Derby Advisors Explains How to Get a Mortgage When Self Employed

With over 15 million Americans currently consider themselves to be self-employed, many workers are making the move from having a standard wage or salary job to working as an entrepreneur or business owner. While there is an undeniable sense of satisfaction that comes with working for one’s self, being self-employed can make the process of buying a home quite a challenge. If you’re self-employed and hoping to buy a home, you’ll need to take a few extra steps to make yourself and your finances more attractive to lenders. Read on for seven things to keep in mind when applying for a mortgage.

1. Gather Your Paperwork

Applying for a mortgage requires a significant amount of paperwork and documentation. For individuals that are self-employed, this process can be even more tedious. When filing paperwork, be sure to include two or more years of tax returns to prove consistent income. This is especially true for workers that receive commissions and bonuses.

Though keeping up with documentation can be burdensome, it is a necessary step for entrepreneurs and small business owners that are hoping to be approved for a mortgage. When providing documentation for your application, be sure to also include a list of liabilities and assets, profit and loss statements, as well as a 1099 form. Additionally, having a signed letter from an accountant confirming your business is still operational is also beneficial.

2. Lower Your Risk

The reason many self-employed borrowers experience difficulty when applying for a mortgage is that applicants that are self-employed are high-risk borrowers. By taking steps to lower your risk, you’ll make your application more appealing to lenders, as they appreciate applicants that have consistent cash reserves as well as a steady income. In addition to proof of income, applicants can reduce risk by showing they have a stable emergency fund that they can draw on during low-income months.

3. Don’t Assume the Approval Process is More Challenging

Though many self-employed workers already believe their chances of being approved for a mortgage are lower than the average applicant, this isn’t always the case. When applying for a mortgage while self-employed, you'll essentially follow the same process as anyone else with a salary or wage. While self-employed applicants have to provide a bit more documentation to prove their income, this is the same process that all applicants must undergo.

All self-employed applicants must understand that their net revenue or income should be used in the application rather than their gross revenue or income. Experts like Derby Advisors share that an applicant’s monthly income is typically derived from their two-year average.

4. Keep Business and Personal Information Separate

As you prepare to apply for a mortgage, be sure to avoid mixing your personal information with your business paperwork. Small business owners and entrepreneurs should never confuse their personal purchases with expenses for their companies as this can negatively affect their credit score. Moreover, doing so will make the process of establishing profit and loss for their business more challenging.

Avoid any confusion by opening a bank account solely for your business expenses. When the time comes to apply for a mortgage, you’ll be able to better establish proof of income while making sure your credit score isn’t ruined.

5. Focus on Building Stable Credit

While separating your professional and personal expenses will help to keep your credit score higher, it’s also important to consider other ways to boost your credit score before applying for a mortgage. As the interest rate for your mortgage will be based on the credit score, it’s essential to prioritize improving your score. Applicants with the highest credit scores will qualify for the lowest mortgage rates, resulting in you saving several thousand dollars throughout the life of the loan.

Start improving your score by fixing reporting errors on your credit reports. As creditors prefer scores of 620 or higher, borrowers should aim high. While borrowers can qualify with lower scores, self-employed applicants are more likely to be approved for a mortgage with a lower interest rate if they start the application process with a higher score. To improve your score, work with your lenders to consolidate high-interest debt or have them lower the credit utilization rate.

In order to guarantee a smooth application process, it’s best to start improving your credit score months in advance. This way, you'll be able to go into the approval process with the highest score possible.

6. Understand the Required Tax Forms

When gathering the pertinent documentation to apply for a mortgage, self-employed workers must also make sure they have all of the necessary tax forms. While other applicants can use W-2 forms to prove their income, those that are self-employed must show 1040 tax returns for all schedules. According to Derby Advisors, entrepreneurs and small business owners are able to write off expenses that will ultimately lower their net income. This makes it more challenging to be approved for a mortgage as these write-offs essentially hurt the debt-to-income ratio.

Self-employed applicants hoping to improve their chances when applying for a mortgage must show that their net income after write-offs meets the preferred debt-to-income ratio, which typically ranges from 36% - 43%.

7. Increase Your Chances of Being Approved

While the approval process for a mortgage requires more of a concentrated effort for the self-employed, that doesn’t make the process impossible. To improve your chances of being approved, experts suggest taking the following steps:

• Register your business
• Pay yourself a wage instead of an owner’s draw
• Decrease your debt load
• Limit your tax deductions
• Keep personal and business accounts separate
• Maintain proper records
• Make a large down payment to offset risk
• Partner with small business mortgage companies

Though many self-employed individuals believe that they are at a disadvantage when it comes to applying for a mortgage, this isn’t necessarily the case. With clear proof of income, proper tax documentation, and a high credit score, entrepreneurs and small business owners will be able to qualify for the best available mortgage for them. If you’re a self-employed borrower hoping to qualify for a mortgage, be sure to keep this information in mind