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How to Get a Mortgage if You're Self-Employed

Jessica Merritt

Many self-employed workers earn a good living, but without a regular paycheck to depend on, these workers might have a harder time proving their income than those who receive a W-2. This makes it more difficult to obtain a mortgage, but buying a home with a mortgage is possible when you're self-employed.

Lenders are primarily concerned that all applicants, including self-employed workers, have the ability to consistently repay the mortgage. They'll need to see that your income is high enough to pay for the mortgage and likely to continue, and that you have a good track record of repaying your debts.

Why Getting a Mortgage Can be Difficult When You're Self-Employed

Obtaining a mortgage can be more challenging for self-employed workers because lenders consider the stability and viability of your business along with your income. According to Fannie Mae, a U.S. government-sponsored enterprise that is a leading source of financing for mortgage lenders, lenders will consider the demand for your business, its location and financial strength, and whether it's capable of continuing to provide you with enough income to support a mortgage.

[Read: The Best Mortgage Lenders of 2017.]

At the same time, just determining your income may pose more of an obstacle for self-employed workers. These workers often have multiple sources of income that may fluctuate, so documenting income requires more paperwork. Compare that with a traditional borrower who receives a regular paycheck and who has a W-2 tax form, on which an employer reports the employee's annual wages.

"A W-2 employee usually sees consistent wages from year to year," says Scott Scribner, Realtor and board member of the National Association for the Self-Employed. "The self-employed borrower often experiences fluctuations in annual income, which can make it difficult for mortgage lenders to predict future income."

Self-employed workers also might write off a significant portion of their income as a business expense, minimizing the size of the mortgage they're able to obtain. Because mortgage underwriters typically look at income after expenses, your taxable income may be too small to qualify for the mortgage you want.

"Self-employed borrowers look to minimize their bottom line by taking advantage of tax deductions, which they should," explains Ryan Kelley, founder of The Home Loan Expert mortgage origination team. "However, having a lower bottom line puts them at a disadvantage when factoring in their debt-to-income [ratio]."

Your income has a major effect on your debt-to-income ratio, or DTI, a significant factor in lending decisions. Lenders need to see that you earn enough income to make mortgage payments along with your other financial obligations. Your debt-to-income ratio is the total of your monthly debt payments divided by your monthly income. For example, if you earn $6,000 each month and expect to owe $2,000 on your car loan, credit cards and proposed mortgage payment, your debt-to-income ratio is 33 percent.

Lenders typically look for a debt-to-income ratio of 43 percent or lower, according to the Consumer Financial Protection Bureau. If your debt payments are perceived as unmanageable for your level of income, the lender will not offer you a mortgage, or you may not qualify for the amount you need to purchase a home.

Common Misconceptions About Mortgages for Self-Employed Borrowers

Self-employed borrowers always pay higher interest rates. Self-employed borrowers with good income and credit should not expect to pay a rate different than what other borrowers do.

If you can't get a mortgage through a traditional lender, there are other, typically more expensive, options available, advises Scribner. Private lending companies; "hard money" or nontraditional lenders; and even individuals offer loan options to those who may not qualify otherwise. "Loans provided by these sources typically carry a higher rate and, in many cases, higher fees," he says.

You'll need a co-signer to get approved. It is possible to be approved for a mortgage solely on self-employment income. If you can demonstrate sufficient, stable income and good credit to support the loan, a co-signer with a W-2 is not necessary. However, there are situations when a co-signer is useful in mortgage approval for the self-employed.

"If a lender is unable to approve a loan based on income, adding a co-signer can help," advises Scribner. "The lender can use the income of the co-signer to support qualifications."

[Read: The Best Small Business Loans of 2017.]

However, you still need to present an excellent financial profile. "Even with a co-signer, the lender will consider the primary borrower's credit score for qualification purposes," says Scribner. "If the primary borrower has poor credit, the lender will usually still reject the application."

You always need to report self-employment income. If you're a moonlighter and can qualify for a mortgage based on income from salaried work, you don't need the lender to consider your self-employment income. And self-employed workers applying with a co-borrower may not need to show income if the other borrower's income is sufficient.

What Lenders Want to See From Self-Employed Mortgage Applicants

The bottom line is that lenders need assurance that you'll be able to make your mortgage payments for the entire length of the loan. Freddie Mac, a government-sponsored enterprise similar to Fannie Mae that purchases mortgages and develops mortgage-backed securities, says that typically, lenders look at the three Cs of underwriting when approving mortgages: credit reputation, capacity to repay and collateral.

Here's what lenders want to see from self-employed mortgage applicants:

-- Stable or increasing income: You should have steady income from self-employment. Some fluctuation is acceptable, but it should overall trend upward. "Mortgage lenders require submission of tax returns in order to verify the income of self-employed borrowers," Scribner says. "The goal of this review is to evaluate the recurring nature and amount of business income. Lenders determine year-to-year trends for gross revenue, expenses and taxable income for the business, which is used to project a trend for the business over time."

-- Consistent work: Ideally, lenders want to see at least two years of self-employment income in the same industry. If you're newly self-employed, some lenders will make an exception if you have one year of self-employment tax returns and W-2s from an employer in the same field. But having a short history of self-employment does not offer lenders the assurance that your income will remain consistent.

-- Good credit: Lenders want to see that you have a consistent record of repaying your debts. Foreclosures, delinquencies, collections, repossessions and bankruptcies will increase your risk. They will look at the type, age, limits, use and status of your revolving credit accounts, and at how often you applied for new credit within the past year. Keep in mind that they're likely to check your business credit if you have a business credit rating.

-- Cash reserves: Your mortgage payment is due every month, even when you're short on work. Lenders may want to see that you have an emergency fund available to get you through months when you're not earning as much money.

-- Significant down payment: A higher down payment offers more assurance to lenders. Scribner says down payment requirements for self-employed workers with good credit and enough income are usually no different than what other borrowers face with traditional lenders. However, if your financial profile isn't strong, a larger down payment can be helpful. "A higher down payment [such as 30 percent or more] can be a mitigating factor if income qualifications are tight," says Scribner.

-- Single-family occupancy: According to Fannie Mae, a mortgage on a single-unit home that will serve as the borrower's primary residence is a lower risk for lenders. Lenders may also offer mortgages on second homes, investment properties, multiunit properties or manufactured homes, but these transactions pose a greater risk.

Mortgage Application Requirements for Self-Employed Workers

Lenders require complete financial documentation for a mortgage application. When you're self-employed, you'll need to provide both business and personal financial documentation. Although requirements will vary by lender, you should be prepared to submit:

-- Complete personal tax returns for two years

-- Business tax returns for two years

-- IRS Form 4506-T, giving permission to the lender to request transcripts for tax returns

-- Profit and loss statements

-- Business bank statements

-- Business verification, such as a DBA or "doing business as"

-- A business license

-- A list of your debts and minimum monthly payments

-- Canceled checks for your current rent or mortgage

-- Any additional income or payments, such as Social Security or disability

Some lenders require additional documentation to consider your business income, such as statements from your accountant and clients.

Before you submit your documentation, be sure that it's up-to-date and organized. You should make it easy for the lender to make sense of your financial situation. Lenders typically require the latest statements and won't appreciate having to request up-to-date information from you.

Plan Ahead to Lower Your Risk

If you're self-employed and considering a home purchase within the next few years, there are several steps you can take to make yourself a more attractive borrower.

Establish a track record of self-employment work. Most lenders want to see at least two years of self-employment history, but one year of self-employment work may be acceptable if you have a past record of relevant employment for which you received a W-2. You should maintain consistent work as much as possible.

It's a good idea to time a mortgage application after two to three years of consistently good earnings, says Scribner. At that point, lenders are less likely to be concerned by income instability, and you may qualify for a higher loan amount.

Improve your credit report. Check your credit report to identify any problems you may need to fix before a mortgage lender checks your credit. Lenders could reject your application or charge you a higher interest rate if you have a low credit score. If you identify any errors, contact the credit bureau to correct them. Look for any other areas of concern, such as high credit limit use, and work to address them. Be careful not to apply for other loans or credit cards in the months leading up to your mortgage application, as multiple new inquiries may harm your credit rating.

Pay down existing debt. You can improve your credit score by paying off some or all of your debt. This will also lower your debt-to-income ratio, which will make it easier for you to be approved for a mortgage.

Save as much as possible. You shouldn't plan to spend all your savings on the down payment. A healthy emergency fund can put lenders at ease knowing that you can still make payments, even if work dries up for a while, or that you can afford to make surprise repairs on your new home.

Maintain clean business records. Make it easier for lenders to understand your business income. Separate your business and personal funds by using business checking and savings accounts and credit cards. Keep an accounting of invoices and expenses each month, and create an updated profit and loss statement at least each quarter. Be sure to retain your records when you file taxes each year.

[Read: The Best Bad Credit Loans for Small Businesses of 2017.]

"Meticulous, detailed business records are very important," advises Scribner. "Separate business accounts are a must. The mortgage underwriter needs confidence in the accuracy of a borrower's financial information and commingling of personal and business accounts is a big red flag."

Legitimize your business. Register your business and get the appropriate licenses and insurance required to operate legally. Running a legitimate business indicates to the lender that you're well-established and serious about continuing self-employment.

Consider reducing tax deductions. If you'd like to show more income on your taxes, you can write off fewer expenses in the years before you apply for a mortgage. However, you will likely have to pay more in taxes when you take fewer deductions, so talk to your accountant and consider this strategy carefully. Keep in mind that with loans underwritten by Fannie Mae, lenders can add certain expenses such as casualty loss, depreciation and depletion back into income considered for loan qualification.

If You Can't Get a Mortgage

If you're self-employed and having trouble qualifying for a mortgage, you may need to consider alternative strategies.

Take time to improve your financial profile. Waiting is rarely an attractive option, especially when you want to buy a home, but you may need more time to improve your financial situation. You can take more time to establish a longer track record of successful self-employment, build your savings and work on paying down debt and improving your credit.

Get a co-signer. A co-signer guarantees your debt, making a promise to pay the loan if you default. Using a co-signer with good credit and income documented in a W-2 can improve your odds of approval. Kelley advises self-employed borrowers to consider a co-signer if they need help with their debt-to-income ratio.

Seek a smaller loan. You may be asking for a larger mortgage than lenders are willing to give you. Reconsider the amount you're asking for by either increasing your down payment or looking at houses with a lower purchase price.

Find work that will provide you with a W-2. Earning a regular paycheck can make you look less risky to a lender. A part-time job may offer more consistent income to back up your self-employment income, which can fluctuate. However, according to The Mortgage Reports, a personal finance news and advice website, lenders will typically look for a two-year history of part-time employment before they'll factor it into your mortgage application.

Work with a mortgage broker. Mortgage brokers are experts in helping their clients obtain a mortgage with the best terms. They may be able to point you to lenders that are particularly willing to work with self-employed borrowers and may offer customized recommendations for reducing your risk and obtaining approval.

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