Many Americans believe that quitting their job and going to work for themselves is a major part of the American Dream, just as much as owning their own home. The good thing is that today, it is possible to be self-employed and own your own home with attractive stated income mortgage products becoming available this year.
Buying your house as a self-employed worker is very much like doing it as an employee for a company. You need to document your income and the amount of money you have in the bank. You will need to have a credit score, but you do not have to have perfect credit either. See bad credit mortgage options.
For most self-employed, it is the income area of the application where they can have problems. But if you learn a few things before you apply for a stated-income mortgage, you should not have a lot of trouble getting approved on a alternative document or a bank-statement mortgage.
Are Mortgage Rates Higher for Self Employed Borrowers?
If you can document your income with tax returns and the underwriter agrees that you mee the income requirements then no the mortgage rate will Not be higher. However, if you need a bank statement mortgage or some stated income program then you may end up with a higher interest rate. It’s important to note that the interest rate for a self-employed individual can align with or even be lower than that of a traditionally employed person. Key determinants of interest rates encompass your credit score, the down payment amount, and the mortgage duration.
Overview of Mortgage Application Process for Self-Employed
Before the housing downturn of 10 years ago, many self-employed borrowers had many loan options. The most common was essentially a stated income mortgage. This is where you did not have to show any pay stubs or tax returns. Most borrowers showed a year of bank statements and their credit score. Some borrowers did not even have to show any proof of their income. This was a true stated income mortgage.
The truth is that stated income mortgages were not always a bad thing. No income verification loans were really created for the self employed that had several businesses and complex tax returns. No-documentation home loans made the home loan process more streamlined for high earners. This cut the cost of issuing loans and boosted efficiency.
But the state income and no doc home loans were soon given out to regular consumers. So, it is not surprising that the system became abused. Low doc and stated income loans were eventually given out to artificially inflate the incomes of people with regular salaries. But this was not what the purpose of these self-employed home loans.
Today, there are few lenders that will give you a stated income or no income verification loan. You do not need to have a regular job or pay stubs, but you must be able to prove your income with tax returns and bank statements.
The Problem with Tax Returns
Some self-employed borrowers do not have the easiest time getting a loan with tax returns. Some of them may not show enough income on their tax returns because they write off many expenses. They could have an income of $150,000 per year, but after they write off their expenses, they are left with a taxable income of half that much.
The underwriter will only give you credit for $75,000 on paper even though it felt like you made a lot more than that. If you were to apply for a stated mortgage with a $2,000 per month payment, you may not be approved. The mortgage payment by itself would require 50% or so of your on paper income.
Self-employed borrowers also can have inconsistent income, because of fluctuations in their business or how much they take in write offs each year. Lenders often look for major fluctuations in your taxable income over the years and will usually use the lower of the most recent years.
If you have income that is lower last year, you may need to explain it to the lender. The underwriter has to verify if this was just a one time slow down and is not a sign of a reduced income trend in your business. Learn more about stated income loans for first time home buyers.
How Do Mortgage Lenders Evaluate Self-Employed Borrowers?
Lenders aim to observe a consistent or preferably growing income trend from self-employment. While traditional employees can substantiate regular income with paystubs and W-2s, self-employed individuals may need to provide alternative income records. These could encompass either two years of personal tax returns or a 24-month history of bank statements. Demonstrating a stable or increasing income over time is crucial for self-employed homebuyers, establishing their financial reliability and strengthening their eligibility for a mortgage. However, bank-statement loans, typically have a higher mortgage rate.
Mortgage lenders assess self-employed borrowers differently than those with traditional employment, recognizing the distinct nature of self-employment income. For self-employed individuals, lenders scrutinize tax returns and financial statements to determine income stability and viability. Two key documents, the profit and loss (P&L) statement and the Schedule C tax form, play pivotal roles in showcasing the business’s financial health. Lenders typically evaluate a borrower’s average income over a two-year period, emphasizing consistency and reliability.
Credit history is another critical factor; a strong credit profile enhances the borrower’s credibility. Lenders may also consider the business’s overall financial health, examining liquidity, outstanding debts, and the stability of income sources. Demonstrating financial responsibility and having a robust credit history can enhance the likelihood of approval for a mortgage. Engaging with lenders experienced in evaluating self-employed applicants can provide valuable insights and guidance through the mortgage application process, ensuring a thorough assessment of the borrower’s financial standing.
Plan Ahead for Your Mortgage
If you are a self-employed borrower, you should talk to a mortgage professional and an accountant about two years before you plan to apply. You should know how much income will be needed each month to get the kind of home you want. Unlike most salaried workers, you can change how much you make on paper each year by writing off more or less of your business expenses.
With proper planning, being self-employed will not hinder you to be approved for a home lone if you can show enough income to afford the mortgage and your other debts. You also need to have proof of being self employed for at least the last two years. Also, you should have two years of tax returns, year to date profit and loss document and a business license if applicable.
While you cannot get an irresponsible no income verification mortgage like you could ten years ago, getting approved for a stated-income loan with a self employed work history is really not that difficult.