About 20% of the American workforce is self-employed as small business owners, entrepreneurs, and freelancers. Being self-employed offers numerous advantages over being a salaried employee, like the freedom to set your work hours and be your boss. But on the flip side, being self-employed makes it harder to get a mortgage. Lenders must be able to verify your income, and this can prove difficult for the self-employed who typically don’t have the documentation needed to do so. But despite this handicap, it’s not impossible to get a loan when self-employed. You have to do a little extra work and find a lender that’s willing to do a little more work on their end. Fortunately, with the gig economy exploding, it’s getting easier every year for self-employed buyers.
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How the Mortgage Meltdown Impacted Self-Employed Individuals
Things were certainly a lot different a little over ten years ago. Before the credit crisis of 2008, self-employed buyers had little trouble getting a mortgage thanks to stated income loans. So long as you had a social security number and average credit, virtually anyone could get a loan simply by stating their income. All without ever having to provide any documentation to prove it. It was an abuse of this system that led to the mortgage meltdown and the introduction of new rules as laid out in the Dodd-Frank act of 2010. This eliminated stated income loans and made it a requirement for every lender to fully verify a borrower’s income before approving them for a loan.
This was a massive blow to self-employed buyers, who don’t usually have the documentation needed to verify their income. The only way they can qualify for a mortgage now is by submitting their net income based on their tax returns. The problem, though, is that most people take full advantage of IRS guidelines on itemized deductions. Such deductions reduce your net income levels and make it almost impossible to qualify for a loan. Meanwhile, salaried employees can be eligible based on their gross earned income, something that doesn’t require you to reduce your income based on any deductions made.
Self-employed mortgages are important
Fortunately, there are ways around this. With self-employed individuals increasingly making up an ever-larger part of the workforce, it is of vital importance to the real estate market that these people can become homeowners, which is precisely why the following loan programs are available.
Top Mortgage Options for Self-Employed Buyers
Bank Statement Loans
Currently, the best mortgage option for self-employed buyers is bank statement loans. These have been specifically designed to help people who would otherwise have trouble qualifying based on their net income on their tax returns. Instead of tax returns, applicants are asked to provide 12-24 months’ worth of bank statements as proof of income. Your average monthly income will be determined by using a percentage of your monthly deposits into your business accounts and 100% of deposits into your accounts. The loan program is available for the purchase of primary residences, second homes, and investments.
Bank Statement Loan Requirements:
- Proof of self-employment for a minimum of two years
- 12-24 months of bank statements
- A credit score in the mid 500s, depending on your lender
- A down payment of 10%-20% depending on your lender, credit score, and whether you’ve had a recent bankruptcy
Pros and Cons of Bank Statement Loans
- Low down payment requirement
- Tax returns are not needed for qualification
- Recent bankruptcies are permitted
- Most have no pre-payment penalties
- Rates are reasonable considering only bank statements are being provided
- You’ll have to show a steady flow of bank deposits
- You cannot use 100% of your business account deposits
- Rates are slightly more than conventional loans but not by much
- The program is not easy to find as not many traditional lenders offer them
No Income Verification Loans
A more flexible option (although with a higher interest rate) is a no income verification loan. What makes these different from bank statement loans is that you’ll be providing nothing other than proof of down payment funds. Here are a few key things to know about this type of loan program:
- They’re available for both self-employed and salaried buyers
- You must have a full two years of employment, whether salaried or self-employed
- The minimum down payment on any purchase will be 20%-35%
- The program is available in both fixed-rate and adjustable-rate
- Interest rates will be higher than bank statement loans
- Even fewer lenders offer this program than those who offer bank statement loans
Non-Owner-Occupied Investment Loans
Many buyers looking to buy an investment property have trouble qualifying due to the obligations of the monthly payment on their primary residence. The non-owner-occupied investment loan exists to help people overcome this. Anyone looking for a short-term flip will find this to be an advantageous option. However, it does come with some heavy restrictions. The main points to understand about this program are:
- It can only be used for non-owner-occupied purchases
- The borrower must already own a primary residence
- The program is available in both adjustable-rate and fixed-rate
- A 75% loan-to-value ratio is required for a purchase, 70% for refinancing
- There is a three-year prepayment penalty that comes with the option to buy down
Mortgage Options for Self-Employed Buyers Who Can Document their Income
Some self-employed buyers can document their income and apply for a conventional or government-backed loan. To do so, you’ll need, at a minimum, two years of tax returns and possibly your current year P&L statement from your accountant. Anyone who can provide the necessary documents should consider one of these mortgage programs:
Anyone who can save up at least 20% for a down payment will find a traditional conventional loan more than adequate. If you can’t scrape together 20%, then look into getting a piggyback loan. This will give you one loan for 80% of the home value and a second loan that makes up the difference. Doing this will help you to avoid PMI or to get a jumbo loan.
Those with a small down payment, but an excellent credit score, can still be approved for an FHA loan. These are loans backed by the federal government and can be gotten with as little as 3.5% down. However, these loan types come with higher upfront costs and a monthly PMI payment that will last for the duration of the loan.
Buyers, or their spouses, who are veterans or active military, can be approved for a VA loan. This program is also government-backed but comes with a 0% down payment, no PMI, and great rates.
How to Improve Your Chances of Mortgage Approval
By far, the best mortgage option for self-employed buyers is the bank statement loan. So long as you’ve been self-employed for at least two years, have a steady flow of deposits into your accounts, and about 10%-20% saved for a down payment, then you can qualify. Whatever program you choose, all mortgage types have one thing in common. The more you can prepare ahead of time, the better chance you stand of being approved. Follow these critical steps below to give yourself the best chance possible.
Save for a Down Payment
The more you can save, the better your options will be. Set a goal for the figure you intend to save for and make a plan to reach that. This will mean making a few sacrifices and working harder; if homeownership is what you want, then you have to be willing to do what is necessary.
Have an Emergency Fund
No home purchase that will leave you bone dry of any funds on closing is ever a good idea. You should aim to have at least six months of expenses saved as a reserve fund in case the unexpected happened. This could be a sudden drop in your income, an unexpected repair in the home, or a medical emergency. To make sure you don’t fall behind on your mortgage payments have enough saved for any rough periods.
Raise Your Credit Score
While bank statement loans can be had for an average credit score, you’ll still want to raise it as high as you can. A high credit score will mean a lower interest rate and a better chance of being approved if your down payment isn’t as high as hoped. This is a process that can take some time but comes down to good financial habits. Make all your payments on time, even if it’s only a partial payment. Pay down all your debt and keep your credit card balance as low as possible.
Make Regular Bank Deposits
If you choose a bank statement loan, then you’ll need to make sure you’ve been making regular deposits into your business and personal accounts. Depending on how you get paid for your self-employed work, try to set up a system where payments will be received on a set day of the week or month. If you can’t show regular and predictable deposits; then you’ll have little chance of getting a loan.
Get Consultation Early
Self-employed individuals face particular obstacles on the road to homeownership. As everyone’s situation is different, the sooner you can get a consultation, the better. Set up a meeting with a loan officer several months ahead of talking to a real estate agent. Make sure that their someone who understands the complexities of self-employed tax returns. Bring any documentation you can to present your case. You may find that the situation isn’t as bad as it seems, and you have more options than you thought. Many people go in thinking that a no income verification loan is their only option. But on review, they discover that they can qualify for a full documentation loan.