Keys to Obtaining a Home Loan when Self-Employed
06/27/2017 Kristin Demshki
Why Use PennyMac?
- More than 1 million customers
- Innovative solutions to purchase or refinance
- Competitive rates and superior service
If you’re one of the 15 million Americans who are self-employed, you don’t have to give up the benefits of being your own boss in order to become a homeowner.
Although securing a mortgage while self-employed may prove a bit more challenging, you can still qualify for the same loan programs as traditional borrowers. The key to a self-employed borrower successfully obtaining a mortgage is income verification.
Lenders want to be sure you can afford your mortgage—and for the self-employed that requires some extra paperwork. These documents can include tax forms, client statements and other records, which all help to prove your ability to repay your mortgage.
Let’s take a look at how the loan process differs for the self-employed, including which items lenders will need from you when you apply and how you can improve your chances of getting approved.
How Self-Employed Mortgages are the Same as Traditional Home Loans
The application process for a mortgage is the same regardless of whether you work for yourself or not. You will need to submit various verification documents, such as income and credit statements, to determine your mortgage eligibility. Just as with a traditional home loan, lenders always look at three main factors during the underwriting process:
- Your capacity to repay
- Your credit history
- The value of the home
Capacity to Repay
To calculate your capacity to repay, lenders will look at the relationship between your income and your debts. Your front-end debt-to-income (DTI) ratio will be determined by dividing your estimated mortgage payment by your monthly income, while your back-end DTI comes from dividing the monthly payments on all debt by your monthly income. When you’re self-employed, your income is typically based on an average of your last two years of tax returns. You ability to repay is also influenced by your reserves, including any assets or cash savings you may have in a bank account.
Credit HistoryYour credit score is used by lenders to determine your ability to fulfill your mortgage payments, and your credit score is a critical factor in determining what your interest rate and loan terms will look like. As with any other mortgage, the higher your score the better. For many mortgages, you will need to have a minimum credit score of 620, with some mortgages requiring a credit score of 640 or higher.
Home ValueThe market value of your home is an important factor for your lender as it helps them gauge their risk. You will find that most lenders require a home appraisal for home purchases loans, to ensure that the property value of your desired residence is in line with the amount you’re borrowing.
The Difference Is Self-Employed Income Verification
When you work for yourself, you get to enjoy the perks of setting your own schedule, choosing your roster of clients, and running a business from the comfort of your own home or office. To offset the additional responsibility that applicants have when running a business, most lenders will want to see a longer track record of earning income.
In a traditional home loan, the lender will typically look at one months of pay stubs and W-2’s to determine an applicant’s income. These pay stubs show a worker’s gross income before taking out any deductions. When you’re self-employed, however, lenders don’t have W-2’s to lean on.
Therein lies the challenge. If you’re like most business owners, you maximize your business expenses and deductions with every tax return—which leaves you with a lower taxable income than you’d have if you were a salaried employee.
Unfortunately, lenders don’t take this into account. Instead, to assess a self-employed mortgage, a lender will look at your business’ bottom line, taking into consideration your profit following expenses. This will require you to submit two years of tax returns as well as sign Form 4506-T, which allows the lender to validate this data for themselves.
You may also need to provide profit and loss statements, which bridges the gap between the last tax return and most recent time period.
Ideally, you’ll want to prove that your income is consistent, reliable, and enough to afford your house payment.
Additional Self-Employment Verification Documents
We’ve already discussed the need to submit two years of income taxes to help verify your income, but some lenders may require you to submit additional business documents. Some of these records may include:
- A statement from your certified public accountant or tax agent
- A business license
- A Doing Business As (DBA)
- Recent business bank statements
Self-Employed Home Loan Options
Here’s the good news: despite the extra steps needed to verify your self-employed income, you can still qualify for the same mortgage programs as anyone else. That includes popular loan programs such as Conventional Loans and FHA Home Loans, with typical loan terms such as 15-year and 30-year mortgages.
5 Tips for Improving Mortgage Approval for the Self-Employed
When you are self-employed, there are several other steps you can take to make yourself a more attractive loan candidate. Here are a few strategies you can use to help you qualify:
- Register your business or apply for the proper licenses.
- Pay off as much debt as possible before applying for a mortgage.
- Save enough money to put down a sizeable down payment, which reduces your monthly mortgage and private mortgage insurance (PMI) payments.
- Keep your business and personal bank accounts separate.
- Maintain clean and accurate business records.
Self-employed mortgages are common —it just takes a little extra paperwork. Take the time to get your finances and records in order before you apply for a mortgage, and it won’t be long before you are on the path to being a business owner and a homeowner!