While getting a mortgage as a W-2 employee may be easier than if you're self-employed, you don't have to go running back to your cubicle to qualify for one. 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 steps you can take to make yourself a more attractive loan candidate.

Key Takeaways

  • Self-employed borrowers can improve their prospects by increasing their credit score, offering a larger down payment, or paying down debt, among others. 
  • Problems that self-employed individuals run into when trying to get a loan is that they use business expenses to reduce taxable income. 
  • Conventional loans, FHA loans, and bank statement loans are among the mortgage options for the self-employed.
  • It's also possible to take out a joint mortgage or enlist a cosigner.

Disadvantages of Getting a Mortgage While Self-Employed

Lenders don't always see the self-employed as ideal borrowers. Borrowers who are employees can be considered to be particularly creditworthy because of their steady, easily verifiable incomes, especially if they also have excellent credit scores. Self-employed borrowers will have to provide more paperwork to document income when compared to traditional employees who can produce a W-2.

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 (LTV) ratio, meaning the borrower will need to come up with a larger down payment.

Due to the economic fallout caused by the COVID-19 pandemic, many lenders are requiring higher credit scores, larger down payments and more documentation to approve mortgages and other loans. This applies to all borrowers, not just the self-employed, and requirements vary depending on the
lender. 

Become an Attractive Candidate

Borrowers who know they can make the payments can do some or all of the following to improve their chances of getting a loan:

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. You should have at least two years of self-employment history. The longer the better as this shows that your income is stable. 

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. A 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.

Provide documentation

Being willing and ready 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. Your lender may also ask for some or all of the following:

  • List of debts and monthly payments
  • Bank statements  
  • List of assets (savings accounts, investment accounts, etc.)
  • Additional sources of income (alimony, Social Security, etc.)
  • Proof of your business or employment (business license, letters
    from clients, statement from your accountant, etc.)

Self-employed borrowers fill out the same loan application as everyone else.

Self-Employed Mortgage Options

If you are self-employed and don't qualify for a conventional mortgage, some lenders still offer loans that might be a fit. Conventional mortgages are not guaranteed by the federal government, so they typically have stricter lending requirements. Here are some other options:

FHA loan

A Federal Housing Administration (FHA) loan is a mortgage that is insured by the Federal Housing Administration (FHA) and issued by an FHA-approved lender. FHA loans are designed for low-to-moderate-income borrowers. They require a lower minimum down payment—as low as 3.5%—and lower credit scores than many conventional loans.

Because FHA loans are federally insured—which means that lenders are protected in the event that a borrower defaults on their mortgage—these lenders can offer more favorable terms to borrowers who might not otherwise qualify for a home loan, including lower interest rates. This means it's also easier to qualify for an FHA loan than for a conventional loan.

Bank statement loan

Bank statement loans, also known as alternative document loans, allow borrowers to apply for a loan without submitting the traditional documents that prove income, such as tax returns and W-2s. Instead, lenders look at 12 to 24 months of your bank statements to determine your
business income. This type of loan may make sense if you don't have income tax returns or others ways to verify your income.

The interest rates on bank statement loans tend to be higher, as the lender is taking on more risk. 

Joint mortgage

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.

Enlist a co-signer

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.

The Bottom Line

If a W-2 employee loses a job, their 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, self-employed individuals are 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, they can also find ways to qualify for a mortgage.