It can be a tricky and tough business to secure a home mortgage loan as a self-employed borrower. Most banks and lenders do not fully understand or fathom how self-employed individuals make a living.
Undoubtedly, being self-employed has its pros and cons. And among the disadvantages is the difficulty of getting a mortgage loan compared to the normal wage earner. For a little help, here’s how self-employed borrowers can apply for a home mortgage loan.
How a W-2 employee obtains a mortgage is exactly the same for a self-employed. Once you’ve found the best property through a real estate agent, you will then need to get pre-qualified for a home loan, acquire a rate quote, provide documentation, fill out an application, and lastly, sign paperwork.
A loan officer or realtor can assist you with all the things that cover the pre-qualification process. The qualification or requirements of a bank with regards to debt to income ratio, credit score, and down payment for self-employed borrowers is the same for W-2 employees.
With these in mind, why is it more challenging for self-employed borrowers? Well, the answer to the question rests on your proof of income. W-2 employees can provide paychecks. However, self-employed individuals are required to provide their whole 1040 tax returns, plus all schedules.
If you own a business, you perhaps know one of the perks of being self-employed is the capability to remove or weed out other expenses. By that, we mean, your overall net income is a lot lower after writing off your expenses, making it more difficult to be eligible for a mortgage except if you increase the down payment size or lower the loan amount.
Most creditors want a borrower’s debt to income ratio (DTI) to be between 31% and 43%. Additionally, the exact number will rely upon different factors, for example, your loan to value and credit score.
From the perspective of the lenders, among the things you need to consider is if your business is steadily declining or thriving. And to determine this, lenders will make use of the Form 1088 to measure the differences of your business every year.
Then, they will study the K-1 income to make borrowers eligible through cash distributions for the previous years. So, if the income does not fluctuate very much and is consistent, no further assessment is needed.
Self-employed borrowers might have a hard time getting a home loan due to the subprime mortgage crisis. Banks recede from high-risks investments to secure and safeguard their reputations and financial interests.
Even so, some creditors still offer different home loan options that could be perfect for the self-employed borrowers.
No Doc Mortgage
In this home loan option, lenders won’t verify or validate any of your income info. Thus, it might be the best option for you, especially if your tax returns manifest a very low profit or business loss.
Since it is riskier and more dangerous for the bank to lend cash to those with unverified incomes, it is likely that your mortgage interest rate will be higher in a no doc mortgage. This type of loan is also called Alt-A mortgage, which falls between subprime and prime loans with regards to the interest rates.
Stated Asset Mortgage
This type of loan is based on what income information a borrower tells the bank, though the bank won’t seek to validate the amount. Stated asset mortgages are often called low doc loans because lenders won’t confirm how much money you make. However, they might want to know the sources of your income.
That said, be ready to hand out a list of your sources of cash flow or recent clients. Also, banks might want you to provide an IRS Form 8821 or 4506.
Another great way to obtain a mortgage loan is to get a co-signer. It could be your relative, close friend, or a parent. This option is also applicable to young adults without a credit history looking for loans. But remember that this individual should be willing and can take full responsibility for the mortgage when you fail to make payments.
Take note that it can be relatively straightforward and simple to get into trouble with no- and low-doc loans since it is easy to falsify numbers. However, keep in mind that you will be the one to suffer the repercussions.
That said, it is wise if you make yourself an attractive candidate to banks and lenders. You can do that by offering a large down payment, maxing out the credit score, having an emergency fund, providing documentation, establishing a successful self-employment track record, and paying off all your debt.
Moreover, you need to work hard to get new clients, secure business licenses, and file additional tax forms to keep your business running. With patience and a little knowledge, self-employed borrowers can undoubtedly get a mortgage.