Getting a mortgage can be more challenging when you're self-employed, but it’s not impossible. For W-2 employees, getting a mortgage can mean showing your tax records from your employer to verify your income.
For approving someone who is self-employed, lenders may be concerned that your income isn’t steady enough to make your monthly payments. Some lenders also prefer not to work with self-employed people because there’s more paperwork.
Why Is It More Difficult?
There are disadvantages to applying for a mortgage as a self-employed person. You’re often not seen as an ideal borrower from a lender's perspective.
You’re seen as more creditworthy when you’re an employee because you have a steady, verifiable income. If you pair this with an excellent credit score, even better.
Along with the notion that self-employed people’s income might be less reliable is that you may have a number of business expenses. Deducting these business expenses can help you reduce your taxable income, which is a good thing because you can pay less to the IRS.
At the same time, if you’re applying for a mortgage, you will show a lower annual income.
Another reason you could face challenges is if the lender wants to see a lower loan-to-value ratio from you. You’ll need to have a larger down payment as a self-employed borrower in certain circumstances.
How to Make Yourself More Appealing
If you’re planning to buy a home, there are things you can do to make yourself a more attractive candidate as far as a lender is concerned.
If you’re self-employed, the odds of getting approved for a mortgage and getting comparatively favorable terms can go up when you optimize your debt-to-income ratio or DTI.
This means you reduce your debt, increase your income, or both.
To optimize this ratio, you want to keep your home shopping on the lower end of what you can theoretically afford.
Be Ready to Show Documentation
You should get your documents ready in advance of shopping for a home, and you should be ready to fully document your income. You’ll probably need bank statements, tax returns, balance sheets, and profit and loss statements.
A lender might also ask for your debts and monthly payments for your businesses and a list of your assets, including your investment and savings accounts.
You may need proof of your business or your status as someone self-employed, including letters from clients or statements from your accountant.
Pay Off Your Consumer Debt
Your consumer debt includes things like your credit card debt. The lower your debt and the fewer the monthly payments you have, the better. If you can take some time to pay off your credit cards or an outstanding car loan, you might be in a better position because you’ll have increased cash flow.
Have Cash Reserves
Along with your down payment, you want an emergency fund that shows that you’ll be able to manage your mortgage payment even if your business takes a hit.
A lender will want to see that you have the cash on hand to cover your property taxes, homeowner's insurance and maintenance and repairs, and your housing payment itself.
If you can’t qualify for a traditional mortgage, let’s say, because of your business expenses, there are other options for mortgages, but they can be more expensive or trickier in certain ways.
A bank statement loan is also known as an alternative document loan. You can apply for a loan with 12-24 months of bank statements rather than your tax returns. The interest rate and down payment will probably be higher since lenders see the risks as greater with this type of financing.
Another option would be a joint mortgage with a co-borrower who works as a W-2 employee. A relative might be able to co-sign for a loan, but they are taking on the responsibility if you default, so not many people would be willing to do this.
Overall, you can get a mortgage if you’re self-employed, but be prepared and know what you’re up against.