According to the U.S. Bureau of Labor Statistics (BLS), the number of self-employed workers in the U.S. sits at approximately 16 million, and that number is steadily on the rise. When it comes to homeownership, there is a huge misconception amongst the self-employed and that is purchasing a home is next to impossible. Although securing a mortgage when you are self-employed poses its challenges, it is FAR from impossible. Being well-informed and prepared is key.
Self-employed borrowers actually undergo the same process when they are applying for a home loan as a W-2 borrower. However, when applying for a home loan, the self-employed should be prepared to invest more time and provide additional paperwork. “The requirements are a little more stringent with more documentation as lenders and banks want borrowers to demonstrate income stability”, says Richard Liu, a mortgage consultant with C2 Financial Corp. They should also be prepared to face possible income hurdles. So, what exactly does that mean?
Self-employed borrowers can often earn more than enough income to qualify for a home loan. However, they struggle with providing the required documentation to validate that income. According to experts, this is the biggest hurdle self-employed borrowers face when applying for a mortgage.
Since self-employed workers do not receive a W-2, lenders face the challenge of relying on tax returns to verify an applicant’s income. This can create obstacles for several reasons:
- Business owners take deductions and write-offs that they are legally entitled to which lower their taxable income; but, at the same time, they need to show enough qualifying income to be eligible to secure a mortgage.
- Tax returns for the self-employed can be complex. A lender must determine the number of factors such as the applicant’s line of business, the type of business entity and how income flows from the applicant’s business to their personal tax return.
Keep in mind, these are only obstacles and obstacles can be overcome!
According to Fannie Mae, “lenders will also consider the demand for your business, its location and financial strength, and whether it’s capable of continuing to provide you with enough income to support a mortgage.” This is true; but, simply put, what a lender really wants to see from a self-employed borrower is:
- Stable or increasing income
- Consistent work (ideally at least two years of self-employment income in the same industry)
- Good credit
- Available cash reserves to get you through months when you’re not earning as much income
- A larger down payment (this may be helpful if your financial profile is not that strong)
Save yourself time by gathering any documentation you may need upfront. When you’re self-employed, be prepared to provide both business and personal financial documentation. You will likely need to provide your lender with:
- Two years of personal tax returns (all pages)
- Two years of business tax returns (all schedules and pages)
- IRS Form 4506-T
- Profit and loss statements
- Business bank statements
- Business verification, such as a DBA or “doing business as”
- Business license
- A list of your current debts and minimum monthly payments
- Canceled checks for your current rent or mortgage
- Any additional income or payments, such as Social Security or disability
Keep in mind that some lenders may require additional documentation.
Again, being prepared is key when applying for a mortgage as a self-employed borrower, so always plan ahead.
- Establish a track record of self-employment work
- Save as much as possible
- Do not mix business expenses with personal expenses
- Monitor your credit report/score and repay your debts on time
- Utilize your accountant to provide an explanation of your business and its cash flow
- Choose a lender who understands and knows how to calculate self-employment income
If you have questions about self-employment and how it affects the mortgage process, contact us today! Our team of mortgage professionals are available and happy to assist you.
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