer than one year with a $60,000 income.
4. Find Ways to Improve Your Credit
Increase Your Score
Your credit score will be looked at multiple times throughout the underwriting process. If you are considering applying for a home loan in the near future, its probably time to pull out all of the stops and do everything you can to get your score a little higher. Paying off existing debts (even if this means a smaller down payment), consolidating debt, removing negative marks on your report (collections, missed payments, etc.), and taking additional actions can all immediately cause your scores to increase. Dealing with debt collectors is certainly a bit of a pain but now is the time for you start making those calls.
5. Offer Detailed Paperwork
Prove It
During the underwriting process, your lending team will probably ask for a lot of personal paperwork—especially if you are self-employed. Remember, it is up to you to prove that, even right off the bat, you will be able to make your mortgage payment every month. The more you can do to prove that your self-operated business is legitimate and profitable, the more likely lenders will be willing to issue a mortgage.
Contrary to what some people believe, lenders actually have some discrepancy when evaluating mortgage applicants.
Statements might include:
Recent Profit/Loss Statements
Current Balance Sheet
Income Statements
Tax Documents
Personal Bank Statements
List of Current Clients & Contracts
Detailed Description of Business
Other Documents, Upon Request
6. Ask Your Lender for Advice
Just Ask
Nobody knows the underwriting policies better than the underwriters themselves. And it’s highly unlikely that you are the first self-employed person they’ve ever dealt with. If it seems that you the lender is not going to approve your loan, be sure to ask what you could potentially do differently. They might have a few ideas that could help quickly change your ability to qualify for a loan.
Conclusion
We’ll be honest: applying for a mortgage as a self-employed person will be more difficult than would be for people with more “traditional” lines of work. However, that does not mean that obtaining a home loan will be impossible. There are millions of self-employed individuals who have successfully bought a home, even with somewhat modest incomes—including the writer of this very article. As long as you take direct action to improve your personal finances, prove an ability to produce income, and cooperate with your lenders, a home of your own remains within reach.
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