Qualifying for a Self-Employed Mortgage

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Bills Bottom Line
If you are self-employed and want to qualify for a mortgage, then you will need to show the lender that you have an ongoing business with stable and sufficient income to pay back your mortgage. The lender will carefully review your tax returns. Consult with your CPA or certified tax preparer so you will be able to show the lender all the necessary documents.
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Self-Employed? Learn about Getting a Mortgage

Being self-employed has its benefits – you choose the hours and you are the boss. However, when it comes to getting a mortgage, you face more hurdles. You have to provide more paperwork than an employee and must work harder to prove that you can afford the mortgage.

If you are self-employed, it is important to understand:

  • Why it is harder for self-employed to get a mortgage
  • What a lender looks for in a self-employed applicant
  • Adjustments made to your income
Tip

Getting properly prepared to apply for a mortgage is good advice for every borrower. You need to work on improving your credit score, keeping a clean credit history, lowering your debt to income ratio, and saving money for a down payment. Make sure that you prepare to qualify for a mortgage. 

 

Self-employed: Harder to get a mortgage?  

It is harder for a self-employed borrower to get a mortgage. Not only do self-employed applicants have to provide more information and documents, but those documents are much harder to read and correctly interpret. Here are some of the reasons lenders have a harder time giving a self-employed applicant a mortgage:

  • Income is harder to predict
  • Business debt can also be a personal liability
  • Small businesses fail at a high rate
  • It is costlier and more difficult to underwrite the loan.

Lenders determine the income figure they will use, after reviewing your tax returns and financial statements. Your attempt to lower your taxes (less income and higher expenses) can definitely conflict with lender's debt-to-income requirements. You may only qualify for a smaller mortgage than you anticipated getting.

What is a Lender Looking for in a Self-employed Borrower?

In order to qualify for a mortgage. the most important factor you need to show the lender  is that you have the ability to make your monthly payments on time.

Here are some of the main issues a lender will look at when determining  if a self-employed borrower can afford to repay the loan:

  1. Income: Is your income stable? How likely is it to continue and at what levels? The lender will look to see if there are any significant changes, or gaps in your income history.
  2. Earnings: What are the trends and sources of your earnings? Keep in mind that lenders will look to see if there are any significant changes in your income. In general, they will not average your income over the last two year. Instead they will take the lower of the 2-year average or last-year income.
  3. Asset Liquidation: Lenders will look to see if you are liquidating any assets that might lower your income flow.
  4. Documentation: Lenders require more documentation including 2 years of signed federal tax returns and all applicable schedules.

Your Self-employed income: What counts?

While wag- earners rely on their monthly salary, self-employed borrowers rely on their cash flow. The businesses profit and loss depends on a number of expenses, some of which are bookkeeping expenses.

If you are self-employed and apply for a mortgage your lender will carefully examine your 1040 tax returns and the Schedule C attachment. The lender makes certain adjustments to your income and adds back these expenses to increase your income:

  • Depreciation
  • Depletion
  • Business Use of Home
  • Amortization/Casualty Loss

Any nonrecurring income that is not part of the regular business operations will be deducted from your income.

 A self-employed mortgage applicant should check with their accountant (or certified tax preparer) to get a full set of tax returns. Make sure that you understand the amount of income you have and the stability of recurring income.

Bills Action PlaBills Action Plann:

If you are self-employed and looking to buy a home or refinance a mortgage make sure that you:

  1. Save up funds and don't deplete business funds that may hurt your income.
  2. Work closely with your accountant to get together a complete package of two year income sheets.
  3. Work with the lender to get an estimate of your monthly income.
  4. Like any borrower work on improving your credit, lowering your debt load, and building up a strong down payment.
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