If you’re applying for a mortgage, you need to prove to your potential lender that you’re a responsible borrower who will be able to pay back the money you’re loaned. Therefore, an important part of the mortgage approval process involves demonstrating poof of income.
But what happens if you work for yourself? Here’s what you need to know about securing approval for a home loan when you’re self-employed.
The Challenges
There are a few key challenges to getting a mortgage when you don’t report to a traditional employer. When lenders are evaluating a borrower’s creditworthiness, they want to see evidence of steady monthly income. Freelancers’ paychecks are often project-based or vacillate depending on the month, making it harder to verify the borrower’s financial stability. In addition, many people who are self-employed reduce their taxable income by reporting business expenses. This is a smart idea financially speaking, but it means that a freelancer’s tax returns might incorrectly indicate that they can’t afford a house.
What Doesn’t Change
No matter your employment situation, every mortgage lender will evaluate your DTI, or debt-to-income ratio, to determine whether or not you will be able to make regular payments on your home loan. Potential lenders will also look at your credit score – if it’s 680 or above, you’re in a good position to get a mortgage; and if it’s at least 740, you’ll have the best chance of getting a home loan with a low interest rate.
Along with income and credit score, assets play a role in who qualifies for a mortgage. Especially if you’re self-employed, be prepared to report every asset possible. This may include cash on hand and money in checking or savings accounts, or non-liquid assets like bonds, stocks, and any 401(K) or individual retirement accounts.
Application Tips If You’re Self-Employed
- Maintain a strong credit score: Your credit score plays a big part in helping you secure a mortgage with a low interest rate, regardless of your specific employment situation. If your score isn’t where you want it to be, focus on reducing debt, avoiding late payments and lowering your credit utilization.
- Pay off debt: The less you owe, the better your DTI ratio. In addition to budgeting and saving, look into consolidating your debt to take advantage of a lower interest rate. This will help you pay off your debt more quickly and get you in a stronger position to qualify for a home loan, even if you’re self-employed.
- Save up for a larger down payment: Being ready with a solid own payment offers assurance to lenders that you have the financial resources to qualify for a home loan. In addition, paying more up front means less interest paid over the life of the loan. Five to ten percent now typical for a down payment, and with good credit and employment, you’ll be in a good position to secure a mortgage.
- Ask your CPA: Self-employed borrowers will be asked to provide the two most recent years of filed federal tax returns as well as evidence of receipt of income in the current year. Net income will be used for qualification purposes. If you already work with a professional to prepare your taxes, they can help provide documentation on your income, assets and ability to afford a home. On the other hand, if you generally run your own financials for your self-employment, be sure to stay on top of the paperwork and provide every piece of documentation you can to potential lenders – from tax returns, to bank statements, to proof of assets or additional income sources.
- Consider a joint mortgage: Applying for a home loan with a spouse or other co-borrower who works a traditional job may be an avenue to consider. However, do be aware that when approving a joint loan, lenders still consider the credit score and income of both borrowers – so it still pays to make each party’s qualifying criteria as strong as possible.
