How Hard is It for Self-Employed People to Get a Mortgage?
Many people dream of being their own boss. And with good reason –multiple studies link self-employment with higher job satisfaction and enhanced physical wellbeing.
As of July 2022, 16.4 million out of 158.1 million Americans were self-employed, which represents 10% of the workforce, according to the U.S. Bureau of Labor Statistics. And that percentage is likely to increase since self-employment among Americans has been on the rise for the past decade.
Yet self-employment is not without hardships. Getting loans can be difficult, especially home mortgages. However, this shouldn’t deter self-employed mortgage seekers. Getting a loan may seem daunting, but it’s easier than ever for the self-employed to find mortgage loans with competitive rates and customizable options.
Here are some steps the self-employed can take to find suitable mortgages.
More: Looking to buy soon? Set yourself up for having your offer accepted on a home by getting preapproved for a mortgage prior to your home search.
Find a Lender Specializing in Self-Employment Income
With a steady job and a W-2, it isn’t hard to qualify for loans, provided the borrower meets income and credit requirements.
Self-employed people can have more challenges due to the variability of their income.
Using a lender familiar with self-employment is the number one factor in finding a suitable loan, said Caliber Home Loans senior executive loan consultant John Ammar in an interview. Caliber Loans is a direct lender specializing in self-employment income.
“Finding a lender competent in navigating self-employment income is probably the most critical thing,” Ammar said.“There is so much that goes into it as far as your income, whether or not you are providing a positive or negative income on those tax returns.”
Start Here: Verify your self-employed mortgage eligibility
Get a Conventional Loan
Self-employed borrowers can get conventional loans with the lowest rates when the adjusted gross income (AGI) on their federal tax return meets lender requirements. Mortgage lenders like Caliber qualify borrowers for loans based on their AGI.
But with the prevalence of business deductions, many borrowers will not show a high AGI.
“What your bank statements show and what your tax return shows are going to be wildly different for people who claim small business exemptions on their tax return,” Ammar said. “It’s not what you’re bringing into the bank account, it’s what you’re declaring and paying taxes on, and that’s why taxable income is what we use when qualifying borrowers for our self-employment loans.”
Self-employed people with higher taxable income qualify for conventional loans, as long as they have a well-established track record of self-employment income. For W-2 employees, lenders might look at income for the past three months to assess a borrower’s credit risk. However, for the self-employed, they go back significantly further.
“We average your income over two years to qualify you for your purchase,” Ammar said. “If you’ve been self-employed for seven years, you only have to show one year of tax returns.”
Seek Nontraditional Financing
To qualify for the lowest rates, some self-employed people might boost their taxable income by turning down available deductions. But these deductions help many businesses grow effectively, so leaving this money on the table can hamper small business growth.
Instead, entrepreneurs can exploit unconventional lending options to get a mortgage.
Self-employed people can get mortgages based on cash flow instead of the AGI on their tax returns, said Ray Williams, President of Mortgage Maestro Group, in an interview. Williams said his company routinely finds loans for self-employed people with payments that are many times their taxable income.
Commonly, small business owners might use bank statements to prove their income. Others might use 1099s, profit and loss statements or other business documents to prove what Williams called “verified income.”
Pay Higher Rates
Admittedly, there is a tradeoff with bank statement mortgages: you don’t have to forgo lucrative tax deductions, but you will pay higher rates.
“The tax code is written to reduce what we pay to the IRS, not increase it,” said Williams. “Business owners are not doing anything wrong by using the tax code, yet they’re penalized by the traditional mortgage industry to buy a house.”
But rates aren’t everything, and as Wiliams points out, this tradeoff makes sense to many entrepreneurs.
“You might pay a higher interest rate for a solution, but it allows you to keep running your business the way you always have,” Williams said.
But is paying that higher interest rate worth it?
“For many business owners, it comes down to a determination,” said Williams. “Do I put money into marketing, growth and hiring someone? Or do I claim the income, forgo deductions, pay the IRS a bunch of money in taxes and not grow my business?”
And even when self-employed borrowers pay a higher rate, they might not be paying as much as they think.
“Those that use these programs understand one thing: higher interest rates mean bigger mortgage deductions,” Williams said.
Business owners can also write off some other housing expenses when they use their homes for business purposes.
Keep Debt Low
So how much income do lenders want to see? As with other mortgages, it depends on the borrower’s recurring monthly debt payments – credit cards, car payments and house payments– that show up on the borrower’s credit report.
“You want to definitely keep your monthly debt-to-income ratio below 45%, ideally below 40%,” said Caliber's Ammar. Lenders are more likely to approve mortgage applications within those ranges, he said.
So if a self-employed person earns $5,000 in monthly income, lenders would like their total monthly debt payments to be less than $2,000 per month.
Low personal debt can help self-employed borrowers qualify for higher monthly mortgage payments.
Use a Mortgage Broker
Finding a broker specializing in self-employment mortgages can also be a significant advantage when comparing various loan types. By using a broker, borrowers usually only have to fill out one loan application to get multiple options, making it easier to select an optimal solution.
Mortgage brokers may increase a loan’s closing cost if they take a commission from the borrower at closing. However, many brokers can access wholesale loan products, which might have lower rates than retail lenders offer.
For the self-employed, a broker that understands business ownership is ideal. Self employed people should seek out “a qualified professional who understands business, taxes and cash flow” in addition to mortgage topics, said Mortgage Maestro's Williams.
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