How Much Of A Downpayment Will I Need If I'm Self-Employed?
The mortgage lending game has changed quite a bit over the past few years, which should come as no surprise in the 20/20 hindsight after the housing bubble burst. In the run-up to the Great Recession, banks and other lenders were approving home loans on "stated income" and offering products like interest only loans. Those days are gone, at least for the foreseeable future, and now, qualifying for a mortgage is more difficult.
For the self employed, the dynamics haven't changed all that much. Even during the period of loose lending standards, those who owned their own business had a tough go of getting a home loan. The reason is simple: lenders always seek to minimize risk and self employed individuals present more risk because they are not salaried. Though this might seem unfair, as salaried workers can easily find themselves without a job--little or no income--lenders don't see it the same way.
However, this certainly isn't to say that just because a person runs their own business does not mean they have no business applying for a home loan. The fact of the matter is the process will present more challenges. Because lenders will verify as much as possible, they seek a lot of documentation from self employed mortgage applicants.
What Lenders Want from Self Employed Home Loan Applicants
For those who are salaried employees, the necessary documentation is decidedly less than for applicants who work for themselves. In general, lenders will require self employed individuals to sign IRS Form 4506-T, which allows third parties to request tax transcripts. Lenders differ, but most will request between two and five years of tax returns.
In addition, full disclosure of assets, as well as liabilities, is necessary. Mortgage lenders prefer applicants with substantial assets, both property and liquid. Credit scores of self employed home loan seekers should be about or above 720, but this isn't a hard and fast rule.
Business owners and other self-employed individuals have often found it more difficult to obtain mortgage financing than their salaried counterparts. This is largely due to the income and employment verification requirements and underwriting guidelines which need to be adhered to. Unfortunately, while these individuals may enjoy great income levels, verifying income can present an array of hurdles when it comes to getting mortgage help for the self-employed. --Real Estate.com
The irony of the situation for being approved for a mortgage is the fact that people who work for themselves reduce their income on paper to avoid taxes. That's fine for paying less to Uncle Sam, but won't go over well with lenders. The hurdle is positioning one's self as someone who has the ability to repay the loan. Sadly, bank statements aren't an acceptable proof of income as they were in the 1990's.
How Business Owners can Get Approved for a Mortgage
Knowing this, you're probably wondering how it's possible for a self employed person to get approved for a mortgage. It is possible, just a bit more difficult. Here are some things you ought to do before you apply for a home loan:
- Reduce your debt-to-income ratio. Your debt-to-income ratio or DTI is a very important number and represents the difference between your gross monthly income and your monthly obligations. Though lenders do approve borrowers with a DTI of up to 45 percent, you'll be smart to go in with 35 percent or less. Start paying off those debts now.
- Thoroughly pour over your credit file. This should go without saying, but some people have a false sense of their credit score. You can get approved with a score of 620, but you'll pay a hefty interest rate and may have to pay points. Get your credit reports from Annual Credit Report.com and dispute any inaccuracies by mail, not online.
- Build-up your savings account. Lenders want to see self employed applicants with sufficient reserves. This means at least two months of principal, interest, taxes and insurance payments. Put this money aside and don't touch it until well after you close.
- Bring a healthy down payment to the table. Speaking of cash, you should be also saving for a down payment. Salaried individuals can be approved with as little as 3.5 percent down, but that's not always true for business owners. Try to beef it up to 10 to 15 percent to get a good rate.
- Don't incur new debt. This is where practically everyone who purchases a home goes wrong. They get approved and as settlement day draws near, start getting that new furniture itch. Large purchases can be a death knell because lenders generally run a second credit check 7 days or less before closing.
Another strategy is to apply with your spouse as the primary applicant. Depending on the lender and the type of loan you seek, your income source will either help you to secure a mortgage or won't be a negative factor.