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How to Get a Self-Employed Mortgage
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A self-employed mortgage is a home loan for people who receive income from their own business, rather than a regular wage. Getting a self-employed mortgage may be difficult if you don’t choose the right lender or aren’t prepared for the extra hoops you’ll need to jump through to get approved.
What is a self-employed mortgage?
A self-employed mortgage allows borrowers who earn income from a business, trade or profession to get home financing. Because a self-employed borrower isn’t guaranteed a set amount of pay, lenders take extra care to determine if the income is stable enough to repay the loan.
A lender considers you self-employed if you have 25% or more ownership in a business. Lenders are primarily concerned with:
- How consistent your income is now
- How stable your income has been in the past
- Where your business is located
- What type of business you run
- What the demand is for the product or service you offer
- How financially strong the company is
- How likely the business is to generate income to cover the new mortgage
Providing proof of income for a self-employed mortgage
There are four primary factors that affect a lender’s calculation of self-employed income:
- How long you’ve been self-employed
- How you document your income
- How much you make personally from your business
- How much your business actually makes
Lenders also pay attention to whether you’re using any business assets to make the down payment on your home. They want to ensure taking money out of a business account won’t make it hard to operate if there’s a sudden change in the economic or business environment.
How long you’ve been self-employed
Most lenders calculate your qualifying income based on an average of the personal earnings reported on your tax returns for the last two years. Lenders may approve a shorter self-employed history (12 to 24 months) if your tax returns show your prior job was selling the same products or services as your current self-employed business.
How you document your self-employed income
Lenders typically request the following documents to prove self-employed income:
- Two most recent years of personal tax returns. In some cases, only one year is acceptable, as long as the tax return shows at least 12 months’ worth of self-employment income.
- Two most recent years of business tax returns. The business return requirement may be waived if:
- You’ve been in business at least five years
- Your income has grown the past two years
- You aren’t using any business funds for your down payment
- IRS transcripts. Most lenders process a Form 4506-T to verify that the information filed on the tax returns matches the information in the IRS database.
- Profit and loss statements. Also called a P&L for short, this financial statement shows how much total profit you’ve made after subtracting out business expenses. Lenders expect earnings on track with or higher than what you made on your tax returns.
- CPA letters. Lenders may ask your tax professional for a letter of explanation to clarify your income. “Because CPAs are licensed and bound by laws and ethics, [lenders are] comfortable having a CPA sign off on the numbers,” said Anil Melwani, a CPA and owner of 212 Tax in New York.
Analysis of your personal and business income
Most lenders analyze self-employed income based on some version of Fannie Mae’s cash flow analysis Form 1084. The method used to come up with self-employed income varies depending on whether your business is a sole proprietorship, partnership or corporation.
Lenders also want to make sure your business is healthy. They review how much debt the business is taking on and whether the income is increasing or falling from year to year. Even if a sudden drop in business income doesn’t affect your personal income, a lender could look at it as a red flag in your financial future.
The type of business structure you have set up may also trigger additional requests for information. “We definitely get [calls] more for Schedule C/sole proprietorship borrowers,” Melwani said. “If it’s a partnership or a corporation it probably looks more established in terms of the bank’s point of view,” Melwani added.
Using business assets for your down payment
If you’ve stockpiled some cash in your business accounts, you may be thinking about using some of the money to make a down payment on your home. If you do, be prepared to:
- Get a letter from your CPA or tax professional to confirm taking the funds out won’t harm your business.
- Provide a copy of your business returns so the lender can look into the overall health of your company.
- Provide business bank statements to show how your balances and expenses trend over time.
COVID-19 changes to self-employed mortgages
During times of economic uncertainty, lenders are more diligent about verifying that the income you earn from your business is stable and likely to continue. Efforts to curb the spread of COVID-19, a respiratory disease caused by coronavirus, have included statewide shutdowns of businesses that state governments don’t consider essential. This has led many mortgage companies to create new guidelines to verify you can repay a new mortgage.
“Lenders don’t want to give out money to someone who could lose their business and lose their job,” Melwani said. Many businesses are on the verge of bankruptcy or closing, so the lenders keep verifying the borrowers’ companies are still operating, said Melwani.
Lenders making mortgages during the coronavirus pandemic may ask you for:
- A profit and loss statement audited by a tax professional showing earnings up until one month before closing
- A profit and loss that is not audited but is signed and dated by the borrower, along with two recent months of bank statements that support the profit and loss figures
- A signed statement or business plan from you verifying COVID-19 has affected your business
- Confirmation that the business is not restricted by a shelter-in-place or stay-at-home order required by the state
- Proof of receipts or purchase contracts showing that services or products are still producing income within 10 days of closing
- Proof the business is still operating by checking the internet or some third-party employment verification source
Alternative self-employed mortgage options
If you’ve been told you don’t qualify for a traditional mortgage or don’t want the hassle of the documentation that’s required, a non-qualified mortgage (non-QM) may be worth exploring. Non-QM loans don’t meet the qualified mortgage standards set by the government and are also called alternative or no income verification mortgages.
However, these aren’t the “fog-a-mirror-and-get-a-loan” products of the past: New federal laws still require non-QM lenders to verify your ability to repay the loan. Some of the more common non-QM mortgage options are:
- Bank statement loans. With this program, lenders calculate your income based on an average of your deposits over the last 12 to 24 months of your personal or business bank statements minus a set percentage of expenses.
- Asset depletion. High-net-worth borrowers can convert assets into qualifying income with an asset depletion loan. For example, a non-QM lender offering a 20-year fixed asset depletion loan to a borrower with a $250,000 savings account might convert the balance into $1,041.67 per month worth of income ($250,000 divided by 240 months equals $1,041.67).
You’ll need a bigger down payment and you’ll pay higher closing costs and interest rates than you would with a regular self-employed mortgage. However, a non-QM loan may bridge the gap if your tax returns aren’t acceptable to traditional lenders.
How to find a self-employed mortgage lender
Some lenders for self-employed mortgages offer conventional loans, loans insured by the Federal Housing Administration (FHA) or loans guaranteed by the U.S. Department of Veterans Affairs (VA) and the U.S. Department of Agriculture (USDA). However, ask your loan officer if they have experience underwriting self-employed income; if they don’t sound confident, you may want to compare rates until you find someone who can talk self-employed shop.
You may also want to give your CPA a heads up if you’re planning to apply for a self-employed mortgage. With so much uncertainty in the economy and underwriting taking so long, you should start early and be more prepared and organized than ever, before you start the mortgage process, Melwani said.