Being self-employed means dealing with a unique set of challenges when applying for a mortgage. For the average employed applicant, the process involves filling out an application, listing your credit score/assets/income, and waiting for approval.
Self-employed applicants also do the same thing, but what happens after is when things become difficult.
For employed applicants, the process is simple. The lender goes to their employer, verifies their income, and determines how likely it is for that income to be sustained.
On the other hand, self-employed applicants have no way to verify their future income leaving lenders in a tough position.
Keeping this in mind, it’s time to learn how to get approved for mortgage loans when self-employed
What is a Lender Looking For?
Let’s start with the basics.
If you’re self-employed, it’s time to organize your finances. Being prepared will go a long way in gaining the lender’s approval.
The average lender is going to ask for the following information:
- Income (Past 2-3 Years)
- Nature of Your Employment
- Location of Your Employment
- Financial Viability of Your Business (Balance Sheets Can Help!)
- The Likelihood of Your Business to Generate a Reliable Income
Knowing they’re going to ask for this means you need to have the necessary documents ready to go. Being prepared at the time of application can save you a lot of trouble later on.
What Documents Does the Lender Require?
The lender is going to have a list of documents a self-employed applicant has to provide. It’s best to have these documents ready to go before the lender asks.
The best place to start would be your income tax documents (past 2-3 years). This should include verification of an uninterrupted source of self-employment income.
If possible, it’s always recommended to have multiple forms of income verification on hand.
These can include:
- Verification From a Certified Personal Accountant (CPA)
- Current Clients
- Membership to a Professional Organization
- State and/or Federal Business License
- DBA (Doing Business As) Name
- Business Insurance Documentation
Having one or more of these will go a long way in gaining approval from the lender. They will realize you are the real deal and can be verified through multiple sources as a legitimate applicant.
Most lenders are also going to ask for additional income-related documentation verifying your earning claims.
In this case, you can look to offer personal tax returns, profit/loss forms, and W-2s that are coming through your corporation.
What if you haven’t been self-employed for 2+ years? Is it impossible to go out and apply for a mortgage?
Based on established financial standards in the lending market, a business should be active for at least 12+ months to be deemed legitimate in the eyes of a lender. This includes sustaining a regular business income during this period.
It’s highly recommended to have 2+ years of sustained income to gain approval, but it’s possible to get approved with less. In this case, they are going to require clear-cut training and education-related documentation to verify your application
How to Get Your Mortgage Approved For Self-Employed(1099)
If you are running a business, it’s important to understand what works and what doesn’t with mortgage lenders. As a prospective client, you need to have everything in order beforehand.
1 Check Your Credit History
In this case, your credit history will play a tremendous role in verifying your mortgage application.
If your credit history shows unpaid debt and/or a history of missing payments, your chances of getting approved plummet rapidly. It’s important to know your credit score and ensure you’re in good standing.
Using the same logic, it’s also important to have some form of credit history. There are times when self-employed applicants are used to paying cash and don’t use credit.
This is a negative in the eyes of a lender because they can’t verify your authenticity as an applicant even if you’re honest about making payments.
It’s also important to bring your credit utilization rate down. For example, let’s assume you have a credit limit of $20,000 and you are currently using $15,000 due to recent payments. This doesn’t look good to the lender as it means you’re overextending yourself as a self-employed applicant.
By paying off some of this credit, your credit utilization rate will stabilize making it feasible for the lender to approve your application.
For COVID 1099 borrowing, it’s expected for individuals to showcase consistent earnings during the COVID-19 period. This includes a variety of documents including receipts, payments, and any other relevant information. Lenders will request this information immediately.
2 Look at Your Debt-to-Income Ratio
Lenders will often assess an applicant’s debt-to-income ratio. This refers to a person’s monthly debts in comparison to their gross monthly income. If your DTI is high, this makes you a risky borrower.
For example, let’s assume you are bringing in a gross monthly income of $10,000. However, your monthly debt is $7,000. This makes you a risky borrower because DTI doesn’t take into account additional monthly expenses such as utilities, groceries, property taxes, and more.
How low should your DTI be as a self-employed applicant?
It’s highly recommended to aim for a debt-to-income ratio that is below 50%.
Due to COVID-19, the debt-to-income ratio should be well within the 30-45% range if possible. This can help with COVID 1099 borrowing ensuring the loan does go through at a reasonable rate with a certified lender.
3 Separate Your Business Expenses
It’s easy to get your personal and business expenses confused. However, when applying for a mortgage, it’s time to separate your business expenses.
This means you are going to want to put all business-related expenses on a business account.
If you start accumulating debt on your personal cards, this will show up as a huge negative to lenders.
Any business-related expense has to be kept separate, so it is not used as the reason for denying your application. This can help with your debt-to-income ratio as well.
With COVID 1099 borrowing, it’s become important to separate business-related expenses as much as possible. If there has been any noticeable impact in earnings, it’s best to offset them with a business account so it doesn’t weigh heavily during a loan application.
When it’s time to apply for a mortgage, you’re going to need to have a plan in mind.
Don’t assume everything is going to go ahead smoothly. It’s important to have the necessary documents in hand and ensure you can maintain a strong debt-to-income ratio.
It is these details that are going to play a major role in whether or not the approval comes through.
Being self-employed doesn’t mean it’s impossible to get a mortgage. This is a myth.
It just requires a bit of planning and the willingness to get everything in order before starting.