Are you self-employed and looking to buy a house? While it can be challenging, getting a mortgage as a self-employed individual is possible.
In this article, we'll cover what you need to know about self-employed mortgages, including the requirements, tips for getting approved, and the benefits of being self-employed.
Understanding Self Employed Mortgages
As a self-employed person, you are responsible for managing your own income and expenses. This can create a level of uncertainty for lenders when they are evaluating your mortgage application.
Unlike salaried employees, your income may vary from month to month or year to year. Lenders want to see a history of your income to determine your ability to make mortgage payments on time.
One way to demonstrate this consistency is by providing at least two years of tax returns and financial statements. This will allow lenders to assess your income over time and determine whether you are a reliable borrower.
In addition to these documents, lenders may also request additional information such as profit and loss statements, business bank statements, and other financial records to get a better understanding of your finances.
Requirements for a Self Employed Mortgage
To qualify for a self-employed mortgage, you'll need to meet certain requirements. These can vary by lender, but generally, you'll need to provide:
1. Proof of income
Being self-employed means that you work for yourself rather than for an employer. This can be a great opportunity to pursue your passions and have more control over your work.
However, it also means that you are solely responsible for your income. Unlike traditional employees who receive regular paychecks from their employer, self-employed individuals often receive payments from a variety of sources.
These payments can come in different forms such as cash or checks, and it can be challenging to keep track of all your income.
To maintain a record of your earnings, you need to provide documents that show your income. Some common documents include tax returns, profit and loss statements, and bank statements.
Tax returns are a declaration of your earnings and expenses submitted to the government for taxation purposes.
Profit and loss statements, on the other hand, are financial statements that show your business's revenue, costs, and expenses, giving you an idea of your net profit or loss.
Finally, bank statements provide a record of transactions on your bank account, including deposits, withdrawals, and transfers.
These documents can provide a clear picture of your income and help you keep track of your finances, making it easier to plan for the future.
2. Good credit
When you apply for a mortgage, lenders will scrutinize your credit history to assess your ability to make timely payments.
Your credit score plays a crucial role in determining your eligibility for a home loan. A good credit score indicates that you have a history of managing your debts responsibly and making payments on time. Lenders view borrowers with high credit scores as less risky and more likely to repay the loan.
A good credit score can also help you secure a better interest rate on your mortgage. A lower interest rate translates into lower monthly payments and a lower overall cost of the loan. This can save you thousands of dollars over the life of the mortgage.
So, if you're planning to apply for a mortgage in the near future, it's important to check your credit report and credit score to ensure that they accurately reflect your creditworthiness. If you have a low credit score, you may need to work on improving it before applying for a mortgage.
This may involve paying down debts, making timely payments, and correcting errors on your credit report. By doing so, you can increase your chances of getting approved for a mortgage and securing favorable loan terms.
3. Down payment
When you're looking to purchase a home, you'll need to have some money set aside for a down payment.
This is a portion of the purchase price that you'll pay upfront, and it's typically a percentage of the total cost of the home. In most cases, you'll need to provide at least 20% of the purchase price as your down payment.
This requirement is similar to what you'd face with a traditional mortgage. However, there are some key differences between a traditional mortgage and a home purchase loan. For example, with a traditional mortgage, you may be able to put down a smaller down payment, such as 5% or 10% of the purchase price.
With a home purchase loan, though, you'll typically need to put down at least 20% of the cost of the home. This is because a home purchase loan is considered riskier for lenders, so they want to see that you have some skin in the game before they lend you money.
4. Reserves
When applying for a mortgage, it is important to understand the concept of reserves. Reserves refer to savings or investments that lenders may require you to have in order to cover several months of mortgage payments.
Essentially, this means that you must have a certain amount of money saved up in case of unexpected financial hardships, such as job loss or medical emergencies.
The amount of reserves required varies depending on the lender, loan type, and other factors. Typically, lenders may require you to have reserves equal to anywhere from two to six months of mortgage payments. These reserves can be in the form of cash savings, stocks, bonds, or other investments that are easily accessible.
Having reserves can benefit both the borrower and the lender. For the borrower, having reserves provides peace of mind knowing that they have a financial safety net in case of unexpected events. For the lender, having borrowers with reserves can reduce the risk of default and improve their overall lending portfolio.
Therefore, it is important to consider building up your reserves before applying for a mortgage to increase your chances of approval and to provide financial security for yourself.
Tips for Getting Approved for a Self Employed Mortgage
Getting approved for a self-employed mortgage can be more challenging than a traditional mortgage, but there are steps you can take to increase your chances of approval:
1. Keep good records
Maintaining a well-organized record of both your income and expenses is essential if you are planning to apply for a loan from a lender. It will help you in providing all the necessary documents required by the lender in a hassle-free manner.
When you have proper records of all your income sources, it will become easier for you to determine your exact income.
It will also help you to understand the sources of your income and how much money you are earning from them. This is important because the lender will want to know about all your income sources before approving your loan application.
Similarly, keeping track of your expenses will help you to understand where your money is being spent. It will enable you to analyze your spending habits and identify areas where you can cut back on expenses. This information is crucial for lenders because they want to ensure that you have enough disposable income to repay your loan.
In addition to this, having a good record keeping system in place will also save you a lot of time while applying for a loan.
This is because you will not have to spend long hours searching for documents to prove your income and expenses. Instead, you can have all the necessary documents readily available, making the loan application process faster and more efficient.
2. Minimize debt
When it comes to applying for a mortgage, having a large amount of debt can negatively impact your chances of being approved.
Lenders take into account your debt-to-income ratio, which is the amount of debt you have compared to your income. The higher your debt-to-income ratio, the riskier you may appear to lenders.
To improve your chances of being approved for a mortgage, it is recommended to pay off any outstanding debts before applying. This can include credit card debt, car loans, and student loans. By reducing your debt, you will improve your debt-to-income ratio and demonstrate to lenders that you are financially responsible.
It is important to note that paying off debt may take time and effort, but it can ultimately benefit you in the long run. Not only will it increase your chances of being approved for a mortgage, but it can also improve your overall financial health and reduce stress related to debt. Prioritizing debt repayment before applying for a mortgage can help you achieve your homeownership goals.
3. Work with a mortgage broker
If you are self-employed and looking to obtain a mortgage, it can be a bit of a challenge. It's not uncommon for self-employed individuals to have difficulty obtaining a mortgage because they don't have a traditional income that lenders can easily verify.
However, a mortgage broker can assist you by connecting you with lenders that specialize in self-employed mortgages.
A mortgage broker is a professional who acts as a middleman between borrowers and lenders, and they can help you find the right lender for your specific financial situation. They have access to a vast network of lenders and can quickly narrow down your options to those who are most likely to approve your application.
Additionally, they can support you through the entire application process, ensuring that you submit all required documents and meet all necessary criteria to qualify for a mortgage. Ultimately, working with a mortgage broker can save you both time and money in the long run.
4. Consider a co-signer
If you're thinking about buying a house, it's important to understand the role a co-signer can play in the mortgage process. A co-signer is someone who signs the loan agreement with you, agreeing to be responsible for the payments if you can't make them.
Having a co-signer can be beneficial if you have a low credit score or a high debt-to-income ratio that could make it difficult to qualify for a mortgage on your own.
The co-signer you choose should have a stable income and good credit history. Lenders want to see that the co-signer has the financial means to make payments in case you fall behind on your mortgage. They also want to see that the co-signer has a history of paying their bills on time and managing their credit responsibly.
Keep in mind that if you default on the loan, the co-signer's credit score will also be negatively impacted. So, it's important to choose someone you trust and who understands the responsibilities of being a co-signer.
The Benefits of Being Self Employed
While getting a self-employed mortgage may be more challenging, there are benefits to being self-employed when it comes to mortgages:
1. More flexibility
Lenders that specialize in self-employed mortgages may be more flexible when it comes to income requirements and documentation.
2. Tax deductions
As a self-employed individual, you may be able to deduct business expenses, which can lower your taxable income and make it easier to qualify for a mortgage.
3. More control
Being self-employed gives you more control over your income and can help you increase your earning potential, which can make it easier to afford a mortgage.
Conclusion
Getting a self-employed mortgage can be challenging, but it's possible with the right documentation and preparation. Keeping good records, minimizing debt, working with a mortgage broker, and considering a co-signer can all increase your chances of approval. As a self-employed individual, you have more flexibility, tax deductions, and control over your income, which can make it easier to afford a mortgage and achieve homeownership.