While getting a mortgage as a W-2 employee may be easier than if you're self-employed, you don't have to go running back to your cubicle to qualify for a home loan. Some lenders may be concerned that you won't earn a steady enough income to make your monthly mortgage payments, and others may simply not want to deal with the additional paperwork that can be involved in providing a mortgage to a self-employed person.
It may take a bit more shopping around to find the best lender for your situation. But don't worry—if you're looking for a self-employed mortgage, there are steps you can take to make yourself a more attractive loan candidate.
Key Takeaways
- Self-employed borrowers can improve their prospects by increasing their credit score, offering a larger down payment, or paying down debt, among other strategies.
- One problem that self-employed individuals run into is that they use business expenses to reduce taxable income, which means less qualifying income for a mortgage.
- Conventional loans, FHA loans, and bank statement loans are among the self-employed mortgage options.
- It's also possible to take out a joint mortgage or enlist a co-signer.
Disadvantages of Getting a Mortgage While Self-Employed
Lenders don't always see the self-employed as ideal borrowers. Borrowers who are employees can be considered to be particularly creditworthy because of their steady, easily verifiable incomes, especially if they also have excellent credit scores. Self-employed borrowers will have to provide more paperwork to document income when compared to traditional employees who can produce a W-2.
Another hurdle to getting a self-employed mortgage is that the self-employed have business expenses. While deducting these costs helps business owners reduce their taxable income, it also means their tax returns show a lower annual income, which may cause lenders to wonder if the borrower makes enough money to afford a home. Finally, banks may want to see a lower loan-to-value (LTV) ratio from self-employed borrowers, meaning the borrower will need to come up with a larger down payment.
When economic conditions are less than ideal, lenders tend to require higher credit scores, larger down payments, and more documentation to approve mortgages and other loans. Stricter requirements can fall harder on the self-employed, but some lenders will usually be easier to work with than others.
Become an Attractive Mortgage Candidate
Borrowers who know they can make the payments on the home loan they want can do some or all of the following to improve their chances of getting a self-employed mortgage.
Optimize Your Debt-to-Income Ratio
Increase your odds of getting approved for a self-employed mortgage by optimizing your debt-to-income (DTI) ratio. You can do this by increasing your income and reducing your debt. The easiest way to optimize your ratio is to shop on the lower end of what a mortgage calculator (such as the one below) says you can afford. If the calculator says you can afford a $500,000 home, try keeping your budget under $350,000. This will give you greater flexibility in your budget to invest in your solo 401(k) and will make you more likely to be approved for a self-employed mortgage.
Establish a Self-Employment Track Record
If you can show that you know how to play the self-employment game and win, lenders will be more willing to take a chance on you. You should have at least two years of self-employment history, documented by tax records.
During those two years, you might rethink some of your business deductions. While write-offs allow you to save on taxes, they also reduce your taxable income, which is what banks look at when they evaluate potential loan candidates. A stable or increasing income will also make you more attractive.
Max Out Your Credit Score
In any borrowing situation, a higher credit score will make you a more attractive candidate to get approved and qualify for lower interest rates.
Offer a Large Down Payment
The higher the equity in the home, the less likely a borrower is to walk away from it during times of financial strain. A bank will see the borrower as less of a risk if they put a lot of cash into the purchase upfront.
Have Significant Cash Reserves
In addition to a large down payment, having plenty of money in an emergency fund shows lenders that even if your business takes a nosedive, you will be able to keep making your monthly housing payments. Bolster your savings so you'll be set to cover property taxes, homeowners insurance, and any maintenance and repairs that come up.
Pay Off Consumer Debt
The fewer monthly debt payments you have going into the self-employed mortgage process, the easier it will be for you to make your mortgage payments. If you pay off your credit cards and car loans, you may even qualify for a higher loan amount because you'll have more cash flow.
Provide Documentation
Being willing and ready to fully document your income through previous years' tax returns, profit and loss statements, balance sheets, and bank statements increase your chances of qualifying for a self-employed mortgage and getting more favorable rates. Your lender may also ask for some or all of the following:
- List of debts and monthly payments for your business
- List of assets (savings accounts, investment accounts, etc.)
- Additional sources of income (alimony, Social Security, etc.)
- Proof of your business or self-employed status (business license, letters from clients, statements from your accountant, etc.)
- Proof of current rent or mortgage payments
Self-employed borrowers fill out the same loan application as everyone else.
Self-Employed Mortgage Options
If you are self-employed and don't qualify for a conventional mortgage, some lenders still offer loans that might be a fit. Conventional mortgages are not guaranteed by the federal government, so they typically have stricter lending requirements. Here are some other options for a self-employed mortgage:
FHA Loan
A Federal Housing Administration (FHA) loan is a mortgage that is insured by the Federal Housing Administration (FHA) and issued by an FHA-approved lender. FHA loans are designed for low-to-moderate-income borrowers. They require a lower minimum down payment—as low as 3.5%—and lower credit scores than many conventional loans.
Because FHA loans are federally insured—which means that lenders are protected in the event that a borrower defaults on their mortgage—FHA lenders can offer more favorable terms to borrowers who might not otherwise qualify for a home loan, including lower interest rates. This means it can also be easier to qualify for an FHA loan than for a conventional loan.
Be aware that FHA loans do come with significant other costs, including a large upfront mortgage insurance premium, so keep this as a backup option if you can't get approved for a conventional self-employed mortgage.
Bank Statement Loan
Bank statement loans, also known as alternative document loans, allow borrowers to apply for a loan without submitting the traditional documents that prove income, such as tax returns and W-2s. Instead, lenders look at 12 to 24 months of your bank statements to evaluate your business income.
The interest rates on bank statement loans tend to be higher, as the lender is taking on more risk.
Joint Mortgage
Getting a joint mortgage with a co-borrower who is a W-2 employee, such as a significant other, spouse, or trusted friend who will share ownership of your home, is another way to improve your prospects of getting approved for a mortgage if you are self-employed. A co-borrower provides more assurance to your lender that there is a steady income to pay back the debt. However, your co-borrower will also need good credit and a low-to-moderate debt-to-income ratio to qualify with you.
Enlist a Co-Signer
Finally, a parent or other relative might be willing to co-sign your mortgage loan. Keep in mind that this person will need to be willing and able to assume full responsibility for the loan if you default. That's a lot to ask.
Can You Get a Mortgage If You're Self-Employed?
Yes, you can get a mortgage if you're self-employed. In general, you'll need to prove two years of income history from your self-employment with tax returns.
Is It Harder to Get a Mortgage If You're Self-Employed?
Yes, it can be harder to get a mortgage if you're self-employed. You'll need to provide more documentation than someone who has had the same W-2 employment for several years. Some lenders do not work with self-employed individuals because of the increased underwriting requirements.
How Much Income History Do I Need for a Self-Employed Mortgage?
The longer you can prove income history for self-employment in the same industry, the more likely you are to be approved for a mortgage. As a general rule, you'll want to have at least two years of documented self-employment income at or above the level you need to afford the loan you want.
Are Self-Employed Mortgages More Expensive?
Not necessarily. Make sure you're getting the best deal possible by getting pre-approved quotes from multiple lenders and comparing loan estimates.
The Bottom Line
If a W-2 employee loses a job, their income will drop to zero in the blink of an eye in the absence of unemployment insurance (UI) benefits. Those who are self-employed often have multiple clients and are unlikely to lose all of them at once, giving them more job security than is commonly perceived.
Of course, self-employed individuals are already used to having to work extra hard to file additional tax forms, secure business licenses, get new clients, and keep the business running. Armed with a little knowledge and patience, they can also find ways to qualify for a self-employed mortgage.
