Navigating the Murky Waters of Mortgages for the Self-Employed

As a self-employed entrepreneur looking for a loan to finance a property, you may have quickly noticed that there are a bunch of hurdles you’ve got to jump over in order to get approved. While the mortgage process seems to be more geared towards traditional W-2 employed borrowers with regular paychecks, those who are self-employed need to do a lot more to butter up the lender.

Don’t sweat it – there’s no reason for you to have a mortgage application rejected if you’ve got all your ducks in a row and give lenders exactly what they’re looking for.

Good Credit Score

Your credit score is a crucial factor that lenders look at when approving someone for a mortgage, including the self-employed. If your score is 740 and up, you’ve got the best chances of getting approved for a mortgage, as well as being offered the lowest interest rates. On the other hand, if your score is 600 and under, your chances of landing a deal are slim. If you do get approved, the interest rate will be much higher.

Loan-to-Value Ratio

This fancy little number is simply the percentage of the loan you’re asking for in relation to the property’s value. The lower the number, the better. Lenders will see high loan-to-value (LTV) ratios as higher risk. If you are accepted for a mortgage, you’ll either be offered a higher interest rate, or you’ll have to buy mortgage insurance. If possible, put as much of a down payment as possible to keep this number low.

For instance, if you need a $250,000 loan to buy a home worth $300,000 (which means $50,000 was put down), your LTV would be 83.33%. On the other hand, if you only need a loan of $150,000, your LTV would be 50%, which is more desirable in the eyes of the lender.

Debt-to-Income Ratio

In addition to calculating how much your loan will be relative to the value of the home you plan on buying, lenders will also look at your debt-to-income ratio (DTI), which is your estimated monthly housing costs in addition to all your other monthly debt relative to your total income. Lenders will average out your net income from your most recent two tax returns and your year-to-date income and expenses.

Obviously, the more money you have leftover after paying all your debt – including your mortgage – the better to ensure your lender stamps your mortgage application as “approved.”

Last Three Years of Tax Returns

Since you don’t get a regular paycheck that comes along with a pay stub, your lender will have to look at some other documentation to make sure you’re actually earning a stable income. Usually, it’s the last three of years worth of tax returns that will need to be handed in for the lender to look over. If the loan is approved, your “monthly income” will be based on the average of these tax returns. This documentation will also provide proof to the lender that your business actually exists.

Many self-employed entrepreneurs might try to save a buck or two on the amount of taxes they pay by reporting a lower income every year. However, this plan can backfire when it comes time to approach a lender for a home loan, since it might look as if the income is not sufficient enough to keep up with mortgage payments.

Proof of Ongoing Expected Revenue

Even if you’ve got a million bucks in the bank and a killer credit score, you could still be denied a mortgage if your business doesn’t have a quantifiable income. Lenders will want some sort of proof that your business is bringing in the bacon, rather than slowly whittling away. One of the more popular ways lenders can get this information is from a profit-and-loss statement from your accountant. A declining or unstable income can prevent self-employed borrowers from qualifying for a mortgage.

The Bottom Line

Yes, it’s true – the self-employed might have to go through a few more hoops to get approved for a mortgage compared to the average borrower. But if you have a healthy credit score, a good chunk of change in the bank for a down payment, and your business is making money year after year, there should be little to stand in the way of getting a home loan.