The mortgage approval process can be stressful for anyone, but self-employed people encounter an extra measure of scrutiny. You may have succeeded in pursuing the American dream of owning a business only to find that financing a home is more difficult than if you worked for someone else. Here’s our guide to mortgages for the self-employed.
It’s all about ability to repay
Mortgage companies aren’t biased against the self-employed. Lenders simply want to be sure their borrowers can repay their loans. If your income is reported on a W-2, you’re considered a more stable applicant than a self-employed person whose income varies and whose business may not succeed.
The first steps of applying for mortgages for the self-employed are the same as for any loan applicant. You’ll need to shop around for the best rate and terms, prequalify and complete paperwork. Certain qualifying factors are the same even if you’re self-employed. Your debt-to-income ratio must fall below 43 percent. A good credit history is a must if you want a good interest rate. Putting a sizable percentage down on the purchase price shows commitment.
The difference in seeking a mortgage as a self-employed person lies in the documentation you must provide to convince the lender you’ll be able to repay the loan.
Prepare to submit in-depth documentation
When it comes to mortgages for the self-employed, proof of reliable and sufficient income to repay the mortgage will be the biggest hurdle to clear. Self-employed people must provide at least two years of tax returns plus business profit-and-loss statements.
If you’ve owned your business for several years and show solid, growing income, you’ll likely be seen as stable and reliable. If you’ve been in business less than two years, however, you will have to persuade the lender that your business has a strong future.
Self-employed people may have to pay a higher interest rate than salaried employee applicants would. But the more you can show you are seriously dedicated to a growing business that has good prospects and can provide you sufficient income to pay a mortgage, the better your chances of getting a loan at an agreeable rate.
One potential snag with mortgages for the self-employed stems from legitimate business deductions. It makes sense for self-employed taxpayers to claim every allowable business expense against income to reduce the taxes they owe. But the lender uses the resulting lower net income to measure debt-to-income ratio, which may hurt loan approval prospects.
Improving your chances if you’re self-employed
Self-employed people can take steps to ensure they’ll have an easier time when they apply for a mortgage.
- Form either a C corporation or a limited liability company (LLC) and register your business with state or local government agencies.
- With your business incorporated, pay yourself income reportable on a W-2 income rather than a 1099.
- Don’t claim every business expense on your taxes the year before applying for a mortgage, even though you will owe more in taxes.
- Do not operate your business out of personal bank accounts. Set up separate business accounts. Use QuickBooks or other business software to keep finances in order.
- As with your personal finances, pay down business debt and maintain a timely payment history.
- Make as large a down payment as possible. Putting down 20 percent or more shows commitment that mortgage underwriters like to see.