The mortgage process was designed for traditionally employed borrowers, but that doesn’t mean you have to get a 9-to-5 job if you want to buy a new home. Self-employed people can qualify for mortgages, though it takes a bit more work. If you’re self-employed, don’t despair! Here are several ways you can prepare before applying for a mortgage.
Assess your finances – business AND personal
Every borrower should review their finances to determine if they’re capable of covering a mortgage and the associated expenses of owning a home. When it comes to self-employed borrowers, lenders will not only consider their personal income but also the state of their business.
That’s why it’s important for self-employed applicants to seriously consider whether their business is healthy enough to support the mortgage. Be honest and ask yourself the following:
- Do you have any existing business or personal debt? If so, how much?
- Does your business make enough income on a consistent basis to cover your debt payments, including a mortgage?
- Do you have at least two years of steady (or growing) income from your business?
- What monthly mortgage payment budget can your business support?
- How much can you comfortably afford to cover the down payment and closing costs?
Get your documentation in order
Self-employed applicants will need to provide different or additional documentation that traditionally employed borrowers don’t.
For your proof of income, you should be prepared to submit the following:
- Two years worth of personal tax returns
- Two years worth of business tax returns, including a Schedule C, K-1, 1120, or 1120S depending on your business structure
- Three – to six months of personal and business bank statements
- Year-to-date profit and loss (P&L) statement
- Balance sheet
You will also need to verify your self-employment as well. Most lenders require at least two years of consistent self-employment within the same industry. You can use the following documents to prove your employment history:
- Signed CPA statement
- Business license
- Proof of business insurance
- Letters from current clients
Some lenders may require additional documentation so check with your lender for specifics.
Check your credit score
It goes without saying, but a high credit score makes the qualification process easier. Higher credit scores signal to lenders that you’re more likely to meet your obligations and are a low-risk borrower.
Review your credit score and correct any mistakes as quickly as possible. Keep your credit score high by continuing to pay your bills, pay down your existing debt, and limit the amount of new debt. You’ll want to keep your credit utilization or debt-to-income (DTI) ratio low, especially in the six to 12 months before applying for a mortgage.
Keep tax deductions to a minimum
Many self-employed borrowers often reduce their taxable income by claiming as many deductions as possible. While it reduces your overall tax bill, it can be detrimental when it’s time to apply for a mortgage. Why? Too many deductions may cause you to have missed out on the required income threshold to qualify for a mortgage. It can also lead lenders to question whether you make enough to afford a new home. You should keep your tax deductions as low as possible for at least two years before you plan to apply for a mortgage.
Separate your personal and business expenses
If you run your own business, it’s best to keep your personal spending separate from your business spending. Lenders review your personal finances to rate your creditworthiness, so if you’re covering your business expenses with your personal money, then you’ll appear to have an artificially higher credit utilization than normal. Separating your finances (like checking, savings, and credit cards) will simplify your taxes, help you keep better track of the money coming and going from your business, and make you appear more legit.
Consider applying with a co-borrower
Self-employed applicants may be able to avoid some of the required documentation if they apply with a co-borrower that receives a traditional W-2 form. However, the co-borrower may need to show they’re able to comfortably afford all of the expenses. Talk with your lender to see which approach works best for your situation.
Make a larger higher down payment
While it’s possible to qualify for some mortgages with as little as 3%, having a higher down payment is beneficial in several ways. First, it reduces how risky you appear to lenders since you’re borrowing less and putting more equity into the home, your lender may reduce your interest rate with a higher down payment, and if you’re able to put down 20%, you can avoid the additional cost of private mortgage insurance. A higher down payment isn’t required
Homeownership is within reach even if you’re self-employed. When you’re ready to buy, we hope you’ll consider Discovery Homes. We build new homes throughout the Bay Area that are perfect for families of all sizes. Visit us online at DiscoveryHomes.com to learn more about our new home communities, view virtual tours, and more.