Being self-employed doesn’t have to be a barrier to get a home loan. Today, there are many options available to you including government-backed and conventional loans. You don’t have to pay higher interest rates or put more money down on the home either. You can get a loan just like anyone else as long as you have good qualifying factors.
Your Loan Options
As a self-employed borrower, you have the same loan options as everyone else provided that you can document your income and assets. Now, if you have trouble documenting your income for some reason or you take too many deductions on your taxes, you may have to take an alternative documentation loan. This isn’t a bad thing, though. We’ll discuss this below.
For now, let’s look at your conventional, VA, FHA, or USDA loan options. Every loan program welcomes self-employed borrowers. You just have to have ample proof of your income. Because you work for yourself, this means tax returns for the last two years. These tax returns must show sufficient income to cover the mortgage and your existing bills. This means your adjusted gross income, not the income before any deductions you take.
What if you don’t have two years of self-employed income? Don’t worry – most lenders don’t require that any longer. But, they do require a history of you being in the same industry. As long as you go from working for someone to owning your own business in the same industry, you’ll prove you have the experience to make it. If you enter a completely different industry, you may be held to the two-year rule.
If you can’t prove that income or consistency, an alternative documentation loan may be in order.
The Alternative Documentation Loan for the Self-Employed
What used to be known as the ‘subprime’ loan, is now the alternative documentation loan. It has the same rules and pretty much looks the same as the subprime loans. But, because of the housing crisis, subprime has gotten a bad rap, which prompted lenders to slightly change its name.
With the alternative documentation loan, you can prove your income in a different way. For example, rather than providing tax returns, you can provide 12 months of bank statements. On those bank statements, you must be able to show consistent income. This is what the lender is after – they need to know that you can afford the loan.
This is a good alternative for the self-employed that take a large number of deductions on their tax returns. Rather than avoiding the deductions, you can prove your income with the bank statements. Most lenders take the bank statement income at face value. However, if they see many withdrawals for consistent expenses, they may deduct those amounts from your total income.
Qualifying as a Self-Employed Borrower
Because you are self-employed, you do pose a slightly higher risk. This may mean you’ll have to have a higher credit score or more liquid assets. Basically, you need something that offsets the risk of being self-employed. The lender needs reassurance that you can afford to pay the loan.
A good credit score is a great start. It shows the lender that you have financial responsibility. That’s all that they want to see. They are about to give you a very large loan that they hope you will pay back. With a high credit score, the likelihood of you paying the loan back is much more likely than if you had a low credit score.
Aside from a good credit score, you can also prove to the lender that you have reserves. This is money you have set aside in a liquid investment that you could use to pay your mortgage should your income stop. This gives the lender reassurance that you’ll pay your debts no matter what happens moving forward.
Finally, a low debt ratio can help your case as well. Showing a lender that you are not overextended in debt can help them see that you are financially responsible. They don’t want to take a chance on someone that already has numerous debts outstanding. If the going gets tough, they won’t know who you will pay. Hopefully it would be your mortgage since that is where you live, but you never know. Having a low debt ratio can eliminate this worry from the lender’s mind.
There are many options available to the self-employed borrower whether as a government-backed or conventional program. You can even go alternative if you need to, just be prepared to pay a slightly higher interest rate. Either way, you will have a loan to help you buy or refinance a home as long as you have the qualifying factors that the lender requires.