Most people take out a mortgage to land a home, according to the Consumer Financial Protection Bureau. But getting approved for that loan can be a tricky business when you're independently employed. Read on for tips on how to get a mortgage when self-employed.
What do mortgage lenders seek?
Irrespective of whether or not you are self-employed, mortgage lenders commonly look for what is known as the four C's when deciding whether or not to approve an applicant for a mortgage. These criteria, according to the government-sponsored mortgage loan company Freddie Mac, are:
- Capacity to repay: Factoring in your income, debts, savings and work history (including the track record of your self-employment venture), a lender will assess its confidence in your ability to repay your loan.
- Capital: This is how much you have in savings and other liquid reserves. Having substantial capital bolsters your mortgage application because it is a backup source of funding for loan repayment should you lose your primary source of income.
- Collateral: These are the assets you are pledging to your lender in exchange for receiving a loan. Should you default on your loan payments, this collateral is up for seizure.
- Credit: This is your credit score and history. Loan applicants with strong credit scores and no bankruptcies, delinquencies or foreclosures are better poised for approval.
Does being self-employed make it harder to get a mortgage?
It's not the act of being self-employed itself that makes it harder to get a mortgage. Still, solo workers do often find it more difficult to get approved for a mortgage because they have a harder time proving that they meet the four C's described above, particularly the first: the capacity to repay. This plight isn't always because the self-employed have insufficient income to repay a loan but because their employment and income are often more inconsistent and more difficult to verify. The uncertainty of future success in business also works against self-employed people seeking a mortgage.
What documentation do you need to get a mortgage?
Meeting the necessary mortgage documentation requirements is a crucial component of how to get a mortgage when self-employed. The specific documentation requirements for mortgage approval vary by lender but generally include some or all of the following:
- Business license
- Assumed name/DBA verification if doing business under a name other than your own
- Personal and business tax returns for two years (If you have a long track record of self-employment, one year of tax returns may be sufficient.)
- Bank statements from business bank accounts showing deposits
- IRS Form 4506-T, which lets a third-party (e.g., a lender) retrieve transcripts of your past tax returns on file with the IRS
- Profit and loss statements
- List of debts
- Non-business income (i.e. Social Security payments)
- Work verification (e.g., a letter from a client attesting to the fact that you have provided the services you claim your business offers)
- Verification of bond or liability insurance
How does my business setup impact my mortgage chances?
While not the only factor under consideration, your business structure can undoubtedly influence the odds that you will get approved for a mortgage. Generally, business structures that require the business owner or owners to shoulder the debts of the business personally (e.g., sole proprietorships and general partnerships) are viewed by lenders as riskier business structures. Often, because of the perception that the threat of default is higher. As the Small Business Administration explains, lenders shy away from loaning to sole proprietorships because of a "perceived additional risk when it comes to repayment if the business fails." On the flip side, LLCs and corporations in most cases minimize the personal liability of the owners, so they are generally viewed more favorably by lenders.
How do you prove your self-employment income for a mortgage?
Proving your self-employment income isn't quite as easy as whipping out a pay stub or W-2 form. However, if you employ diligent record-keeping practices, you can make the case that you have a consistent income. Some of the documents listed above, such as your tax returns and bank statements, will already help paint a picture of your financial situation for lenders. You can additionally use the following to verify your claims of self-employment income:
- Form 1099-MISC for each payer of non-employee compensation
- Invoices
- Statements from third-party payment platforms showing proof of other deposits
- Check deposit slips or check images
- Copies of money orders
- Signed letter from CPA attesting to business income
