How to Qualify for a Mortgage When You’re Self-Employed
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We’ve been working towards buying a new home, for the past couple of years. We bought our first home before having kids and starting our business and it has been busting at the seams for several years. I’ve done considerable research about how to qualify for a mortgage when you’re self-employed and, honestly, I was a little concerned.
It’s not that we’re not on top of our money, because we definitely are, but the stigma attached towards those who work for themselves is real. As such, the requirements for getting a mortgage when self-employed can be a bit much.
This is not to say you can’t get a mortgage when you work for yourself. Just that it will potentially be a challenge. Thankfully, we had a relatively easy experience in getting our mortgage. But, we prepared as much as we could prior to put our best foot forward. If you’re self-employed and want to qualify for a mortgage, here’s how to do it.
Income is likely the biggest thing if you want to buy a house when self-employed. I can attest to the fact that income can fluctuate greatly when you work for yourself. We have killer months followed by “just enough” months. Thus, budgeting is key.
Ultimately, the lender wants to see something they can “count” on. They will likely ask for the following:
- Personal income tax returns for the past two years
- Business tax returns for the past two years if you operate as a corporation or partnership
- Something official (CPA, business license, etc.) that shows you’ve been in business for at least two years
If you don’t have any of the above it’s going to be a challenge to get a mortgage. I will say that it also depends on the lender and what they want. Assuming you’re able to provide the above information, they will do the following:
- Average your income for those two years. They will typically go with the average, not your high income number
- They look for an upward trajectory. If you don’t have an upward progression in income you may face a challenge
I’ll spare you the extended detail, but the lender is looking for a certain level of health of your business. They want to make sure it’s moving the way they think it should. And, really, we should want our businesses to grow year over year – right? 🙂
You also need to keep in mind that they look at your net business income, not gross. So, if you’ve been overly deduction happy it can hurt when you try to qualify for a mortgage. Additionally, if you have W-2 income that is gold in the eyes of the lender so make sure to notify them if you do.
What Assets You Bring to the Table
One of the biggest financial mistakes I ever made was putting nothing down on our former house. That was not something we were willing to do this time and we wouldn’t have qualified for a mortgage if we didn’t have money saved up for a down payment.
We put down close to a 30 percent down payment on our new house. We did that for a few reasons: to not have to pay for PMI and because we knew it would make us look better in the eyes of the lender. If you’re not able to hit at least the 20 percent mark, I suggest you wait a little longer before applying for a mortgage.
The lender also looks at what you have beyond the down payment. I’m not talking what you have invested for retirement. They want to see a certain level of cash reserves. Since we all know income can fluctuate, they want to make sure you can handle mortgage payments if you have a bad month or two.
I was never given a hard and fast number, but have found that six months worth of cash reserves is a good target to shoot for. We were easily at that mark, with funds sitting in our savings account so I felt good enough with what we had.
This is where I was concerned. Not that our credit is bad (we both have scores around 820) but we like to churn credit cards for free travel. We both had numerous hits on our credit report and I was concerned that reality would impact our lender’s decision.
Knowing we were going to apply for a mortgage, we stopped applying for cards roughly 9-12 months before but that’s not a set in stone number. My advice is to be smart about it and curtail card applications if you know you’ll be trying to get a mortgage.
That being said, a higher credit score can help mitigate your income risk – to a certain extent. If you have a score of 720+ you should be able to qualify for the best rates possible.
If you want to get a mortgage when you’re self-employed, debt is going to play a big factor in the lender’s decision. The only debt we had was our mortgage so we were ok here though many may not be in that position. If you have a business loan you may think you’ll be fine. Unfortunately, they will count that against you in their calculations.
The lender is really going to determine what your Debt-to-Income (DTI) Ratio is when making the mortgage decision. In short, DTI takes your mortgage and adds in any non-housing debts, then divides it by your average monthly income. Let’s look at an example of this below:
Mortgage payment = $1,000 per month
Car payment = $400 per month
Student loan payment = $400 per month
Other consumer debt = $200 per month
Total monthly debt/payments = $2,000
Total monthly household income = $5,000
You will have a DTI of 40 percent.
This is an important number to know, outside of trying to qualify for a mortgage. The highest DTI you can have and still qualify for a mortgage is 43 percent though am sure some lenders may have issues with giving out a mortgage to a self-employed individual with that high of a DTI. Our DTI is sub 10 percent so we were good at this level.
Do Your Work Before Applying for A Mortgage
If there’s one thing I can take away from trying to get a mortgage while self-employed is the importance of doing your due diligence prior. Many lenders won’t even look at you if you don’t have two years of returns. Keep in mind they may also want to see an upward progression in income levels as well.
The other thing to seriously consider is the lender you choose. We worked with our last lender – largely because she was no longer with Wells Fargo. Wells Fargo, like other large banks, are more reluctant to hand out mortgages to entrepreneurs.
Her new bank is a local bank that has been in Nebraska for over 100 years. Thanks to their reach in the local community, they have access to federal funds that other larger banks don’t or won’t give out. In effect, this allows them to loan their money to us. This more personal approach allows them to learn about their mortgage candidates and give us a chance because they see we’re worth the risk.
As an aside, I believe this issue of getting a mortgage while self-employed is going to become more of an issue in coming years. Pew Social Trends reported in 2015 that 3 out of 10 workers are self-employed or work for those who are self-employed.
This number will only grow as we move toward a freelance economy, in my opinion. There is still a pre-conceived notion that a “real” job where you work in an office 9-5 is more secure than working for yourself. We’re surrounded by risk and I think we’ve all learned one thing over the past decade – many, though not all, are at the whim of their employers. Hopefully, in time, big banks will get the message and work a little more with self-employed individuals.
Have you tried to get a mortgage when self-employed? What challenges did you face? Why do you think we have the misconception that “real” jobs are always more secure than working for yourself?
John is the founder of Frugal Rules, a dad, husband and veteran of the financial services industry whose writing has been featured in Forbes, CNBC, Yahoo Finance and more.
Passionate about helping people learn from his mistakes, John shares financial tools and tips to help you enjoy the freedom that comes from living frugally. One of his favorite tools is Personal Capital , which he used to plan for retirement and keep track of his finances in less than 15 minutes each month.
Another one of John's passions is helping people save $80 per month by axing their expensive cable subscriptions and replacing them with more affordable ones, like Hulu with Live TV.