If you are self-employed, you may think it’s impossible to get a loan. While it is certainly a little trickier, there are definitely lenders and loan programs available to help you get the loan you need. It all comes down to your documentation and how prepared you are for the loan.
Below we help you understand what you need as a self-employed borrower and how to present yourself as a low-risk borrower.
The Income Documents
The largest worry most self-employed borrowers have is how they will document their income. While it’s true that there aren’t any ‘stated income’ loans any longer, that doesn’t mean it’s impossible to get a self-employed mortgage. You have to be able to prove your income with your tax returns.
What does this mean for you? It all comes down to how you report your income. You obviously have to report the income you made from your self-employment. But, what you deduct from that income is what really counts here. If you take too many deductions, it can hurt your bottom line. Lenders use your adjusted gross income for qualifying purposes. This means your income after any deductions you’ve taken.
While it may make sense to take the deductions available to you as a business owner, it will reduce how much mortgage you can afford in the eyes of the lender. If you can help it, try to limit the number of deductions you take during the two years leading up to your mortgage application. This way you can have a higher adjusted gross income and hopefully qualify for a larger mortgage.
The lender will need all schedules of your tax returns to make sure they see the ‘big picture.’ They want to know how much income you claim, what you deduct, and any other special circumstances that surround your income as a self-employed borrower.
The Asset Documents
As a self-employed borrower, you may also have to provide your bank statements for mortgage approval. They want to make sure that you actually make what you report on your taxes. They also want to make sure that any money you plan to use for your down payment or closing costs are yours. They will generally ask for two months’ of bank statements to make sure you didn’t take a loan or stash someone else’s money into your account just to make it look like you had enough money.
Sometimes lenders will need to see your business asset statements too. They usually only need them if your personal and business accounts seem to overlap. It’s best if you keep the two accounts completely separate so there aren’t any red flags that make the lender wonder which money is yours and which belongs to the business.
You Need Consistency
If there’s one thing lenders look for when deciding if you are a good risk, it’s the consistency of your income and employment. This is the case for any borrower, but it carries a greater weight when you are self-employed.
Lenders want to see that your business is thriving. You can prove this by showing consistent or increasing income year after year. You can also prove to the lender that you have what it takes to succeed in the business. A few simple ways include showing a history of working for someone else in the same industry or proving that you recently had schooling or training to help you succeed in the business.
If you show a decrease in income, it throws up a red flag. Lenders will need to know why your income fell. They will investigate the solidity of your business and how the industry as a whole is doing. They don’t want to give a loan to anyone that is in a business that doesn’t have the potential to succeed.
You Should Have Compensating Factors
If there’s one thing you can do it’s to provide the lender with compensating factors or reasons to give you a loan. The fact that you are self-employed puts the lender in a fragile situation. But, if you have factors that can back it up, making you look less risky, you may have a better chance of approval.
The most common compensating factors include:
- High credit score – Try to maximize your credit score by paying your bills on time, paying your debts down or off, and avoiding any collections or judgments. During the time leading up to your mortgage application, refrain from applying for any type of new loan.
- High down payment – If you can afford a larger down payment than the minimum required, it decreases the lender’s risk of default. The more money you have invested in the property, the more like you are to make your payments.
- Have reserves – If you have a substantial amount of assets beyond what you need for the down payment and/or closing costs, you can use them as reserves. Lenders count the liquid assets that you have based on the number of months of mortgage payments they can cover. The more months of mortgage payments you have on hand, the better your chances of approval.
Being self-employed doesn’t mean you won’t get a loan. It may mean that you have to work a little harder and provide more documentation to make sure that you get the approval you want. Some lenders welcome self-employed borrowers while others avoid them. You may find that you have to shop around for a while in order to find the lender that is best suited to your needs.