Self-employed? 5 steps to help you get a mortgage
When you work for yourself, securing a home loan can require some extra effort.
If you are among the thousands of Americans who turned the dark cloud of the recession into a silver lining by becoming self-employed, you may think you are now in a position to refinance your mortgage or buy a home. Even with good credit and sufficient assets, though, you'll find that even the best mortgage lenders will require you to produce your tax returns and possibly a quarterly profit-and-loss statement to show that you have sufficient income to make your mortgage payments. (Bing: Download a blank mortgage application
Most applicants today are prepared to jump through a few hoops to qualify for a mortgage, but if you're self-employed you may have a few more hoops than some people. If you're new to self-employment, you will want to wait until you have two years of self-employed tax returns filed before applying for a new mortgage so your self-employment income will be included in your loan application.
All borrowers today need good credit, with a minimum score of 620 or 640 for a Federal Housing Administration loan (minimum score depends on the loan) and a score of 740 or higher to be offered the best mortgage rates for a conventional loan. Some lenders consider self-employment income a higher risk than regular paychecks, so a higher credit score can offset your potential risk factors and give a lender greater confidence when considering you for a loan. Check your credit report to see if you have negative information that can be corrected or improved before you apply.
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Low debt-to-income ratio
Lenders typically like to see an overall debt-to-income ratio of 41% or less, although borrowers with other compensating factors may qualify for a mortgage with a ratio as high as 45%. You can use a mortgage calculator to estimate your housing costs along with your other debt. Paying off some bills to reduce your debt-to-income ratio can be another compensating factor in your favor.
Many self-employed individuals reduce their income for tax purposes by deducting business expenses. Be aware that your income for a mortgage loan will come from your tax returns. So if your income is too low, you may qualify for a smaller mortgage amount than you thought. Your income will usually be the average of your two most recent tax returns. Even if you made more money this year than last year, it may not matter to your lender. Lenders often require a quarterly profit-and-loss statement in addition to your most recent tax returns. New rules from the FHA say that self-employed borrowers are required to prove their ongoing income in the form of a year-to-date profit-and-loss statement if more than one quarter has passed since the last tax return was filed.
If you are refinancing, your mortgage will be based on the amount of your home equity. If you, like many other homeowners, experienced declining home values in your area, you may want to consider a "cash-in" refinance. A cash-in refinance builds your home equity faster and, if you are underwater on your home loan, can bring you back above water. If you're buying a home, a bigger down payment can make it easier to qualify for a mortgage, since the loan amount will be smaller.
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The rules about how much you need to have in cash reserves vary from one lender to another and for different mortgage products, but you should have at least two months of housing payments (principal, interest, taxes and insurance) in the bank to protect yourself in an emergency. Lenders particularly need to know that self-employed borrowers, whose income often fluctuates more than regular employees, can handle their finances and have savings.
If you're compensated by comission, you'll have to follow these rules as well. New Realtors, Loan Officers, Car Salesman, Waiter, Bartender, etc. who get more than 25% of their income off of tips or comissions have to have the 2 years experience and documentation for the income to be considered stable.
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