If you are self-employed, you may have a tougher time finding a mortgage. Lenders like consistency and reliability – two things many self-employed borrowers cannot provide. Fortunately, this doesn’t mean there aren’t loans out there for you. All of the standard loan programs for regularly employed borrowers may still be available.
Fannie Mae and Freddie Mac have the share of conventional loans on their books. Lenders follow their guidelines when deciding if you qualify for a mortgage. If you work for yourself, you’ll need:
- At least one year of self-employment income reporting on your tax returns
- Proof that you have the necessary skills/experience to succeed in the business
- Proof of the stability of your self-employment income
Fannie Mae puts great emphasis on your income. Typically, they want two years of tax returns. This allows the lender to average your income and ensure that you can afford the loan year-round. If you have only had the business for one year, but you can prove that you have experience in the industry, it may be enough.
Lenders need to know that you didn’t start a business on a whim without any experience in the industry itself. Showing that you have work or educational experience along with proof of a successful year in business for yourself may be enough.
Each lender has its own requirements regarding the necessary down payment and credit score for self-employed borrowers. Apply with at least three lenders to find out what stipulations each lender requires. Find the lender that will work with your circumstances, while providing the best terms.
FHA loans also offer an opportunity for self-employed borrowers. FHA loans used to be for first-time homebuyers only, but today many people use it to their advantage. With a low down payment requirement and flexible credit underwriting guidelines, an FHA loan can be a good option.
In order to qualify, you’ll need:
- Proof that you have been in the industry that your business is in for at least two years
- Proof that your industry has the ability to stay profitable/successful
- Your income must have remained stable over the last two years (no more than a 20% decrease)
Like conventional loans, FHA loans require you to prove your experience in the industry if your business is new. FHA lenders like you to have two years of self-employment experience, but will let you get away with one if you have a history in the industry.
Self-employed borrowers must provide two years of tax returns, plus a YTD P&L to show that you are on track to make the same amount (or more) this year. FHA borrowers must also prove that they have their own funds to cover the closing costs. There must be sufficient proof that the funds aren’t coming from the business.
Increasing Your Chances of Approval as a Self-Employed Borrower
No matter which type of loan you try to get as a self-employed borrower, you should maximize your qualifying factors. This includes:
- Get your credit score as high as possible. Even though FHA loans allow credit scores as low as 580, lenders are unlikely to approve a self-employed borrower with a 580 credit score. Do what you can to increase your score by paying your bills on time, paying your debts down, and avoiding any new credit applications before applying for a mortgage.
- Save money for a down payment. The more money you can invest in your home, the less risk of default you pose to a lender. This may help a lender approve you for either a conventional or FHA loan as a self-employed borrower. The more money you invest, the more likely you are to do what is necessary to make your payments on time.
- Prove that you have what it takes to succeed. The largest risk lenders take on self-employed borrowers is the risk of a failed business. Prove to lenders that you have the experience in the industry (both literal and educational). Without experience, lenders may worry that your business won’t last long.
If you can’t find a willing lender for a conventional or FHA loan as a self-employed borrower, try alternative lenders. Also known as subprime lenders, they offer loans you won’t find elsewhere. These lenders keep the loans on their own books, which allow them to make their own rules.
Subprime lenders aren’t ‘bad news’ or risky. Do your homework and shop around to find the lender you are most comfortable with when applying for loans. Look at the big picture including the interest rate, term, and the closing costs for the loan. Most loans today don’t have a prepayment penalty, so you probably won’t have to worry about that.
The key is to shop around and see what options you have as a self-employed borrower. Today’s lenders offer many more solutions than you may realize. See which loan fits your budget and your needs in order to make the most of your investment.