How to Qualify for a Home Loan When Self-Employed

Kat Tretina

Updated On: June 1, 2022  •  3 Minute Read

Loans

If you want to maximize your earning potential, working for yourself is a smart strategy. According to Glassdoor, self-employed individuals earn $107,857 per year, on average. That income is more than double the national average for all occupations.

However, being your own boss has some downsides, especially if you plan on buying a house. Self-employed mortgage applicants may have a tougher time qualifying for a home loan, and there are more hoops you have to jump through.

Here’s what you need to know to buy a home when you’re self-employed.

The biggest problem for self-employed home-buyers

When you apply for a home loan, lenders review your application and look at different factors:

• Credit score: Your credit score is a three-digit number that tells creditors about your credit habits and payment history. The higher your credit score, the better. Not sure what your score is? CreditSoup allows you to check it for free

• Income: Lenders want to make sure you can comfortably afford your payments. In general, the home price should be no more than three to five times your income.

• Debt-to-income ratio: Your debt-to-income (DTI) ratio, or the amount of debt you have relative to your income, shows lenders how much breathing room you have in your budget. Lenders look for candidates who have a DTI under 43%. Use the DTI calculator.

• Down payment: While a down payment that is equal to 20% of the home’s purchase price is desired, it’s not necessary. You may be able to get a loan with a down payment of just 3.5%.

• Cash reserve: Banks don’t want you to wipe out your whole savings to buy a home; that leaves you at risk of falling behind on your payments if an unexpected expense comes up. Lenders usually want to see that you have at least two months’ worth of payments saved beyond the money you’ll need for the down payment and closing costs.

• Employment history: Lenders want to see borrowers with a steady employment history. With a stable career path, borrowers are more likely to keep up with their payments. For self-employed borrowers, employment history is often the hardest criteria to satisfy. Lenders view self-employment as more volatile than working for an established company.

How to qualify for a mortgage when self-employed

While getting approved for a home loan while self-employed can be more difficult, it can be done. To maximize your chances of qualifying for a loan, follow these five steps:

1. Save money for a down payment

With certain types of loans, such as a FHA mortgage, you can buy a home with just 3.5% down. However, when you’re self-employed, you can better your chances of getting a loan and securing a competitive interest rate by putting down a larger down payment. In general, aim to save at least 20% of your targeted home’s price to use as a down payment.

2. Wait until you’ve been in business for two years

Lenders are looking for stability. If you’ve recently started a business or just began freelancing, you’ll struggle to find a lender willing to work with you. There are some lenders that offer “no-document” or “alternative-document” mortgages, but those loans tend to have higher interest rates than traditional mortgages.

Instead, wait to start searching for your home until you have at least two years’ of self-employed tax returns completed.

3. Keep your personal and business finances separate

If you currently intermingle personal and business accounts, stop that bad habit right away. To prove your business’ security, banks will need to review your information. They will look to see how you manage your finances, and will expect you to have separate personal and business bank accounts.

4. Stay organized

When you apply for a mortgage, lenders will ask you for documentation. Unfortunately, you’ll probably need to show a lot more documentation than someone that is employed by a company. To prevent any hiccups, stay organized and be prepared to show the following:

• Your business license
• Your business’ articles of organization
• Letter from clients detailing your work for them
• Proof of business insurance
• Doing Business As (DBA) documents
• Employment Identification Number
• Profit and Loss statement
• Letter from your accountant

5. Talk to a mortgage lender

Once you’ve completed the above steps, you can move forward with the mortgage process. Talk directly with a bank or credit union about your options. In many cases, the lender will review your information and tell you what your chances are of qualifying for a loan at that point.

Ready to start the application process? You can apply for a home loan online.