Getting a Mortgage When You’re Self-Employed
For the nearly 33 million Americans who are self-employed or are nontraditional workers—freelancers, contractors, and others who rely on independent client-based work—getting a mortgage will require a little extra paperwork, possibly a bigger down payment, and certainly more hoops to jump through. But it’s not impossible.
Proving income stability
The number one priority for lenders when considering any mortgage applicant is their ability to repay the mortgage—consistently and on time. Usually, lenders determine this by looking at an applicant’s W2 from their employer, which lists their salary and can be used to determine salary history. Without a regular paycheck and this government-issued document to prove it, the self-employed will have to work harder to prove that their income is sufficient for the mortgage.
It’s important to know that lenders consider the stability and viability of your business alongside your take-home pay. They need to know your business has a future and that you will continue to receive work from clients. Lenders might consider the market demand for the business, its location, its financial strength, and its future prospects of being lucrative.
For those self-employed workers with multiple sources of income that may fluctuate, a thorough documentation of income with additional paperwork may be required.
Debt-to-income ratio (DTI)
Self-employed workers will need to meet the debt-to-income (DTI) ratio requirement of their lender—usually 43–36 percent or lower. Your DTI ratio is your total monthly debt payments divided by your monthly income.
Meeting a lender’s DTI ratio standard can prove difficult for the self-employed if that person has minimized their bottom line too much by taking advantage of self-employment/business tax deductions by writing off a large portion of their income for business expenses. Taking these deductions isn’t a bad thing—after all, it allows you to pay less in taxes—but it does decrease your bottom line (income after expenses), which can hurt your DTI ratio, even if you have very little debt.
It’s a tough situation, because the other option to show more income on your taxes would involve writing off fewer expenses and taking fewer deductions, thus paying more in income taxes. Speak with a mortgage advisor or accountant the year prior to applying for a mortgage to see which strategy would best serve you.
With a steady income, a low DTI ratio, and good credit, someone who is self-employed shouldn’t pay a higher interest rate on a mortgage than a salaried worker. But sometimes the numbers don’t line up in your favor, and you won’t be approved for the loan amount you want. If this happens, you have three options: reduce the loan amount you’re applying for, wait another year and see if you can change the numbers that gave you trouble, or get a co-signer for the mortgage.
A co-signer will need all the things a strong mortgage applicant should have: proof of steady income, low DTI ratio, and good credit. The co-signer should be aware that if you default on the loan or are late on any payments, the lender can come after them for payment—in full.
What you need for your mortgage application
Precise requirements will vary by lender, but in general you should be prepared to submit the following documentation or information as a self-employed mortgage applicant:
- Personal tax returns for two years (some lenders will make an exception for the newly self-employed if you have one year of self-employment tax returns and W2s from an employer in the same industry)
- Business tax returns for two years (you may not need business returns if you’ve been in business for more than five years)
- IRS Form 4506-T, giving permission to the lender to request transcripts for tax returns
- Profit and loss statements
- Business bank statements
- Business verification, such as a DBA or “doing business as”
- A business license, if applicable
- A list of your personal and business debts and minimum monthly payments
- Canceled checks for your current rent or mortgage
- Additional income or payments, such as Social Security or disability
- Down payment, typically 30 percent or more
- Cash reserves
It cannot be overstated how important it is to keep personal and business finances and funds separate across credit cards, saving accounts, and checking accounts. Keeping clear, separate accounts of invoices and expenses will go a long way in preparing you to successfully apply for a mortgage.