The traditional American dream centers around families or individuals working full-time careers, saving enough for a down payment and taking out a mortgage for a dream home. But that dream has changed because more people consider themselves self-employed and don't always earn consistent income.
The good news is that if you're self-employed, you can still get a mortgage to buy a home. Here's what you need to know:
Prepare to face stricter standards
Current lending standards are slanted to favor stable income sources and employment statutes. So if you go to a bank for a mortgage and are self-employed, prepare to face tougher lending standards, advised Bankrate [1].
Your requirements will also be different. According to Money Crashers, you'll need to provide the following information to lenders [2]:
- Source of income.
- Analysis of income trends.
- Debt-to-income ratio at or lower than 43 percent.
- At least two years worth of tax returns.
- Credit score between 640-700.
Let's go over some of these requirements:
Income verification
Naturally, lenders want to make sure you have a stable income before agreeing to loan you money. But because your income can often be sporadic, you should provide at least two years worth of paychecks.
"Lenders want to make sure you have a stable income."
Analysis of income trends
You'll need to explain to the lender why your financial history may show periods of little to no income. Always be upfront about why and how your income dipped.
DTI ratio at or lower than 43 percent
The lower your debt load, the better. Lenders might be hesitant to loan you a mortgage because if your income dips, they may worry if you'll be able to afford monthly payments in addition to other debts.
If you're serious about buying a home, make a strong effort to lower your DTI before speaking with a lender.
Two years of tax returns
Lenders want to see your full tax returns so they can develop a better understanding of your real income. When you're self-employed, you can take advantage of many tax write-offs that lower your qualifying income.
For example, you might've reported a self-employment income of $80,000 in 2017, but because of $50,000 worth of write-offs, your yearly income is actually listed as $30,000. At first glance, that's a low yearly income so providing your full tax returns gives lenders a better understanding as to why your taxable income was low.
A good credit score
This one should be considered a no-brainer. Without a good credit score, your chances of securing a mortgage dwindle.
Your credit score is influenced by many factors, one of which is your credit utilization ratio. If your credit score isn't up to snuff, focus on paying off existing debts (which will also help lower your DTI ratio). It'll take time, but your credit score will begin to improve and increase your chances of getting a mortgage.
How to increase your chances even more
Providing the right documents, keeping a low DTI ratio and having a solid credit score are only a few pieces to the overall puzzle of taking out a mortgage. If you want to bolster your chances of qualifying for a mortgage even more, consider boosting the size of your down payment. Usually, homebuyers should put forth at least a 20 percent down payment for a new home, though this isn't always the case.
Depending on the mortgage type, you may not have to come up with 20 percent of a home's value. For example, if you're applying for a Federal Housing Authority mortgage loan, you realistically only need to have a 3.5 percent down payment [3].
But since you're self-employed, you'll increase the chances of getting a mortgage by making a larger down payment, NerdWallet stated [4].
If you're looking to fund your down payment, consider turning toward your Individual Retirement Account for money. It has provisions in place to help you purchase a home for the first time.
You're allowed to withdraw $10,000 from a Traditional or Roth IRA if you're younger than 59 ½ years old, as long as the money is used to purchase a house. Keep in mind you'll need to pay taxes if you're withdrawing money from a Traditional IRA but not a Roth.
As someone who's self-employed, you like being your own boss. Just realize that you don't have a lot of say over the mortgage approval process because lenders want to make sure you're a qualified candidate.
You may face stricter scrutiny, but rest assured, it's entirely possible to buy a home if you're self-employed.
Sources:
[1]. Self-employed? How to get a mortgage
[2]. How to Get a Mortgage Loan If You're Self-Employed With Fluctuating Income
[3]. FHA Down Payment Rules
[4]. Self-Employed? 8 Keys to Getting Approved for a Mortgage and Buying a Home
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