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Mortgages for the Self-Employed: What You Need to Know

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According to the U.S. Small Business Administration there are over 31 Million small businesses in the United States.  If that doesn’t wow you, check this out…over 80% of them had no employees.  Once you do the math, you’ll quickly realize that’s a lot of self-employed workers in this country.  

Self-employed workers can be real estate agents, accountants, singers, writers, chefs…the list goes on and on.  So what happens when these folks are looking for a mortgage?  Big banks might not be the answer because of the application requirements such as paystubs and W2s.  

Don’t worry though, this is the exact situation why A Nightmare on Loan Street Blog was started.  This blog post is going to help anyone in that situation learn about their options and what they’ll need in order to qualify for a mortgage.  

First, let’s dive into four things that will impact the application the most:

  • Credit Score
  • Debt to Income Ratio
  • Down Payment
  • Work History

Remember, when taking out a loan, the lender is ultimately using all of these tools to evaluate the borrower’s ability to repay the loan.  

Your credit score and credit report are going to be a factor no matter which lender you choose.  Most want to see a score above 620.  The main reason for this is that a higher number shows them that you have been able to repay debt.  

Debt to Income ratio may be a new term for some of you reading this.  Don’t sweat it though, I can help break this down.  This is your monthly minimum recurring debt divided by your monthly income before taxes.  It’s common for lenders to look for a percentage lower than 47%.  If your Debt to Income ratio is lower, that’s even better.  Like a golf score, lower is definitely better.  

Let’s review an example.  Say you make $3,000 a month before taxes, and you have $1,000 in recurring monthly expenses.  These expenses could be things like a car payment, rent, and/or student loans.  $1,000 / $3,000 = 33%.  This would be a really attractive Debt to Income ratio.  

Before moving on, when it comes to credit scores and Debt to Income ratios, these are things that can be improved over time.  For instance, if your credit score isn’t so hot, you can work on paying down existing debt to improve this number.  If your Debt to Income ratio is too high, there are two ways to help: increase your monthly income or reduce your monthly debt.  I know, easier said than done.  But with the gig economy in full swing, there are a lot of other ways to earn income on the side.  Have some free time and a car?  You could always drive for a rideshare company.  That’s just an example, and there are plenty more ways to earn money on the side (just look at your friends on Facebook).  The other thing to think about is that by eliminating debt, you can increase your credit score (good) and lower your Debt to Income ratio (also good) at the same time.  

Down payments can vary widely among lenders.  However, a larger down payment (say 20% or more) can help in a few ways.  It reduces the lender’s risk because they don’t lend you as much money.  Because of this, it often unlocks lower interest rates, which can be excellent news for the borrower.  

If you don’t have enough to make a large down payment, this is again something that you can work at over time.  Remember two paragraphs ago when I mentioned the gig economy?  That’s one way to help.  But you don’t always need another job - this could also mean disciplined saving over time or your next innovation as an entrepreneur.

Finally, work history.  Most lenders want to see that you’ve been working for yourself for at least two years.  If you haven’t, all is not lost.  You can show previous work history (via a W2) to help with this, or borrow with a co-signer.  A co-signer is someone who assumes responsibility for the loan if you default.  Co-signers are not just walking down the street ready to be on the hook for your loan though.  This is usually someone you’re really close with (a spouse) or trusts you a whole ton (your best friend…sometimes). 

Now that you know the skinny on the basics of mortgages for the self-employed, what kind of mortgage options are out there?

A common option for the self-employed and small business owners is the bank statement mortgage.  This alternative loan uses 12-24 months of bank statements instead of paystubs and W2s as the main documentation.  If you’re self-employed, these are documents you already have available.  From there, the lender will come up with an average monthly income to help calculate your Debt to Income ratio.  This method accounts for seasonal variability or irregular income patterns.  Maybe you make most of your money in the summer months or you’re commission based and don’t rely on a regular paycheck.  If so, a bank statement mortgage might be right for you.  

If you are interested in learning more about the bank statement loan, or are ready to take the next step, it’s a good idea to reach out to a specialist like Truss Financial Group.  Truss takes a common sense approach to lending, and they have a team of experts in bank statement loans for the self-employed.  Give us a call today!