Is it difficult for the self-employed to get a mortgage?
Many people dream of being their own boss. And for good reason, several studies establish a link between self-employment and greater job satisfaction and better physical well-being.
In July 2022, 16.4 million out of 158.1 million Americans were self-employed, representing 10% of the workforce, according to the US Bureau of Labor Statistics. And that percentage is likely to rise as self-employment among Americans has increased over the past decade.
However, self-employment is not without difficulties. Getting loans can be difficult, especially home loans. However, this should not deter self-employed mortgage seekers. Getting a loan can seem daunting, but it’s easier than ever for self-employed people to find mortgages with competitive rates and customizable options.
Here are some steps self-employed people can take to find suitable mortgages.
After: Looking to buy soon? Prepare to get your offer on a home accepted by getting pre-approved for a mortgage before your home search.
Find a lender specializing in self-employment income
With a stable job and a W-2, it is not difficult to qualify for loans, provided the borrower meets income and credit requirements.
Self-employed people may have more difficulty due to the variability of their income.
Using a lender familiar with self-employment is the number one factor in finding a suitable loan, John Ammar, senior executive loan consultant for Caliber Home Loans, said in an interview. Caliber Loans is a direct lender specializing in self-employment income.
“Finding a competent lender to handle self-employment income is probably the most critical thing,” Ammar said. “There are so many things that come into play when it comes to your income, whether or not you provide positive or negative income on tax returns.”
Start here:Check your self-employed mortgage eligibility
Obtain a conventional loan
Self-employed borrowers can get conventional loans with the lowest rates when the adjusted gross income (AGI) on their federal tax return meets the lender’s requirements. Mortgage lenders like Caliber qualify borrowers for loans based on their AGI.
But with the prevalence of business deductions, many borrowers will not show a high AGI.
“What your bank statements show and what your tax return shows is going to be very different for people claiming small business exemptions on their tax return,” Ammar said. “It’s not what you bring into the bank account, it’s what you file and pay taxes, and that’s why taxable income is what we use to qualify borrowers for our self-employment loans. .”
Self-employed people with higher taxable income are eligible for conventional loans, provided they have a well-established history of self-employment income. For W-2 employees, lenders can look at past three months’ income to assess a borrower’s credit risk. On the other hand, for the independents, they go back much further.
“We average your income over two years to qualify you for your purchase,” Ammar said. “If you’ve been self-employed for seven years, you only have to submit one year of tax returns.”
Seek non-traditional financing
To benefit from the lower rates, some self-employed workers could increase their taxable income by refusing the available deductions. But these deductions help many businesses grow efficiently, so leaving that money on the table can hinder small business growth.
Instead, entrepreneurs can leverage unconventional lending options to secure a mortgage.
Self-employed people can get mortgages based on cash flow instead of AGI on their tax returns, Ray Williams, president of Mortgage Maestro Group, said in an interview. Williams said her company routinely finds loans for the self-employed with payments that are several times their taxable income.
Generally, small business owners can use bank statements to prove their income. Others might use 1099 forms, profit and loss statements, or other business documents to prove what Williams called “verified income.”
Pay higher rates
Granted, there’s a trade-off with bank statement mortgages: you don’t have to give up lucrative tax deductions, but you’ll pay higher rates.
“The tax code is written to reduce what we pay to the IRS, not increase it,” Williams said. “Business owners are not doing anything wrong using the tax code, but they are being penalized by the traditional mortgage industry for buying a home.”
But pricing isn’t everything, and as Wiliams points out, this trade-off makes sense for many entrepreneurs.
“You might pay a higher interest rate for a fix, but it allows you to continue running your business the way you always have,” Williams said.
But is paying that higher interest rate worth it?
“For many business owners, it comes down to determination,” Williams said. “Am I putting money into marketing, growing, and hiring someone? Or do I claim the income, forgo deductions, pay lots of money to the IRS in taxes and not growing my business?”
And even when self-employed borrowers pay a higher rate, they may not be paying as much as they think.
“Those who use these programs understand one thing: higher interest rates mean bigger mortgage deductions,” Williams said.
Business owners can also deduct certain other housing expenses when using their home for business purposes.
After:Check your self-employed mortgage options
Keep your debt low
So how much revenue do lenders want to see? As with other mortgages, it depends on the borrower’s recurring monthly debt payments (credit cards, car payments, and house payments) that show up on the borrower’s credit report.
“You definitely want to keep your monthly debt-to-income ratio below 45%, ideally below 40%,” Caliber’s Ammar said. Lenders are more likely to approve mortgage applications within those ranges, he said.
So, if a self-employed person earns $5,000 in monthly income, lenders would like their total monthly debt payments to be less than $2,000 per month.
Low personal debt can help self-employed borrowers qualify for higher monthly mortgage payments.
Hire a mortgage broker
Finding a broker that specializes in self-employed mortgages can also be a big plus when comparing different types of loans. By using a broker, borrowers typically only need to complete one loan application for multiple options, making it easier to select an optimal solution.
Mortgage brokers can increase the closing costs of a loan if they take a commission from the borrower at closing. However, many brokers can access wholesale lending products, which may have lower rates than those offered by retail lenders.
For the self-employed, a broker who understands business ownership is ideal. Self-employed people should seek “a qualified professional who understands business, taxes and cash flow” in addition to mortgage-related topics, said Mr. Williams of Mortgage Maestro.
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