While getting a loan as a W-2 employee may be cheaper and easier than if you're self-employed, you don't have to go running back to your cubicle to qualify for a mortgage. Some lenders may be concerned that you won't earn a steady enough income to make your monthly payments, and others may simply not want to deal with the additional paperwork that can be involved in providing a mortgage to a self-employed person. But don't worry; if you're self-employed, there are mortgage products available as well as steps you can take to make yourself a more attractive loan candidate.

What to Expect

As someone who is self-employed, lenders may not see you as the ideal borrower. Expect to pay higher interest rates than the ones commonly advertised on mortgage websites; those rates are for prime borrowers, or borrowers who are considered to be particularly creditworthy because of their steady, verifiable incomes and excellent credit scores. Similarly, because you may be a less attractive candidate, you might have a reduced ability to shop around and negotiate a lower interest rate. You may also have to put more work into finding lenders who are willing to work with you in the first place. (For more, see The Importance Of Your Credit Rating.)

Another problem you may encounter is that if you've used lots of business expenses to reduce your taxable income on your tax returns, lenders may wonder if you make enough money to afford a home. Finally, banks may want to see a lower loan-to-value ratio (LTV ratio), meaning that you'll need to come up with a larger down payment.

Mortgage Options
Due to the subprime mortgage crisis, it may become more difficult for the self-employed to obtain mortgages as banks shy away from riskier investments to protect their financial interests and their reputations. (To find out more, see Who Is To Blame For The Subprime Crisis? and The Fuel That Fed The Subprime Meltdown.)

However, some lenders may still be willing to give you one of the following types of loans.

  • Stated Income/Stated Asset Mortgage (SISA)
    This type of mortgage i
    s based on what you tell the bank your income is; the bank will not seek to verify this amount. Stated income loans are sometimes also called low-documentation loans; this is because while lenders will not verify how much you make, they may seek to verify the sources of your income. Be prepared to provide a list of your recent clients and any other sources of cash flow, such as income-producing investments. The bank may also want you to submit an IRS Form 4506 or 8821. Form 4506 is used to request a copy of your tax return directly from the IRS, thus preventing you from submitting falsified returns to the mortgage company, and costs $39 per return. But you may be able to request Form 4506-T for free. Form 8821 authorizes your lender to go to any IRS office and examine the forms you designate for the years you specify. This service is free.
  • No Documentation Loan
    In this type of loan, the lender will not seek to verify any of your income information. This may be a good option if your tax returns show a business loss or a very low profit. Because it is riskier for the bank to lend money to someone with an unverified income, expect your mortgage interest rate to be higher with either of these types of loans than with a full-documentation loan. Low and no documentation loans are called Alt-A mortgages, and they fall between prime and subprime loans in terms of interest rates. For lenders, they are considered more risky than prime loans, but less risky than subprime loans.

While many self-employed individuals and couples may choose one of the above options due to the difficulty of sufficiently documenting their incomes, those who can prove their incomes and who are willing to submit the extra paperwork can still apply for full-documentation loans, which will have lower interest rates than their low- and no-doc cousins. While a traditional employee might simply need to provide copies of W-2s for the last two years, because self-employed individuals do not receive this document, they may need to provide information about their businesses, such as previous years' tax returns, a current business license, a signed statement from an accountant, profit and loss statements, and balance sheets.

Getting a joint mortgage with a co-borrower who is a W-2 employee, such as a significant other, spouse, or trusted friend, is another way to improve your prospects of getting approved for a mortgage if you are self-employed. This provides more assurance to your lender that there is a steady income to pay back the debt.

Finally, a parent or other relative might be willing to cosign your mortgage loan. Keep in mind that this person will need to be willing and able to assume full responsibility for the loan if you default.

Can You Really Afford It?
It can be easy to get into trouble with low- and no-documentation loans because it's easy to fudge the numbers. Realize that you, not the bank, know best about whether you can really afford the loan, and that you will be the one who truly suffers if you lose your home. Learn from the experiences of all the subprime borrowers who have gone into foreclosure and don't get in over your head. (For more insight, read Mortgages: How Much Can You Afford?)


Make Yourself an Attractive Candidate
If you know you can make the payments, you can do some of the following things to improve your chances of getting a loan.

  1. Max Out Your Credit Score
    In any type of borrowing situation, a higher credit score will make you a more attractive candidate to get the loan in the first place and to qualify for lower interest rates if you're approved. (For more insight, read Five Keys To Unlocking A Better Credit Score.)

  2. Offer a Large Down Payment
    The higher your equity in the home, the less likely you are to walk away from it in times of financial strain. Therefore, the bank will see you as less of a risk if you put lots of cash into your purchase up front.

  3. Have Significant Cash Reserves
    In addition to a large down payment, having plenty of money in an emergency fund shows lenders that even if your business takes a nosedive, you'll be able to keep making your monthly payments. (Find out how in Build Yourself An Emergency Fund.)

  4. Pay Off All Your Consumer Debt
    The fewer monthly debt payments you have going into the mortgage process, the easier it will be for you to make your mortgage payments. If you pay off your credit cards and car loans, you may even qualify for a higher loan amount because you'll have more cash flow. (Check out, Digging Out Of Personal Debt.)

  5. Have an Established Track Record of Self-Employment
    If you can show that you know how to play the self-employment game and win, lenders will be more willing to take a chance on you. Some advice suggests that you should have at least two years of self-employment history; other advice, however, says that when interest rates are low, you should try to get a mortgage as soon as you're ready, even if you don't have a long history of successful self-employment.

  6. Be Willing to Provide Documentation
    Being willing to fully document your income through previous years' tax returns, profit and loss statements, balance sheets and the like will increase your chances of qualifying for a loan.

Conclusion
If a W-2 employee loses his or her job, the person's income will drop to zero in the blink of an eye in the absence of unemployment insurance benefits; those who are self-employed often have multiple clients and are unlikely to lose all of them at once, giving them more job security than is commonly perceived. Of course, if you're self-employed, you're already used to having to work extra hard to file additional tax forms, secure business licenses, get new clients and keep your business running. Don't let anyone tell you that you'll never get a mortgage if you're self-employed, or that you shouldn't quit your day job to pursue your dream of running your own business until you've already purchased a home. Armed with a little knowledge and patience, you'll be able to have your own home and work in it, too.

Related Articles
  1. Retirement

    Roth IRAs Tutorial

    This comprehensive guide goes through what a Roth IRA is and how to set one up, contribute to it and withdraw from it.
  2. Home & Auto

    Don't Be the Victim of Auto Loan Rip-Offs

    Subprime auto loans – and 60-day delinquencies – are up. These 4 signs of predatory auto loans can tip you off before you're caught in one.
  3. Retirement

    Best Mortgage Companies Friendly to Retirees

    If you’re no longer in the workforce and need a loan to buy a home, which companies are the most welcoming? Plus, good news about qualifying for a loan.
  4. Credit & Loans

    Don't Get Overcharged for Your Mortgage

    Don't pay more for a mortgage than necessary. Here’s a quick look at the different categories and how to be sure you're getting the best deal.
  5. Credit & Loans

    What is an Alt-A Mortgage?

    Called "liar loans" for their low documentation requirements, Alt-A mortgages were hot until the subprime crisis. Now Wall Street wants to bring them back.
  6. Home & Auto

    Rent-To-Own Homes: How The Process Works

    A rent-to-own agreement can benefit homebuyers with bad credit or insufficient funds for a down payment. Here’s how one works.
  7. Options & Futures

    What Does Quadruple Witching Mean?

    In a financial context, quadruple witching refers to the day on which contracts for stock index futures, index options, and single stock futures expire.
  8. Credit & Loans

    10 Reasons To Use Your Credit Card

    There are several benefits to paying with credit instead of debit, if you use a credit card responsibly.
  9. Home & Auto

    7 Must-Have Real Estate Contract Conditions

    Buying a home can bury you in paperwork. But it’s worth your time to make sure your contract contains these seven important conditions.
  10. Credit & Loans

    5 Extreme Ways To Raise Your Credit Score

    Desperate to rebuild your credit score because you can’t obtain a loan with a decent interest rate? Here are some extreme options to try.
RELATED FAQS
  1. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  2. What is after-hours trading? Am I able to trade at this time?

    After-hours trading (AHT) refers to the buying and selling of securities on major exchanges outside of specified regular ... Read Full Answer >>
  3. How can you pay your Walmart credit card?

    Holders of Walmart credit cards can make payments on their balances due by mail, online or at Walmart and Sam's Club stores. ... Read Full Answer >>
  4. Do FHA loans require escrow accounts?

    Federal Housing Administration (FHA) loans require escrow accounts for property taxes, homeowners insurance and mortgage ... Read Full Answer >>
  5. How many free credit reports can you get per year?

    Individuals with valid Social Security numbers are permitted to receive up to three credit reports every 12 months rather ... Read Full Answer >>
  6. Do FHA loans have prepayment penalties?

    Unlike subprime mortgages issued by some conventional commercial lenders, Federal Housing Administration (FHA) loans do not ... Read Full Answer >>
Hot Definitions
  1. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  2. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  3. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  4. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  5. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  6. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
Trading Center