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Getting a mortgage when you're self-employed is possible, but it can require a bit of extra effort. It's not because self-employed borrowers must meet impossible standards: Basic income, credit and down payment requirements are largely the same for a mortgage whether you're an employee or self-employed, though terms will vary from one loan to another. The difficulty usually lies in proving your self-employment income.
To get a mortgage when you're self-employed, you may need to take additional steps to show the lender that you've been in business for a minimum period of time and that your business has the financial strength to provide a steady income over the long haul. If you're thinking of applying for a mortgage in the near future, here are some basic steps to follow.
Get Your Finances Ready
A mortgage represents a huge commitment on the part of a lender, with hundreds of thousands of dollars and decades of payouts at stake. Lenders want to know that your income, cash assets and credit are strong. You can improve your chances of securing a mortgage by preparing your finances for scrutiny.
Document Your Income
The biggest hurdle self-employed borrowers face during the mortgage application process is proving their income.
Typically, mortgage lenders look at your tax returns, bank statements and current-year profit and loss to determine your income and income history. Every dollar you make may not count as income on your mortgage application—for example, business expenses you've deducted on your tax return aren't part of your bottom line.
Calculating your income and assembling the documentation you'll need to prove it are an important first step, precisely because it isn't as simple as presenting a few pay stubs and an employer contact to verify employment history. However, once you've pulled this information together, you'll gain a clearer picture of how much mortgage you can afford and what you may qualify to borrow.
Pay Down Debt
Reducing the amount of revolving debt you carry will improve your credit utilization—and likely, in turn, your credit score. Lenders want to make sure you aren't overextending yourself with credit, which could put your timely mortgage payments in jeopardy.
A low credit utilization ratio shows that you're managing your credit effectively. Credit utilization also accounts for 30% of your FICO credit score. To calculate your credit utilization ratio, add up your total credit card balances and divide that number by the total of all your credit lines. So, for example, if you owe $1,000 each on three credit cards, each with a $5,000 limit, your credit utilization ratio is $3,000 divided by $15,000, or 20%. The lower your utilization, the better for your credit scores.
Paying off debt also helps your debt-to-income ratio (DTI). Your DTI measures how much of your monthly income goes toward debt payments such as credit cards, student loans, your mortgage and auto loans. Paying down credit card debt or paying off a car loan lowers your DTI and frees up income to pay your mortgage. DTI is an important factor in mortgage approval, so reducing your outstanding debt could significantly help your chances of mortgage approval.
Keep Business Credit Separate
Although many business owners use personal credit to finance their businesses, establishing separate business credit and using it to pay for large purchases and manage cash flow may help with your mortgage application.
Maintaining separate business credit keeps business expenses off your personal credit cards. This keeps your personal credit utilization down, which can boost your credit score and improve your DTI.
Add to Your Down Payment
The larger your down payment, the smaller your mortgage. Moreover, having at least 20% of the purchase price for a down payment will help you avoid paying for mortgage insurance.
Additionally, a larger down payment is reassuring to lenders. It shows that you have the financial wherewithal to save money and gives you a bigger stake in your home purchase.
Save Up Cash Reserves
Lenders like to know that you have funds available to cover your mortgage payment and monthly expenses even if you run into a rough patch financially. Maintaining three to six months' worth of expenses in savings is a smart financial move and also shows lenders you have emergency funds ready in the event of a financial setback.
Improve Your Credit
Good credit opens doors when you're applying for a home loan. The higher your credit score, the greater your chances of securing low interest rates, favorable terms and loan approval. Consider these tips for putting your best foot forward:
- Check your credit score and report at all three credit reporting bureaus (Experian, TransUnion and Equifax) on AnnualCreditReport.com.
- Wait to open new credit accounts (other than your mortgage) to minimize credit inquiries on your credit report.
- If your score needs a lift, consider using the next six months to pay your bills on time, reduce debt and work on your credit habits. Get tips on improving your credit score and track your progress for free using Experian's free credit monitoring.
Find the Right Lender and Loan
Before you start house hunting, take a moment to shop for the right lender and loan. Self-employed borrowers have a range of options to explore, from conventional mortgages with banks, credit unions or online lenders, to federal VA or FHA loans with low down payment requirements.
If you have the income, down payment, cash reserves and credit to qualify for a mortgage, being self-employed shouldn't stop you from finding the right loan. That said, some loans and lenders may be a better fit for you. For example, most lenders want to see at least a two-year track record in business, but some may be willing to work with you if you have at least one year in business and steady employment prior to striking out on your own. Underwriting guidelines may be more flexible at some financial institutions than others. Rates and terms will also vary. In the end, you may need to shop around to find the best lender for you.
Not sure where to start? Working with a mortgage broker may help. Brokers work with a variety of lenders, generally at no cost to you. An experienced broker can help you zero in on loans that are right for you and may even help walk you through the application process.
Whether you decide to enlist the help of a broker or find your own list of lenders to try, consider getting preapproved for a loan before you start house hunting. That way, you can work through the application and approval process without pressure and go forth knowing exactly how much you have to spend.
When you're ready to apply, be prepared to supply documents that support the history and income stability of your business. Here's a typical list of items you may be asked to provide:
- A business license, business insurance documents or a letter from your accountant that indicates how long you've been in business
- Personal tax returns showing business income, usually for the past two years
- Profit and loss statement that shows year-to-date sales and expenses for the current year
- Itemized receivables (outstanding invoices for which you expect to be paid)
- Business bank statements showing income, expenses and cash flow
The Bottom Line
Though the mortgage approval process can be a bit more complicated for self-employed borrowers, the basic qualifications for getting a mortgage are the same across the board. You'll be approved for a mortgage that fits your income, down payment and credit profile, just as any other borrower would be. If you're self-employed, you may simply have to take a few extra steps to prove your position.
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