How To Buy a House When Self-Employed

It takes a bit more work to qualify for a mortgage as an independent contractor

Person working on a laptop at a small pottery business
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Buying a home is doable if you're self-employed, but you should be prepared for a more rigorous underwriting process than that which your employed friends experience. It will take some time and patience, but you can get there.

There are more than 14 million self-employed homeowners around the nation, and you can be one of them if you know the steps to take.

Key Takeaways

  • Most lenders require two full years of self-employment before you're eligible to apply for a mortgage.
  • Be prepared to hand over documents showing your business finances, as well as records relating to your personal finances.
  • Some lenders are making exceptions on a case-by-case basis for businesses that have been hit hard by the COVID-19 pandemic.

What Lenders Are Looking for When You're Self-Employed

Lenders look at many of the same mortgage requirements of self-employed borrowers as they do if you're working for a company. Here are the big things they'll consider:

Your Credit Score

Having a good credit score is more important than ever if you're self-employed. "My advice is to first check your credit because the higher your score, the better the interest rate," said Linda McCoy, board president for the National Association of Mortgage Brokers.

In addition to being granted a better interest rate, you'll have more options available to you. You might have more luck with another loan program if you're not able to qualify for a conventional mortgage, but you'll have more success if you have a good score.

Your Debt-to-Income Ratio (DTI)

Lenders use your DTI ratio to calculate how much mortgage you can afford. You're limited to a total monthly debt payment of 43% of your income for most loans.

You may not be eligible for a mortgage if 43% or more of your paychecks each month are already going toward debt payments.

Your Down Payment

Most mortgage programs require a minimum down payment of at least 3% of the purchase price of your home, but 20% is even better. This is especially the case if you'll be going with a conventional mortgage, which is the most common type of home loan. Anything less than 20% down will require that you pay an additional fee for private mortgage insurance (PMI), and that can significantly eat into your homeownership budget.

Stability of Employment

Lenders generally assume that you can continue working there indefinitely if you're employed by a company, even if that's not always a safe bet. Lenders consider your situation to be riskier if you work for yourself.

They'll spend a lot of time looking at your business's details. Most lenders generally won't consider your business income unless you can demonstrate at least two full years of consistent self-employment.

Financial Strength of Your Business

Other things lenders look for are signs that your business is going to last. Anything you can do to show that your product or service is in demand and that you run a legitimate enterprise, such as presenting a license or registration, will help convince a lender to approve you for a mortgage.

This can be tricky because the economic challenges that began in 2020 have forced many businesses to shut down. But there are workarounds. "There were some exceptions made for COVID where we went back and got the previous two years on certain types of businesses," McCoy said. "This was on a case-by-case basis."

Documentation You'll Have To Provide

Getting all the necessary documents ready to apply for a mortgage is an important step.

Be prepared for an even bigger document roundup than a traditionally employed buyer would face.

Lenders may vary in the specific documents they'll need from self-employed applicants, but you should be prepared to provide the following:

  • Two years' worth of personal tax returns
  • The current year's profit and loss (P&L) statement
  • Two months' worth of business bank statements
  • Two years' worth of Form 1099s from your clients
  • Two years' worth of past business tax returns, including any Schedule Cs, Schedule K-1s, or other forms that you file

Your lender may also require other documents from you in some cases, such as:

  • Business license
  • Proof of business insurance
  • Signed statement from your certified public accountant (CPA)
  • Receipts for business purchases
  • Independent contractor agreements

Understanding Your Debt-to-Income Ratio

Calculating your personal DTI can become a little muddled when you're self-employed because your personal name is often associated with business debts.

A business debt can generally be included under your business's name and excluded from your own personal DTI if your business has never made a late payment on that debt, you pay that debt out of company funds and not from your personal account, and if your lender considers that debt in consideration in your business's cash flow analysis.

Know Your Options

Mortgage loans aren't one-size-fits-all, and some can be more generous about their qualifying terms than others. Do some research to find out what types of programs are available to you because you may have better luck if you go with something other than a conventional loan. They tend to be the hardest to qualify for.

Government-backed loans can be a good option. FHA loans are more forgiving of credit woes. They require less in the way of a down payment, although you'll have to pay for mortgage insurance. The FHA insures your mortgages, so lenders are more willing to take a chance on you.

A VA loan is also insured and might be an option if you've served in the military. Look into a USDA loan if you're considering buying in a rural area. You might also want to contact your state HUD office or finance agency for any programs they might offer that can help you along.

How To Improve Your Chances of Getting a Mortgage

There's no doubt that getting a mortgage is harder for the self-employed than for traditionally employed folks. But aside from waiting at least two years after you start your business, there are a few other things you can do to help yourself.

Limit Your Deductions

"Many borrowers claim as many tax deductions as possible on their returns. When they decide to finally buy a home, they find out that they don't have enough qualifying income left after those deductions to purchase the home of their dreams," McCoy said. "If you expense it off, so do we."

This can particularly be the case with self-employed taxpayers who file Schedule C with their tax returns because this is where they deduct their costs of doing business. On the one hand, you don't want to pay tax on more income than you have to. But keep in mind that the total shown on Schedule C after you subtract your expenses from your earnings is the income that lenders will look at.

Now might not be the best time to invest a lot of money in your business if you know you'll want to buy a home in the next couple of years. It could reduce your income and boost your DTI, making you potentially unable to get a mortgage.

Be Able To Prove Your Income

It can be tricky to substantiate your income when you're self-employed, particularly in a cash business or as a freelancer. Set a period of time aside before you apply for a mortgage and use it to document your earnings. Keep copies of your receipts to customers, or better yet, set yourself up so that they pay you electronically and you'll have account transcripts.

Do whatever you have to do to prove your income beyond copies of your own records. Just make sure they match up with what you're telling the IRS you earned.

Consider a Larger Down Payment

Dig deep to put more money down, if possible. You might be on the borderline between approval and denial of your loan. The size of your down payment might tilt the balance in one direction or the other.

The Bottom Line

There are advantages to reaching out to a good mortgage loan officer early in the process if you're interested in buying a home as a self-employed borrower. Look for someone who specializes in helping self-employed would-be homeowners. They can help guide you in preparing for what you should do, even years ahead of when you actually apply for a mortgage.

"I talk to people all day long. They tell me their story, and I'm a problem solver like most loan originators. That's what we do," McCoy said. "We help them get through that sometimes complicated mortgage loan process."

Frequently Asked Questions (FAQs)

Do you have to earn more money to buy a house if you're self-employed?

Lenders are mostly checking to see that your income is stable and that you can afford the mortgage you're applying for. You won't be penalized if you earn $50,000 per year on your own versus potentially being paid more if you worked for an employer. But you might have to show more documentation.

How do you calculate self-employment income for a mortgage?

Self-employment income is calculated based on your business income minus your business expenses: in other words, your net income. Lenders average this number over the past two years. Your average income would be calculated as $37,500 if your net income was $25,000 in one year and $50,000 in the next.

How do you prove self-employment income for a mortgage?

Your lender will look at a minimum of two years' past tax returns. They may also require that you provide other supporting documents, such as Form 1099s from your clients, Schedule C, K-1s for your personal taxes, or W-2s if you pay yourself from a corporation you own.

Article Sources

  1. Freddie Mac. "Turn Self-Employed Borrowers Into Homeowners."

  2. Consumer Financial Protection Bureau. "What Is a Debt-to-Income Ratio? Why Is the 43% Debt-to-Income Ratio Important?"

  3. Consumer Financial Protection Bureau. "Determine Your Down Payment."

  4. Consumer Financial Protection Bureau. "What Is Private Mortgage Insurance?"

  5. Chase. "How To Get a Mortgage When You're Self-Employed."

  6.  Freddie Mac. "Qualifying for a Mortgage When You're Self-Employed."

  7. Fannie Mae. "Selling Guide."

  8. Department of Housing and Urban Development. "Let FHA Loans Help You."

  9. USA.gov. "Help Buying a New Home."

  10. Discover. "Self-Employed? You Can Get a Mortgage."