Self Employed Mortgage: How To Get Approved

Certified Mortgage Advisor
NMLS 1701021
Published 
March 22, 2020

Fear of getting a mortgage

If you're self-employed and looking to get a mortgage, you might be a little fearful because you hear all these horror stories of people not being able to get approved for a mortgage because they're self-employed. Well, I'm going to walk you through two different ways. Two different types of loans you can use to get approved for a mortgage if you're self-employed. it's really not that difficult.

So how do we get approved, if you are self-employed.  So maybe you own a company, whether that looks like an LLC (Limited Liability Company) or Corporation, and you are trying to get a mortgage.

What is the difference between self-employed from an employee

So why in the world is this income even different from a regular employee? So the main reason why your income as a self-employed buyer is different from somebody who's like a W2 employee is because a lender actually takes on more risk.

What lenders think and want

They've used self-employed buyers as riskier than regular employed buyers, and that's because lenders want stable, consistent income. So when somebody works for a company, normally that income is viewed more consistently than somebody who's self-employed because they have a company that provides a paycheck. And there's the assumption that the company is doing well. That's just an assumption that lenders take.

But when you're self-employed lenders don't usually take that assumption. Their assumption is you own that business or the majority of that business, and they need to make sure that not only are you underwritten, but the business is also able to provide cash for you in the future to pay that mortgage down.

APR

So they use what's called the Ability to Repay role that basically says lenders have to look and see, can you actually afford this mortgage? Can you pay it back based on everything that they're looking at, and they can only consider taxable income. This is where self-employed buyers get into a little bit of trouble. Because maybe this year you made a hundred thousand dollars personally. But you wrote off, I see some people write off maybe $60,000 worth of that. So to the lender, you only made $40,000. They can't take a hundred thousand dollars as your income, because you said that you had $60,000 worth of expenses. So that's why it can be a little tricky is because you have a lot of deductions and income might be fluctuating depending on seasonality or depending on the different years.

And most likely if you're self-employed your income is probably trending in a specific direction. Hopefully it's going up each year. But it's possible that it's going down as well, just due to the nature of self-employment.

Two-years of self-employment

So something that you'll want to know is that self-employed buyers need to have a minimum two years of being self employed. So if you were at a W2 job last year and you just flipped to a new self-employment job this year, you're not going to be able to get a loan. You need to be self-employed for two years. No matter what your income looks like in that range, you need to be self-employed for two years to be able to qualify for a mortgage.

And the reason why is because lenders want to see that you have a longer history of employment that you're working consistently and they also want to see income that's consistent.

Two Types of loans

So there's going to be two different types of loans that you're going to run into. You're going to run into a traditional loan and a portfolio. So we can call these like a niche product or we can use interchangeable language.

Traditional loans

These traditional loans are just your regular loans. Things like conventional loans, FHA, VA, USDA. The big four main loans that you see, there's the loans that regular people get. Those types of loans, these niche portfolio loans are things that allow you to not have to show your tax returns and they use alternative documentation to prove your income.

Let's first talk about traditional loans are things like Conventional, USDA, FHA ,and VA loans. So when we're qualifying with one of these loans, our write offs are going to have a huge impact. So if we made a hundred thousand dollars this year, but we wrote off $60,000 worth of expenses our net is only going to show $40,000. So now I can only qualify with a loan using a $40,000 income that dramatically changes how much I can qualify for. So if you have write-offs, those are going to be impacted pretty greatly on your mortgage because the lender only wants to look at your net income and not the gross income.

And there's no way to get around this using a traditional type of loan, like conventional FHA, USDA, or VA. They have to look at the net. There's no option around that for these types of loans.

Traditional loan requires tax returns

Also, they're going to require one to two years of personal and possibly business tax returns. I know it can be scary to have a lender look at these, especially if you're thinking there's I might not have enough income but when you work with a lender, it should be a collaborative experience, not something that you're afraid of. So what I would suggest is to have these documents ready up front, show them to the lender and say, Hey, I don't know where I'm at, but I need some help exploring what I can qualify for? What do my tax returns show as far as the income that I could use on my loan?

So get those documents up front. Most of the time, you'll just need the personal, sometimes you'll need the business tax returns as well. It depends on the loan program and how you're setting up your loan. But your loan officers should be able to walk you through what that looks like.

P&L

Also, you might be asked for a profit and loss form. So this might be included when they ask for your business tax returns. So they want to see the viability of your business, especially if it's a sole proprietorship or you have a majority stake in the company. They're probably going to want to look at profit and loss to see the trend and cash flow of your business year over year.

Your interest rate is the same

Also when you get these loans, they're going to be just the regular interest rate that anybody else would get. So a lot of times I hear self-employed buyers feeling like they're going to get charged a higher interest rate because they're self-employed, which isn't true. If you are able to qualify for a loan with your write offs, or maybe you don't have a lot of write-offs, if you can qualify for one of these loans as a self-employed buyer, then absolutely you'll get the same interest rate that every other employee, a W2 employee would get on a Conventional, FHA, USDA or VA loan.

Portfolio Loan

So let's say that your write-offs are too high and you don't have enough net income to show how much income you actually make. So maybe in this example, you do make a hundred thousand dollars a year, but you wrote off $60,000. So you need to be able to qualify with a hundred thousand.

So the way that you do that is through a portfolio loan, traditional loans are going to be mainly if you can qualify on your net. Portfolio, loans are going to be, if you need to qualify it on your gross.

Main types of Portfolio Loans

So there are two main types of portfolio loans. One is a bank statement program. Sometimes people call this stated income.

Stated Income

This used to be a thing before the housing crash happened and doesn't exist anymore because we had the housing crash and they were like really bad loans. A stated income loan would be where someone would walk in and say, "Hey, I make a hundred thousand dollars a year", and then make it would say, "That sounds great. Here's a loan". It doesn't work like that anymore. Some people are renaming bank statement programs as stated income, which isn't true because bank statement programs look at income.

So bank statement program is where instead of showing your tax returns, a lender asks for your past 12 to 24 months bank statements. And then what they do is they average the deposits over the past 12 to 24 months and give you an income. So that's how they decided the income. You might be able to use personal bank statements or you could use business bank statements.

Normally with business bank statements, they use a factor of 50% expense ratio. So if in your business expenses, or if you're in your business bank account, let's say over the past 12 months you earn $200,000. The lender would cut that in half and say you earned a hundred thousand. If it was your personal bank statement and you had a hundred thousand dollars. They would use a hundred thousand dollars for your income. So it can be a little tricky again. Talk with the lender. They'll help you do all the math here. So you have bank statement programs.

1099 Programs

You also have 1099 programs. These are a little bit newer, a 1099 program is where a lender would just look at your past year or past two years, 1099s. And then they normally use an expense factor on that as well. So normally what I've seen is an expense factor of 10. What they would do is take your 1099 from last year, let's say last year you made a hundred thousand dollars on a 1099. They would take 90% of that as your qualifying income. So they would say you made $90,000 in qualifying mortgage income.

15% down or higher

Alright, portfolio programs have a little bit of a downside though. Normally they need about 15% down or higher. These traditional products. I mean USDA 0% down. VA's 0% down. FHA is 3.5% down in conventional. 3%. So 15% down can be a little bit tight.

You better have good credit

You also need good credit. Normally you're going to want to be in like the mid to higher 600 score range, somewhere around a 660, a 680 and higher.

12-24 Months Bank Statement Average

Again, most of the time it's going to be 12 to 24 months bank statements. And something that you're going to run into, no matter what portfolio program you use, is going to have a higher interest rate. So it can be pretty high, honestly. So a traditional conventional loan, I'm just going to say if the interest rate right now was 3.5% with a portfolio loan, you're probably looking closer to a 5 to 7% interest rate. They're just going to be a lot higher because they are riskier because they're keeping those loans in a house. They're usually not going to be able to sell them on a secondary market to Fannie Mae or Freddie Mac, like you can with a traditional loan and they work well if you need them. I would always try to go with qualifying for a traditional loan if possible, because the portfolio loans are just a little bit more expensive.

Things to consider

Number one is you don't want to be tax blind when you're going into this process. So a lot of people who are self-employed, I get it. You're already working a ton. You're managing a business that you're doing the things in your business. You're managing employees and orders and everything that needs to go on with you setting up your business. The last thing you want to do is worry about taxes.

So most of the time, business owners have their taxes prepared by somebody else and the accountant normally is trying to help you. They're trying to say, Hey, I want to get all these deductions for you. So you save money in taxes and you think great. But the flip side of that is when you write off all this stuff on your taxes, you might not be able to qualify for a mortgage. So don't be blind when you're having your taxes done.

Talk to a lender before submitting your taxes

Something you can do is talk with a lender. Hey, I want you to take a look at my taxes, see what they look like right now. Get that advice before you then file your taxes for the upcoming year. That way you can see, is there anything that I need to change? Maybe do I need to hold back on some of the deductions that I'm putting in my tax return so that I can qualify for a mortgage?

So something to be mindful of a lender can help you take a look at what you can qualify for. With an accountant, their job is to help you save the most money on taxes. Lender's job is to help you qualify for a mortgage. And they're working against each other at that point. So talk with both and see if you can come up with a remedy, that's going to help you qualify for a mortgage. If that's what you're looking for in the near future.

Co-borrower or co-signer

Another consideration is if you can't qualify for a traditional loan and you really don't want to go with a portfolio loan, one option is to add a non-occupant co-borrower or co-signer; it's the same thing. Basically, what happens is you would be the primary borrower on the loan and you would have somebody cosign for you who won't live in the property. This is a great option. I've done this with several people who have been self-employed, we had trouble documenting income and they didn't have a down payment. So we added a co-signer and that co-signer basically said, "Yep, I'll sign up to show my income and credit on this loan and guarantee that it gets paid". So that is one option, if you have that available to you.

Down payment for that is about 5% down minimum most of the time. So it really is a great strategy to use that, and then maybe refinance. What I always suggest in this strategy is keep your loan and then the buyer who's self-employed to then eventually refinance into a traditional loan so that the co-borrower can get off of that.

Because a co-borrower normally doesn't want to be on a mortgage for her very long. Another option is, use a niche program, use a bank statement program and then refinance into a. Our regular traditional loan after you may be filed taxes one more year with less deductions.

Find a lender who is willing to help

So overall, if you're self-employed, it's not the worst thing in the world to go through the mortgage process, it's going to be more documentation for you. It might be slightly more stressful. It might be a little bit longer of a process, but find a lender who's willing to collaborate with you and help you through understanding what you can qualify for and what steps you need to take. If you don't qualify for the program that you want right now.

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