Unlock Your Dream Home: Mastering Self-Employed Mortgages, Plus 3 Proven Tips

Whether your workspace is a cozy nook in your home, a bustling co-working hub downtown, or even the driver’s seat of your trusty pickup truck, you’re among the 15 million self-employed individuals in the U.S. who are living the dream of being their own boss, according to the Bureau of Labor Statistics. The journey may have its challenges, but the gratification of watching your business flourish from a mere idea on paper to a profitable venture is unmatched.

However, when it comes to obtaining a home loan, self-employed individuals face unique hurdles that demand some extra effort. Don’t worry, this Redfin article will show you have to lock in that dream mortgage, calculate your self-employment, and proven tips and strategies to get you there.  

Unlocking the Self-Employed Mortgage: Who Qualifies as a Borrower?

Being self-employed doesn’t always mean you need to own a business. Mortgage lenders classify individuals as self-employed if they fall under any of the following criteria:

• You hold a 25% or more ownership stake in a business
• You are not a W-2 employee and receive 1099 tax forms
• You work as an independent contractor, gig worker, or freelancer
• At least 25% of your income is derived from self-employment

If you fit any of these descriptions, you might be eligible for a self-employed mortgage.

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How to get a mortgage when you’re self employed

As a self-employed individual, the journey to homeownership may present unique challenges, but it’s a dream well within reach. Whether you’re a freelancer, independent contractor, business owner, or receive 1099 income, this comprehensive guide will walk you through the essential steps and strategies to navigate the mortgage process successfully.

What do mortgage lenders look for

Lenders will need proof of the following before they consider your mortgage application:

• Income stability: Lenders want to see evidence that your income is stable and reliable, ensuring you can make consistent mortgage payments.
• Creditworthiness: Your credit score and history play a significant role in determining your creditworthiness and how likely you are to repay the loan.
• Debt-to-Income (DTI) ratio: Lenders will verify your DTI ratio to assess how much of your income goes towards paying debts, helping them evaluate your ability to manage additional mortgage payments.
• Employment history: A steady employment history assures lenders of your job stability and capacity to maintain long-term income.
• Proof of down payment: Lenders typically require documentation to confirm the source of your down payment, ensuring it comes from an acceptable and verifiable source.
• Financial records: Providing tax returns, bank statements, and other financial records helps lenders understand your overall financial health and reliability.
• Business income (for self-employed borrowers): If you’re self-employed, lenders may ask for additional documentation, such as profit and loss statements, to verify your business income.
• Appraisal of the property: Lenders order an appraisal to confirm the value of the property you intend to purchase, ensuring it aligns with the loan amount.
• Homeowner’s insurance: Proof of homeowner’s insurance is essential to protect both you and the lender from potential losses.

What documents should you provide

When you start the home buying process, you will need to show a history of continuous self-employment income, typically spanning a minimum of two years. Below are examples of documents that a lender may request during this evaluation:

• Personal and business tax returns: Typically, lenders require two to three years of both personal and business tax returns, including all schedules. These returns help assess your income stability and the financial health of your business.
• Profit and Loss (P&L) statements: Profit and Loss statements for your business are crucial to demonstrate your business’s revenue and expenses, providing further insights into its profitability.
• Bank statements: Recent bank statements for your personal and business accounts over the past two to three months offer a snapshot of your cash flow and financial transactions.
• Business license and registration: Proof of your business’s legal existence, such as a business license or registration, is essential for lenders to verify your business’s legitimacy.
• Form 1099s and/or 1099-Ks: If you receive 1099 forms as an independent contractor or freelancer, these documents validate your income from various sources.
• Business Debt Documentation: Details of any outstanding business debts, loans, or lines of credit can help lenders assess your financial obligations.
• Business bankruptcy or discharge papers: If you’ve been through a business bankruptcy or discharge, you might need to provide relevant paperwork and an explanation.
• Personal identification and proof of address: Valid government-issued photo ID and proof of your current address are standard requirements for any mortgage application.
• Business contracts or agreements: If you have long-term contracts or agreements with clients or customers, providing copies can demonstrate a stable source of income.
• Articles of incorporation/formation: If your business is incorporated, you may need to provide documentation of its articles of incorporation or formation.
• Client invoices and payment receipts: Copies of invoices and receipts from clients or customers can serve as additional proof of income.
• Explanation letter for income fluctuations: If there are significant fluctuations in your self-employment income, an explanation letter can clarify any unusual circumstances.

It’s essential to have these documents well-organized and readily available when applying for a self-employed mortgage. Providing comprehensive and accurate information can increase your chances of mortgage approval and a smoother application process.  The key thing to remember is that even if you know your business is profitable, your accounting software records must clearly show it.

Tips on buying a home self employed

1. Know how to calculate self-employed income

Most mortgage lenders prioritize the stability of your income, particularly in the context of self-employment, where they often require a track record of at least two years of income. Calculating your self-employment income for a mortgage application can be straightforward, following these steps:

1. Look for your net income from Schedule C on your tax returns for the two most recent years.
2. Add the net income figures from the two years together.
3. Divide the total by 24.

For example, suppose your net income for year one was $80,000, and for year two, it was $85,000. To find the qualifying mortgage income, add the two figures: $80,000 + $85,000 = $165,000. Then, divide this sum by 24, resulting in $6,875 per month.

So, based on this example, your qualifying monthly income for the mortgage application would be $6,875.

It’s essential to bear in mind that lenders may be cautious about loaning to individuals whose income declines year after year, as this trend could imply a business that is losing momentum. Demonstrating consistent or increasing income can boost your credibility and strengthen your mortgage application.

2. Understand the types of loans self-employed borrowers can qualify for

Numerous home loan options are available for self-employed individuals. Nevertheless, the eligibility process differs slightly compared to employed individuals.

Conventional Mortgages:

Conventional loans, also known as conforming loans, are open to all home buyers who meet the lending requirements. For self-employed individuals, eligibility for a conventional mortgage insured by Fannie Mae and Freddie Mac typically requires at least two years of self-employment. However, some lenders may consider applicants with one year of self-employment and a documented history of two years of comparable income in the same role. Additional requirements include a credit score of 620 or above, a 3% down payment, and a debt-to-income (DTI) ratio below 45%.

Government-Backed Mortgages:

These mortgage loans, insured by the federal government, offer more flexible requirements than conventional loans, making them an appealing option for self-employed individuals.

• FHA loans: Guaranteed by the Federal Housing Administration, FHA loans are suitable for those with modest incomes. Eligibility criteria usually include at least two years of self-employment history (or one year and two years in a similar role), a minimum credit score of 580, and a down payment of at least 3.5%.
• VA loans: Reserved for service members, veterans, and their surviving spouses, VA home loans are zero down payment mortgages insured by the Department of Veteran Affairs. As a self-employed homebuyer, you typically need to demonstrate at least two years of self-employment history and verify your income. Requirements may vary by lender.
• USDA loans: The US Department of Agriculture guarantees USDA loans to promote homeownership for self-employed individuals. To qualify, you must have a low-to-moderate income and reside in USDA-designated rural areas. Self-employed borrowers typically need a two-year history in their current role, and like VA loans, USDA loans require no down payment.

Bank Statement Loans:

Bank statement loans allow self-employed applicants to apply for a home loan using bank statements to prove their income instead of traditional documents like W-2s, tax returns, or pay stubs. Lenders typically require 12 to 24 months’ worth of business bank statements.

Co-Signer Loans:

If qualifying for a self-employed mortgage proves challenging, having a co-signer, such as a spouse or family member, can be beneficial. A co-signer assumes responsibility for the home loan in case of default, potentially improving your chances of approval.

Each of these loan options provides self-employed individuals with various paths to homeownership, offering flexibility and opportunities for those who may not meet the standard requirements of traditional mortgages.

3. Improve your odds of getting approved

Being self-employed may lead to higher mortgage costs due to perceived higher risk by lenders. The variable nature of self-employment income makes it challenging for lenders to assess consistent earnings compared to traditional employees. Consequently, they may charge higher interest rates or demand a larger down payment to mitigate potential risk. Moreover, self-employed individuals often face more stringent qualification criteria, which may require additional documentation to prove your income stability. 

The complexity of verifying self-employment income may also result in more involved underwriting processes, incurring higher fees. Despite these challenges, securing a mortgage as a self-employed individual is achievable, albeit with potential higher costs and additional considerations.

If you’re self-employed, you can make these several moves to enhance your chances of getting a home loan and locking in a rate that’s better for you:

Register and license your business

Registering and licensing your business not only establishes its legitimacy but also provides lenders with a sense of stability and credibility. This professional standing can boost your chances of securing a home loan at more favorable terms.

Opt for a W-2 wage

Paying yourself a W-2 wage rather than relying solely on the owner’s draws can provide consistent income documentation, making it easier for lenders to assess your financial stability and approve your mortgage application.

Lower your debt load

Reducing your overall debt burden improves your debt-to-income ratio, a crucial factor in mortgage approval. Lowering outstanding debts signals financial responsibility to lenders and enhances your eligibility for a more favorable loan.

Reduce tax deductions

While tax deductions are beneficial for reducing tax liabilities, they can impact your qualifying income for a mortgage. By strategically managing deductions, you can increase your income on paper and improve your chances of loan approval.

Maintain separate accounts

Keeping separate business and personal accounts allows for clearer financial records. This distinction enables lenders to assess your business income accurately and helps present a stronger case for mortgage approval.

Maintain good records

Meticulously maintaining financial records, such as using tools like QuickBooks, demonstrates your organized financial management. Having accurate profit and loss statements readily available can ease the underwriting process and enhance your mortgage application.

Consider a larger down payment 

Offering a larger down payment can reduce the perceived risk for lenders and potentially secure you a lower interest rate. Tapping into savings, such as an IRA or 401(k), may be an option to bolster your down payment.

Explore collaborations with another business

Partnering with a local credit union or mortgage company can provide unique opportunities for securing a mortgage. Building connections and leveraging business partnerships may lead to more favorable lending terms.

Keep an eye on your credit

Lenders carefully assess your credit history as an indicator of your ability to manage debt repayment. Your credit history, documented in your credit report, does not factor in your income; rather, it solely focuses on your credit-related activities. The higher your credit score, the better off you’ll be when applying for a mortgage. 

One key aspect that lenders take into account regarding your credit score is your credit utilization. This ratio quantifies the amount of available credit you utilize. For instance, if your credit limit is $10,000, and your current balance is $6,000, your credit utilization ratio is 60%. Similar to your DTI, a lower credit utilization ratio positively impacts your credit score, which ultimately enhances your mortgage application prospects.

The bottom line is

Securing a mortgage as a self-employed individual requires careful planning and consideration. Despite the unique challenges, achieving homeownership is possible. Maximize your chances of success by organizing financial records, understanding income stability, and improving your credit score. Explore various mortgage options like conventional loans, government-backed mortgages, bank statement loans, or co-signer loans. Keep personal and business finances separate, maintain accurate records, and consider collaborations with local credit unions or mortgage companies. With financial stability and perseverance, self-employed individuals can confidently enter the competitive housing market and realize their dream of homeownership.