While it is possible for the self-employed to benefit from a many different benefits – such as certain income related tax deductions – they may find the process of applying for a home loan a little more challenging.
Based on underwriting guidelines issued by Fannie Mae, anyone applying for home financing with an ownership stake of 25% or more is deemed to be self-employed. Even though anyone can find themselves in the unfortunate position of losing their job when least expected, most home lenders are likely to place the self-employed in a higher risk category compared to the W-2 employees.
Any successful loan application is based on providing key information such as income verification and income stability. This type of proof can be more difficult for the self-employed to provide. If there are any issues with providing the relevant documentation, there is the risk of being classed as a less attractive option for the mortgage company, which leads to strict underwriting requirements and higher interest rates. However, there are a few things that can help to achieve a smooth application.
Income verification
In times of a booming economy, the home lenders were a little more relaxed in the process of income verification. A stated asset or stated income mortgage is a type of low documentation loan that makes the application process less complex with no need to fully verify the self-employed income.
But, the major loan buyers like Fannie Mae and Freddie Mac impose strict income verification rules for the self-employed, so the vast majority of lenders will comply with these guidelines if they wish to sell their home loans on the secondary market.
Typically, the low documentation loan isn’t easy to source for most would-be home buyers. For this reason, it is practical to prepare the in-depth proof of income. The preferred documentation proof for the self-employed relates to the company’s financial statements and tax turns from the last two years. In general, the income will be calculated on the average for the two years of documented proof.
However, there is a certain degree of flexibility in the mortgage qualifying criteria for the self-employed. On occasion, there are lenders that will be willing to accept the tax return for a single year.
Even though Fannie Mae has the standard eligibility requirement of two years of tax returns, the applicant that is seen as a low credit risk may have the option of only needing the provide the latest tax return.
Many self-employed individuals believe the process of applying for a home loan is more complex with a need to supply a profit and loss statement or other business related documentation. But, this isn’t the case. Home lenders will only make a request for the tax returns, which will be less stressful on the entrepreneurs looking to invest in a new home.
For most self-employed, there shouldn’t be any need to make changes to the existing financial report. Simply relying on the tax returns for the last few years is sufficient to match the buying criteria.
Credit history
The majority of self-employed individuals will see a slight variation in the month-to-month earnings, so it will benefit to maintain a low debt-to-income ratio. Any applicant with a low ratio will be more appealing to the home lenders. Good credit score applicants are certain to benefit from the most attractive terms and conditions, such as the most favorable interest rates.
There are plenty of steps that can be taken to protect the credit history, but making the timely bill payments is certain to be the most straightforward. Additionally, it can help to keep unsecured debt or other borrowing to a minimum, such as revolving credit lines and credit cards. Being proactive and taking the steps to clean up the credit history can help to achieve the lower mortgage terms and repayments.
Get prepared early
Early preparation is certain to help in the process of applying for a home loan. The necessary documentation should be organized as early as possible. Making an appointment with a chosen lender to establish the borrowing criteria and potential loan amount is very useful. On occasion, a self-employed individual may rely on tax deductions to help in the process of keeping the income tax as low as possible, but this may have a negative impact on the ability to borrow the desired amount. So, if it is nearing the time of applying for a home loan, it may benefit to forfeit certain tax deductions to improve the qualifying income.
Look at other income
While it won’t be an option for most, the self-employed with a secondary income will likely strengthen their ability to get approved for a home loan. For instance, a joint application with a salaried part-time job is very helpful, especially for those that have seen a noticeable fluctuation in the latest earnings.
What are the typical steps involved in applying for a self-employed home loan?
Here is a quick overview of the self-employed process to get approved for a mortgage:
Make the initial application for a home loan online, by phone or in-person. This may involve showing proof of income, employment history, your locality, debts and savings. If there are any specific rules that apply to the self-employed, they will be discussed at this time.
Any completed application will be referred to the banks team of underwriters who will review the information provided to decide on its authenticity. In certain situations, there may be a need to provide supporting clarifications and documentation.
It is the underwriter’s responsibility to ensure the borrower is fully able to comply with the minimum qualifying standards. So, they will be able to continue to ask relevant information until they are fully satisfied with the application.
In the event the loan application is accepted, the underwriter will be in a position to issue a clear-to-close status.
It is worth noting that the underwriting process may vary among the different lenders and loans, and there is no set pattern that is followed. So, the underwriter has the authority to request whatever information they deem fit to comply with the lenders requirements.