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.
- Getting a loan while self-employed may require paying higher interest rates, as lenders look to compensate for the lack of verifiable, steady income.
- Problems that self-employed individuals run into when trying to get a loan is that they use business expenses to reduce taxable income.
- Stated income/stated asset mortgages are loans based on what a borrower claims as their income. SISA lenders won’t verify the amount of income but may verify the source.
- With no documentation loans, lenders don’t verify any income information, but the interest rate is usually higher than other types of mortgages.
- Self-employed borrowers can improve their prospects by increasing their credit score, offering a larger down payment, or paying down debt, among others.
Getting a Mortgage While Self-Employed
Lenders generally don't see the self-employed as ideal borrowers. Self-employed borrowers can 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.
Because self-employed borrowers are less attractive candidates, they have a reduced ability to shop around and negotiate lower interest rates. More work is also required to find lenders who are willing to work with those that are self-employed.
Another problem self-employed borrowers encounter is that they tend to use a lot of business expenses to reduce taxable income on tax returns, forcing lenders to wonder if the borrower makes enough money to afford a home. Finally, banks may want to see a lower loan-to-value ratio (LTV ratio), meaning the borrower will need to come up with a larger down payment.
Fully documenting income via prior years' tax returns and financial statements increases the chances of a self-employed individual being approved for a mortgage.
Self-Employed 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. However, some lenders still offer loans that might be a fit for those that are self-employed.
Stated Income/Stated Asset Mortgage (SISA)
A stated income/stated asset mortgage (SISA) is based on what a borrower tells the bank their 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 a no doc mortgage, 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 riskier 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.
Become an Attractive Candidate
For a borrower that knows they can make the payments, they can do some of the following things to improve their chances of getting a loan.
Max out the Credit Score
In any type of borrowing situation, a higher credit score will make a borrower a more attractive candidate to get the loan in the first place and qualify for lower interest rates.
Offer a Large Down Payment
The higher the equity in the home, the less likely a borrower is to walk away from it during times of financial strain. Therefore, the bank will see the borrower as less of a risk if they put a lot of cash into the purchase up front.
Have Significant Cash Reserves
In addition to a large down payment, having plenty of money in an emergency fund shows lenders that even if the business takes a nosedive, the borrower will be able to keep making monthly payments.
Pay Off All 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.
Establish a Self-Employment Track Record
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.
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.
The Bottom Line
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, for those that are self-employed, they're already used to having to work extra hard to file additional tax forms, secure business licenses, get new clients, and keep the business running. Armed with a little knowledge and patience, those that are self-employed can get a mortgage.