Self-Employed Home Loans
In the U.S., nearly 10 million people are self-employed, and the number is expected to increase by nearly eight percent over the next few years. If you’re among the self-employed, you know things work slightly differently for you than for people who hold traditional W-2 jobs. Your income stream is different, and your tax situation is different. When it comes time to go through the mortgage process and buy a home, you might find things are different for a self-employed person, too.
There’s good news about buying a home with self-employment: It is possible. In fact, if you have good or excellent credit and can prove you have a steady stream of income, you might find your mortgage experience is similar to that of your traditionally-employed friends and family.
Best Mortgages for Self-Employed First-Time Buyers
Whether self-employed or not, multiple mortgage options are available to you. The type of mortgage that will best suit you depends on your credit, the amount you have saved for a down payment and where you’re hoping to purchase a home. Some mortgages are backed or guaranteed by the federal government, while others are not. If you’re self-employed and looking for a mortgage, consider these options:
1. Conventional Mortgage
The simplest way to describe a conventional mortgage is as a home loan that isn’t guaranteed by the government. When a lender issues a conventional mortgage, they are taking on more risk because the government isn’t there to pay back some or all of the loan balance if the borrower can’t.
Typically, conventional mortgages have tougher qualification requirements compared to other home loans. Borrowers typically need to have a very good credit score to qualify for a conventional loan. There’s also the issue of the down payment. Although people often think you need to put 20 percent down to get a conventional mortgage, you can put down less and still qualify.
If you put down any amount below 20 percent of the value of the home, you’ll have to pay private mortgage insurance, in addition to the principal and interest due each month. Once you’ve paid off at least 20 percent of the home’s value, you can ask the lender to remove the private mortgage insurance premium from your loan.
The term of a conventional mortgage can be up to 30 years. The longer the mortgage term, the more you’ll pay in interest over the life of the loan, but the lower your monthly payment will be. Conventional mortgages also offer the option of having a fixed interest rate, which stays the same for the life of the loan, or an adjustable rate, which fluctuates with the market.
2. FHA Loan
FHA loans are insured and guaranteed by the Federal Housing Administration (FHA). The FHA itself doesn’t make the loans. Instead, a mortgage lender or bank does. If a borrower defaults or isn’t able to pay back their mortgage, the FHA will step in. Since the FHA loan program offers extra protection to a lender, borrowers who might not have the best credit are often able to qualify for them.
FHA loans require a minimum down payment of 3.5 percent. If you have a higher credit score and can afford to make a bigger down payment — at least 10 percent — getting an FHA loan might not make sense for you, because of the fees and mortgage insurance requirements.
The loans require the borrower to pay mortgage insurance, in the form of a 1.75 percent fee at closing and a fee between 0.45 and 1.05 percent every year. Unlike a conventional mortgage, the annual mortgage insurance payment is often required for the life of the loan, even after a borrower has paid 20 percent of the value of the home. The only way to remove the mortgage insurance premium is to refinance to a conventional mortgage.
Like conventional loans, FHA loans are available in terms of up to 30 years. Interest rates can be fixed for the life of the mortgage or adjustable.
3. USDA Loan
If you’re self-employed and have always dreamed of living in the country or a relatively rural area, a USDA loan might be the mortgage that works for you. The USDA loan program provides mortgages with zero percent down on homes in designated areas. Two types of USDA loans are available: direct loans, which come right from the USDA, and guaranteed loans, which are made by a private lender. The guaranteed loan program is backed by the U.S. Department of Agriculture and guarantees up to 90 percent of the value of the loan.
Along with buying a home in an eligible area, you need to meet certain income requirements to qualify for a USDA loan. The mortgages are intended for people who have low to moderate incomes. The USDA provides an income eligibility calculator to use to see if your household falls below the maximum income threshold. Income maximums are based on the type of loan program. The maximum allowed income is lower for direct loans than it is for guaranteed loans.
It’s worth pointing out that although you can’t use a USDA loan to purchase a home in the middle of a major city or urban area, the “rural” requirements might not be as rural as you think. Many homes in suburban areas qualify for USDA loans.
4. VA Loan
A Veterans Affairs loan is a type of mortgage available to people who are either currently serving in the armed forces or who have in the past. How long you need to have served with the armed forces depends on when you were on active duty, usually anywhere from 90 days to 24 months. If you were married to someone who died while on active duty, you can also qualify for a VA loan.
Like USDA loans, VA loans allow you to buy a house without a down payment. Unlike FHA loans, there is no mortgage insurance premium required for VA loans. Interest rates on a VA loan also tend to be lower compared to other mortgages. Closing costs are also often lower, as well.
5. Bank Statement Loan
Unlike an FHA, VA or USDA loan, a bank statement loan isn’t a type of mortgage program. Instead, it’s a process of approving a person for a loan without requiring them to provide proof of income, such as a tax return. When issuing a bank statement loan, a lender looks at anywhere from one to two years worth of your bank statements to get a sense of your total incomings and outgoings.
A bank statement loan can be a viable option for a self-employed person who doesn’t have income tax returns or other verifiable proof of income. The trade-off is that the interest rate on the loan tends to be higher than for other options since the lender is taking on somewhat greater risk.
Self-Employed Mortgage Checklist: What You Need to Have When Applying for a Home Loan
Whether you go for a government-backed loan, a bank statement loan or a conventional mortgage, a lender is going to require a fair amount of documentation before approving you for a home loan. Some of the paperwork you will need to show a mortgage lender includes:
- Tax returns: You’ll need to submit business and personal tax returns if you have them. Your lender will look at your net business income to determine your eligibility. Depending on how long you have been self-employed, you might need to provide at least one or two years’ worth of returns.
- List of current debts and monthly payments: If you have any additional debts, you will have to let your lender know about them, including how much you pay toward your debt monthly. Having additional debt can affect the size of the mortgage you’re eligible for.
- Bank statements: If you decide to get a bank statement loan, you might need to provide up to 24 months’ worth of bank statements. Even if you verify your income using your tax returns, your lender will most likely still ask to see at one month’s worth of bank statements.
- Declaration of assets: Lenders also want to see proof that you have enough money for a down payment. You might need to submit a list of your assets, including money in savings account and investment accounts, when you apply for a mortgage.
- Additional sources of income: If you have other sources of income, such as alimony, Social Security or income from a job, your lender might want to see it, especially if it will affect your eligibility.
- Proof of current housing payment: You might need to give your lender canceled checks or other proof of payment for your current mortgage or rent.
- Verification of your business or employment: It’s not enough to say you’re self-employed. A lender will often want to see proof. The proof can be in the form of a business license, membership in a professional organization, letters from clients or a statement from your accountant.
In addition to documentation verifying your income, assets and debt, lenders might also ask that you fill out several forms, giving them permission to access certain information. For example, you might need to complete Form 4506-T, which gives the lender permission to access transcripts of your tax returns from previous years.
The exact documents required might vary from lender to lender. In some cases, there might be some flexibility from a lender. For example, if you don’t have one document, they might be willing to accept another in its place. What you need to provide might also vary based on your income and how long you’ve been self-employed. Usually, the higher your income and the longer your history of stable self-employment, the smoother the mortgage process will be.
What Lenders Like to See From Self-Employed Loan Applicants
Some self-employed mortgage candidates are more attractive to lenders than others. Buying a house if self-employed can be an easier process if you can show the lender what they want to see. A few things that will make your application more appealing and more likely to be approved include:
1. Good or Excellent Credit
The higher your credit score, the better, if you want to buy a house as a self-employed person. A good credit score is one that’s over 670, while an excellent score is one that’s over 800. Having a good to excellent credit score shows a lender that you have a history of making payments on time, of not taking on excessive amounts of debt and a decently long history of using credit.
If you aren’t sure what your credit is, it’s a good idea to request your score before you start the mortgage process. If it’s not good, you have time to raise it before you apply or begin looking for a house. Some things you can do to increase your score include paying on time, paying off high amounts of debt and avoiding opening new accounts.
Usually, lenders will check your personal credit before approving or denying your mortgage application. If your business has a credit rating, they will also look at that.
2. Stable Income
For the most part, your business or self-employment track record should be on the up-and-up. A lender not only wants to see proof of steady income over the years, but they also want to see some evidence that your income has grown over time. If your income has dropped in recent years, that can be a red flag or cause for concern for a lender and can affect your ability to be approved or can affect the size of the loan you qualify for.
If you had one or two bad years but an equal number or more good ones, you probably don’t have too much to worry about when it comes to getting approved for a mortgage. Your lender is likely looking at the big picture, not at micro trends. If one bad year is followed up by several years of increasing or steady income, a lender will most likely still approve your application.
3. Money in the Bank
In addition to the money you are using for a down payment, a lender might want to see that you have a reserve of cash to use in case times are tight. Having a sizeable emergency fund, such as several months to a year’s worth of mortgage payments set aside can make you more attractive as a borrower.
Another reason why it’s a good idea to have money in the bank is that you might need it to cover the cost of repairs or other surprise expenses as a homeowner. Ideally, you’ll be able to avoid taking on additional debt after you buy your house to keep it in good condition.
4. Steady Work
Someone who works a full-time, salaried or hourly wage job usually gets up and goes to work for 40-hours a week. Self-employment work can be a little more difficult to quantify, but generally speaking, a lender wants to see that you have steady work available to you. There are a few ways you can show a lender that you have regular work. If you’ve been self-employed for a few years, your tax returns might be proof enough.
If you’re relatively new to self-employment, you might show a lender any contracts you have with clients or letters from clients that state that you are doing work for them. The contracts or letters could describe the nature of the work, including how long it might last.
5. Ample Down Payment
You don’t need to put down 20 percent to get a mortgage and a home as a self-employed person. But being able to make a larger down payment can improve your chances of approval. Generally speaking, people who can pay 20 percent upfront are seen as a lower risk compared to people who make a five or 10 percent down payment.
A bigger down payment shows a lender that you’ve been capable of saving up a considerable amount of money. It also sends the message that you’re invested in your new home and might be less likely to default, since you’re putting so much into it from the beginning.
6. Minimal Additional Debt
Ideally, you won’t be going into the process of applying for a mortgage as a self-employed person with a lot of other debt. Your debt-to-income ratio, or the amount of debt you have each month compared to your monthly income, should be on the low side. If you’re applying for a mortgage, 43 percent is usually the highest allowable debt-to-income ratio. As a self-employed person with a variable income, you might want to aim for an even lower percentage.
If you have a lot of debt, whether it’s credit card debt, student loans or a car loan, you might want to focus on paying it down before you apply for a loan, especially if you are self-employed.
Common Misconceptions About Getting a Mortgage While Self-Employed
There are some misconceptions and myths out there about the process of getting a home loan as a self-employed person. Small business owners might need to provide a lender with more or a different set of paperwork compared to employees, but overall, the process of getting approved is very similar for each type of person. Here are a few common sources of confusion when it comes to mortgages for the self-employed:
1. Lenders Look at Your Gross Revenue
For many self-employed people, it’s not quite clear what income a lender will use when deciding the size of loan someone is eligible for or if they’re even eligible at all. Lenders don’t look at your gross income or revenue — the amount you bring in before expenses and other deductions. They also don’t use your adjusted gross income on your tax return. Instead, they look at your net business income — the amount you bring in after you subtract relevant business expenses. That can mean the size of the loan you qualify for is smaller, but also that you’ll be more comfortable paying it back.
2. You Always Need a Co-Signer If You’re Self-Employed
You can be the only person on a mortgage, even if you’re self-employed. As long as you have good or excellent credit and a verifiable source of income, you should be good to go getting your own mortgage. There might be times when having a co-signer can be helpful, such as if you don’t have adequate proof of income, but they aren’t a requirement.
3. You’ll Get Stuck With a Higher Interest Rate
The interest rate a self-employed person pays on their mortgage can be the same or even lower than the rate a traditionally-employed person pays. The factors that influence interest rates include your credit score, how much you put down and the length of the mortgage. If you have an excellent credit score, put down 20 percent and get a 15-year mortgage, you might end up with a rate that’s lower than an employed person with a lower credit score gets by putting down 10 percent on a 30-year mortgage.
Get Started on Your Self-Employed Mortgage Application Today
Ready to see what type of mortgage is right for you or if you qualify for a mortgage as a self-employed person? Assurance Financial can help. We’re a team of loan advisors who can help you find the right mortgage and walk you through the process from beginning to end, step by step.
You can apply online in 15 minutes with us 24 hours a day, seven days a week, with the help of Abby, our digital loan assistant. After Abby processes your application, a human licensed loan officer will be in touch to finish the approval and finalize the details.