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5 Things the Self-Employed Need to Do to Qualify for a Mortgage

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Up to a few years ago, the traditional notion of employment was to get up early in morning, to wear a suit, and to spend the next eight to nine hours working in an office. Technology allowed some people to have leeway, allowing them to work from home on some days. Sadly, the economic downturn in the last five years has resulted in a number of people losing their jobs.

To earn a living, many of you have turned to self-employment. You have become freelancers and entrepreneurs. The internet has allowed e-commerce to prosper and for budding entrepreneurs to build a business with the aid of social media. With a steady income brought about by self-employment, you may be thinking of refinancing your home or buying one instead of renting. Maneuvering through a loan application might be tricky if you’re self-employed, but with a little elbow grease and some determination, it is totally doable.

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Here are some things self-employed people, like you, should do to qualify for a mortgage.

1. Have a Good Credit Score

A good credit rating is a requirement for all borrowers. Normally you’d need a credit rating in the low to mid 600s to qualify for an FHA loan and at least a 700 to be able to be considered for a conventional loan. Financial institutions tend to view self-employed individuals with a jaded eye. Being self-employed is considered to be of higher risk than someone who has a guaranteed salary every month. Having a credit score that is higher than the minimum requirement can offset the risk factors brought about by being self-employed and increases the lender’s confidence in you as a borrower.

2. Properly Document Your Earnings

To be able to qualify for a loan, you must prove that you earn enough to be able to pay your monthly obligation. As a self-employed person, your income stream may be variable. You have to be able to show lenders that while your income fluctuates on a monthly basis, you have enough money to meet your payment schedule. For self-employed individuals, the best way to document your income is to show your tax returns. Most of the time, your tax returns for the last two years will be required. Make sure you have filled out an IRS Form 4506 or 8821, which will allow the lender to verify your income by taking a peak at your tax returns.

3. Lower Your Debt to Income Ratio

Your debt to income ratio is the percentage of your pre-tax monthly income that goes towards paying any outstanding debt. Normally lenders don’t want your debt to income ratio to go over 40%. Conservative lenders sometimes cap it to as low as 35%. If you’ve calculated and found that your debt to income is higher than the lenders caps, pay off a bigger chunk of your credit card debt and any other loans that you may have.

4. Choose Your Deductions Wisely

As a self-employed individual, your primary goal is to maximize your earnings. One of the ways to do that is to maximize the allowable tax deductions, and here lies the problem. Maximizing deductions would translate to reducing your reported income. On paper, you would end up looking like a self-employed person who did not earn that much. If your income is deemed too low, then you won’t qualify for your mortgage. Thus, it is important to choose which items you will declare as tax deductions. One of the options is to reduce your tax deductions until you qualify for a mortgage. Another way is to pay off existing debts so that your debt to income ratio based on the reported income is acceptable.

5. Beef Up Your Cash Reserves

As a self-employed person, banks worry that you do not have a steady income since entrepreneurs enjoy healthy months and lean months during the year. A variable income stream might affect your ability to meet your mortgage payments. Have a bank account that shows that you have enough reserves to cover for at least 2-3 months will go a long way to relieving the lenders’ worries.

If you are deemed to be of higher risk because of your self-employed status, a bank might offset some of the risk factors by requiring a higher than normal down payment. Being liquid will allow you to easily meet that required amount.

In this economy, lenders are naturally wary with their loan approvals. They can be stringent with applicants, especially with those that are self-employed. However, with a good credit score, solid earnings and enough assets, you will be able to qualify for a mortgage.

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If you are self-employed, have you qualified for a mortgage? What did you do to qualify?

Dominique Brown is a financial planner, landord, personal finance blogger and video blogger. He is the owner of YourFinancesSimplified.com where he talks about everything from being a new father to his worst financial mistakes. He has been featured on The Huffington Post and H&R Block. You can find him either on Twitter, Facebook, Youtube or Instagram.

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AUTHOR Derek

My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.

9 Comments

  1. Probably better to do all the big buying before going solo if possible 🙂

    • Yes.. make sure you get all your assets out the way. It can be a hassle.

  2. We thankfully got our rental done this year, because I will be fully self employed next year. I think cash is king, so pay off the debt and have a good chunk to put down.

    • Cash definitely is King, but you still need to factor in opportunity cost and leverage. If you can borrow between 1-4% you are probably better off taking the loan and using the cash to generate more income.

  3. I bought just before I started to work for myself three years ago, and am glad I did, or it would have been mission:impossible! My bank would expect three years of stellar self-employed history before even considering lending me money now!

    • They want 2 years if you’re not self-employed now. So, I’m sure it’s tough as heck if you’re self-employed to get a loan.

  4. My best friend is self-employed and has been for about 5 years. The guy makes mid $200k per year, and he still couldn’t qualify for a loan last year for his house. Ended up just focusing on saving enough to pay cash because he tried about 5 banks before giving up. High credit score, LLC Business, and still had issues.

    • He could show proof of income for 5 years and still couldn’t get a loan? That’s crazy!


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