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What to Know When You’re Self-Employed and Looking for Home Financing

If you’re buying a home when self-employed, you’ll likely have a more challenging path to getting a mortgage than someone with “traditional” employment. Your mortgage lender will require additional documentation, mainly to help prove that your employment and income are stable and reliable. The good news? With a bit of planning and preparation, you can get into that new home.

The Great Resignation and the self-employment trend

The COVID-19 pandemic has had a powerful effect on employment in the United States. Prompting what’s been dubbed “The Great Resignation,” the pandemic has been a catalyst for record numbers of people to leave secure jobs. Some have decided to look for a fresh start in new industries, while some are retiring or taking a break from work to focus on their families and other responsibilities.

Still others have leaped into entrepreneurship. According to the Bureau of Labor Statistics, the number of unincorporated self-employed workers rose by 622,000 between February 2020 and November 2021. More than 10 million Americans now identify as self-employed individuals.

What to expect when you’re self-employed and applying for a mortgage

If you’re self-employed — you’re a sole proprietor, a 1099 contractor, or you own 25% or more of an LLC or corporation — and you’re in the market for a new home, you may already know that you face some additional hurdles in the mortgage application process. Fact is, mortgage lenders consider self-employed borrowers as more challenging to evaluate and underwrite than those with traditional employment.

At a high level, lenders look for the same things from a prospective self-employed borrower as any other mortgage applicant. They want to see a strong credit score, which indicates a responsible use of credit and a history of paying down debts. They evaluate debt-to-income ratio (DTI) to ensure the borrower can afford a mortgage payment and isn’t bogged down in other expenses. And they look at liquid savings and assets to ensure the borrower has enough money to handle the financial obligations that come with homeownership. All of these factors are based on the borrower’s personal financial situation — not their business finances.

But then things get a bit tricky.

What documentation is needed to support your mortgage application?

The mortgage lender likely also wants a verifiable history of at least two years of self-employment, along with confirmation of taxable self-employment income during that time. Even if a borrower uses paystubs and issues W2 wage statements at the end of each year, the lender probably requires additional documentation to verify income. This may include any of the following:

  • Two years of personal and (if applicable) business tax returns
  • W2 statements and paystubs, if the borrower uses them in their business payroll
  • A copy of state or business license
  • A letter from a professional organization in a related field attesting to membership and business experience
  • A signed letter from a certified public accountant (CPA) stating years in business
  • Signed letters from clients
  • Recent business receipts or invoices showing proof of business operation
  • A profit and loss statement, possibly audited by a CPA
  • Bank statements that verify the amount in personal savings; these should show ability to make a down payment while still having money in reserve
  • A Doing Business As (DBA) issued at least two years ago

A mortgage lender may accept less than two years of self-employment history if the borrower can also provide documentation for prior traditional employment. In this case, however, the lender may request documentation about training and education as it relates to the borrower’s profession.

How to plan ahead to apply for a mortgage loan when self-employed

Any home buyer should do their homework before applying for a mortgage loan. This is especially true for a self-employed borrower. Before setting out on your homebuying journey, make sure you’re positioned to make a positive impression to lenders.

Check your credit score and report

Be sure that your credit report doesn’t contain any errors. If you find any, contact the credit bureau to get them cleared up before applying for a mortgage. Here are a few more tips for fixing your credit score.

Calculate and manage your DTI ratio

This is the percentage of your monthly income that goes to paying your debts. Lenders expect a back-end DTI of 36% or lower for conventional loans. To calculate your back-end DTI ratio, divide your qualifying income by your total monthly debts (minimum payments for loans and credit cards, plus housing costs).

For this purpose, your qualifying income is your net business profit plus allowable expenses such as non-cash and non-recurring expenses.

If your back-end DTI ratio is above 36%, look for ways to pay down some of your loans or increase your income.

Keep personal and business expenses separate

While it may be tempting to use your personal bank accounts and credit cards for your business, it’s a better idea to separate them. Separate accounts and cash flows make it easier for a mortgage lender to understand your business finances. Also, develop a method to keep track of your invoices and monthly business expenses and prepare quarterly earnings statements. Keep your tax returns and related documents as well.

Save as much as possible for a down payment

A significant down payment may give a mortgage lender greater confidence in your application. Additional cash reserves can further show that you’re able to make monthly mortgage payments even if your business goes through a lean period.

Have a strong track record of self-employment work and income

Showing solid earnings for two or more years goes a long way toward eliminating the concerns a mortgage lender may have about the steadiness of your income. Waiting may be a tough pill to swallow, but holding off on your application until your business has had sustained success can help maximize your chances of getting a mortgage.

Alternative mortgage loan options for self-employed

If you find that your self-employment is too much of a barrier to getting a conventional mortgage, rest assured that there are other types of mortgage loans for business owners.

Government-backed loans typically allow for higher DTI ratios, lower credit scores, and lower down payment requirements. They also tend to be less strict with the self-employment documentation requirements outlined above. Government-backed mortgages include Federal Housing Administration (FHA) loans, Veterans Administration (VA) loans, and loans from the United States Department of Agriculture (USDA).

You might also consider applying jointly with a traditionally employed spouse. Most mortgage lenders allow this as long as both applicants meet loan requirements.

Another option is to look into bank statement loans. These allow borrowers to use their bank statements to verify income rather than traditional tax statements such as W2s and paycheck stubs. Only a limited number of specialty lenders offer bank statement loans (at this time, AmeriSave Mortgage Corporation does not offer bank statement loans).

Yes, you can buy a home when self-employed

The bottom line? The path to mortgage approval may be a bit more challenging. But by knowing what the lender expects and preparing your finances and documentation to meet those expectations, you too can buy a home when self-employed.

Frequently asked questions about applying for a mortgage when self-employed

My business is seasonal, so it’s difficult for me to prove stable income. Will a mortgage lender hold this against me?

This is probably not an issue. If your income has declined from the previous year, but the mortgage lender has documentation showing that it’s otherwise stable, then the most recent 12-month average income will apply.

What type of self-employment income will a mortgage lender consider?

Mortgage lenders usually consider any self-employment income that’s verifiable, stable and reliable. This could include income from running a small business, freelance and contract work, a side hustle or gig work (such as driving for a rideshare provider). As long as a type of work makes up a regular part of your overall income, you should count it as self-employment.

Does the mortgage lender look at my gross income or my taxable income?

The mortgage lender will consider your taxable income (net business profit plus allowable expenses) when evaluating your self-employment income. This is something to consider if you deduct a lot of expenses for your business.

If you’re self-employed, you’ll have a few additional hurdles to jump in the mortgage application process. But with a little preparation, you can get into a new home. AmeriSave can help. We’ve financed more than 390,000 homes, making the process easier and faster for borrowers like you. Take the first step by getting prequalified with AmeriSave today.

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