Qualifying for a mortgage when you’re self-employed doesn’t have to be a pain. It all comes down to organization. Whether you’re self-employed, commission-based, or a full-time or hourly employee, lenders are all looking for the same thing when you apply for a mortgage: they want to be sure there is a high likelihood you will be able to pay.
Unlike a W-2 employee, however, it takes a little more legwork to verify self-employed income. This is why you want to plan ahead and make sure all your ducks are in a row before you start the mortgage process.
Self-employed mortgage requirements usually entail more document verification and sometimes a lengthier look at your employment history. Fortunately, with a little time on your side, there are plenty of things you can do to make sure your mortgage application looks as stellar as possible when the time comes.
Increase Your Credit Score
As with any borrower, self-employed mortgage requirements include a look at your credit score and credit history. So make sure you do your due diligence before this information gets in front of someone else.
You can obtain your credit report for free from any of the three credit bureaus or from www.freecreditreport.com. Go over it with a fine-tooth comb. Contact the bureau if you find an error, need clarification, or have any questions surrounding your credit report.
A credit score of 720 or higher will usually nab you the best mortgage rate, so make it a point to pay your bills on time and to work out a payment plan with any debts you may have fallen behind on. Companies are typically more than willing to work with you if you simply communicate with them and show you’re making an effort toward resolving the debt.
Offer a Larger Down Payment
A large down payment is a win-win for two reasons. First, it shows the lender you’re willing to put skin in the game. Though self-employed mortgage requirements can include a down payment of as little as 3%, many include a down payment of around 20%. A higher number tells the lender you’ve made a serious commitment to owning a home. This is a commitment you’re not likely to walk away from—in the lender’s eyes, anyway—if you’ve invested a sizeable chunk of cash in this house.
The second reason a large down payment can really help when you’re trying to mitigate the effects of self-employed mortgage requirements is that it lowers the size of the loan. Think about it. If you want to purchase a $425,000 home, but only have $21,000 to put down (5%), you need to qualify for a $404,000 loan. If, on the other hand, you can put down $85,000 (20%), you need to qualify for a $340,000 loan. Plus, you’ll likely secure a more favorable rate.
Improve Your DTI
After securing your tax returns, as well as a list of your assets and debts, a lender will come up with your DTI, or debt-to-income ratio. This formula adds up all those debts, including existing monthly mortgages, loans, credit card payments, alimony/child support, and other outstanding balances. It then divides that number by your income, which can include 1099 payments from clients if you’re self-employed, in addition to any supplemental income like rent, investments, dividends, retirement accounts, and child support/alimony. The result is the percentage of your income that you would be spending on your mortgage and other debts. You want to keep your DTI as low as possible when qualifying for a mortgage; 43% or below is ideal.
Here’s the thing if you’re self-employed, though. This ratio may include your adjusted gross income, which includes various expenses claimed on your taxes. Some of these expenses may be added back in during the underwriting of your loan, but many are not. It’s also important to know that you can’t include any income not declared on your tax return.
When considering self-employed mortgage requirements, you may want to be extra careful about how many expenses you write off. It can come back to bite you as those deductions will lower your income in the eyes of an underwriter, thereby increasing your DTI.
Claiming fewer expenses isn’t the only way to improve your DTI. Side hustles can also bump up your income. Whether you rent out a room in your house, join the sharing economy, take on more freelance work, or sell a product or service in addition to your main business, that extra income can help you out (just be careful you don’t claim a ton of expenses with these endeavors, either).
Flipping the script, lowering your debts will also lower your DTI. You’re already paying your bills on time, but it’s also beneficial to tackle your debts. Make a list of your debts ranging from highest interest rate to lowest. Begin paying down those high-interest debts, then move down the list as you’re able to cross them off.
This is also the perfect time to create a budget (we have a great budgeting workbook you can download for free). Living a little leaner can lead to big payoffs when you’re able to put that money toward paying down your debts. Before you know it, those self-employed mortgage requirements don’t look so daunting anymore because you know you have a healthy DTI in your corner!
Show a Long Self-Employment History
You can be as free-spirited or spontaneous as you like in your social life, but lenders like to associate their borrowers with consistency, stability, and responsibility. In terms of self-employed mortgage requirements, this translates into a solid work history.
Lenders typically like to see that you’ve been at your current line of work for at least two years. The longer your self-employment history, the better. This is especially true if you can show a stable or increasing income over that time. This is true not only for self-employment but also for side hustles or other additional income sources discussed early.
If you are newly self-employed but in the same line of work you were previously, this can help mitigate a shorter history—be sure to ask your loan advisor for details.
Provide Extra Documentation
The last two years of tax returns are just the tip of the iceberg when it comes to self-employed mortgage requirements. You may also need to supply three to six months of personal and business account bank statements and a year-to-date profit and loss (P&L) statement.
You may also need to provide your current balance sheet, 1099s from your paying clients, your most recently paid invoices, additional years of tax returns, and a letter from your accountant stating your business is still active. Those with gaps in employment history, income losses, or irregularities may also need to address these issues through a letter to their lender. Your accountant can assist with this as well. They can also help you adjust the way you write off business expenses if this is hurting your chances of qualifying for a mortgage.
Self-employed mortgage requirements may seem intimidating because it’s a different process than the more straightforward W-2 employee, yet they’re not as complicated as they seem. It’s really about preparing early so you’re ready to hit the ground running when the time comes to apply for a mortgage—and that’s advice anyone can use, regardless of employment situation!
APM loves an early bird, and we’re here to help. Go here to find an APM Loan Advisor near you, and we can get you started on the path toward homeownership whether you’re self-employed or just thinking about making the transition.