Your office might be a built-in desk in the corner of a spare bedroom, a downtown co-working space — or the front seat of your pickup. The Bureau of Labor Statistics reports there are 15 million self-employed workers in America living the dream, being their own boss. Sure, it can be a struggle, but there is great satisfaction in seeing your very own business grow from a sketch on paper to profitability.
Until you try to get a home loan. Self-employed people have to work harder to score a mortgage. Here’s how to crack the code on getting the credit you deserve.
Documentation is the difference
For the self-employed, the actual loan process is the same as for others, says Jason van den Brand, co-founder and CEO of online mortgage company Lenda.
"You're still going to start with a rate quote, you're still going to fill out an application, you're still going to sign paperwork, and you're still going to be required to provide documentation," he says.
Down payment, debt-to-income and credit requirements are the same, but, van den Brand says, the difference in documentation requirements is significant. While employed applicants provide W-2 forms as proof of income, self-employed borrowers will need to show their 1040 tax returns, including all schedules.
“If you’re self-employed, you have to acknowledge that the reality is you’re starting at a disadvantage.”
Mazyar M. Hedayat, Real estate attorney
"That's where it gets tricky," van den Brand says. Typically, self-employed tax filers write off a bunch of expenses that W-2 employees can't. "And so their actual net income after all the write-offs actually is a lot lower than it would be otherwise."
That makes it harder to qualify for a mortgage, because it hurts your debt-to-income ratio. The key is to show a net income, after write-offs, that meets the debt-to-income ratio that lenders prefer, usually ranging from 36% to 43%.
You may pay more for your mortgage
Because some lenders consider self-employed applicants to be higher-risk borrowers, you may pay more for your mortgage, says Mazyar M. Hedayat, a real estate attorney and former title company owner in Romeoville, Illinois.
"If you're a self-employed borrower, you have to make a decision," Hedayat says. "Are you prepared to pay a little extra for the money, in a slightly higher interest rate? My answer to that is that it usually is worthwhile because good credit leads to good credit." With a solid payment history, you might be able to refinance at a lower rate later.
Improve your odds of being approved
Hedayat and van den Brand say that if you’re self-employed, you can make several moves to enhance your chances of getting a home loan:
Register and license your business.
Pay yourself a W-2 wage rather than an owner’s draw.
Lower your debt load.
Reduce your tax deductions.
Keep separate business and personal accounts.
Maintain good records. Van den Brand suggests using tools like QuickBooks to help track and classify income and expenses — and to generate a profit and loss statement, which lenders often require from sole proprietors.
Consider making a larger down payment, perhaps by tapping your IRA or 401(k).
Consider working with another small business, such as a local credit union or mortgage company, Hedayat says. That's where you could benefit from a factor rarely in play in lending today: a relationship.
It’s not impossible
"If you're self-employed, you have to acknowledge that the reality is you're starting at a disadvantage,” Hedayat says. “It's part of the price you pay for calling your own shots, for being your own boss."
Getting approved for a mortgage may be a hard task, but it’s not impossible. In fact, van den Brand says that in an average month, 22% to 24% of the mortgage loans Lenda makes are to self-employed borrowers.