Finding A Mortgage When Self-employed

Photo of person reviewing financial documents in application process for mortgages

It’s Sometimes Tough

If you are planning to apply for a mortgage and you’re self-employed -employed in Los Angeles or beyond, you should know going in that you have more hurdles to leap than do wage-earning employees. The truth is lenders consider the self-employed to be at higher risk than wage-earning employees. The personal income of the self-employed may appear to be low even though the business has good cash flow. Income may also be more up and down, making lenders question whether you can pay the mortgage every month.

Your job is to put the feverish mind of your lender at rest. As with any home loan applicant, you will need to document your income and your assets, show an acceptable credit history and a stable employment history. Prepare yourself for a bit of paperwork, but in the end, know that if you do everything right, you will soon be moving into your new home.

Self-employed people can get any kind of loan wage-earning employees can, but some are easier than others. There are also alternatives that work well for the self-employed when they can’t get approval for a traditional mortgage.

Here’s the basics.

Don’t Apply if Your Business is Brand New

If you just started your business, you are going to have to bide your time before applying for a mortgage. Usually, lenders want to see two years or more of steady self-employment. You may be able to get by with only one year in business if you worked at least one more year in the same field, and you earned at least what you are earning now.

Know the Documentation Requirements

When you apply for a mortgage, documentation requirements vary by lender, type of mortgage and your specific situation. But in general, you may need to show:

  • Proof your business exists such as a business license, signed letter from your CPA indicating you are currently in business or a letter from a professional organization that confirms your self-employment
  • At least two years of personal tax returns
  • At least two years of business tax returns (This might not be necessary if you have a sole proprietorship.)
  • A copy of your Schedule K-1 to indicate your share of earnings if your business is an S-Corp or a partnership
  • A canceled check you wrote to the IRS or a bank statement that shows you paid the taxed you owed last year
  • Year-to-date profit and loss statement along with business bank statements showing cash flow
  • Current balance sheet
  • Recent business receipts or signed invoices that show your business is currently in operation

Know These Income Issues

Lenders, of course, want to feel comfortable that you will pay your mortgage. Whether you are looking for a self-employed mortgage in Los Angeles or anywhere else, if there’s anything lenders like, it’s to be paid regularly and on time. Be aware that income requirements are going to differ among lenders and types of loans, but here are some of the common income issues.

Tax Write-Offs Can Come Back to Bite You

Most self-employed people take all the legal tax write-offs and deductions they can. The downside is, this can significantly lower your income on paper, the income you need to show to be approved for a home loan.

It may be possible to get around this issue with a bank statement loan that enables you to qualify based on the money flowing into your bank account rather than your tax returns. However, these loans have slightly higher rates and other unique qualification requirements. We will address this type of loan and other options to help the self-employed in a future blog post.

Be Prepared to Show Both Personal and Business Finances

If you are self-employed, the lender is going to ask for your personal financial records as you might expect. But they will also want to explore the health of your business. They will be looking at the mortgage amount your business can support on an ongoing basis.

Nontraditional Income Structures Scare Lenders

Lenders are used to granting loans to applicants with traditional jobs where the income that comes in every month is stable and reliable. Self-employed people are much more likely to have fluctuations in income depending on any number of factors according to their industries. Lenders want to be sure you can pay the mortgage even in your down season.

Be prepared to produce more paperwork that documents your income than your friend who has a regular job as an employee. A lender is going to want to see that your income is ongoing and that your current income stream is likely to continue. If you occasionally have some sporadic income, lenders probably won’t count it. If your business shows declining profits, it doesn’t look good for your home loan.

If it’s normal in your industry for business to be up and down from one year to the next, you may need to supply tax returns for more than the standard two years to establish that pattern.

For example, if you have a business that involves long projects, perhaps the beginning of the project has a lot of costs, but payment comes mostly at the end. This is not uncommon. And, once again, there are alternatives to traditional mortgages that are more readily available to the self-employed.

Sloppy bookkeeping Can Hold Up Your Loan

If you are not that organized about your finances, you need to get that in order before you even think about applying for a home loan. A common mistake among business owners, contractors and gig workers alike is mixing business and personal income.

You must document all your sources of income in preparation for the day a lender will ask for it when you apply for a mortgage. Use business finance software or at least a spreadsheet to demonstrate your income flow to lenders. They will want proof.

A Questionable Debt to Income Ratio Can Sink Your Loan

As with any other home loan applicant, lenders will look not only at your income but also the amount of debt you carry. But in your case, they will look at business as well as personal debt.

Your debt to income ratio is an important factor whether you will be approved for a mortgage for the home of your dreams. The requirement is usually a debt-to-income ratio of 43% or less.

Needless to say, before you apply for your home loan and during the time period your application is being considered, you do not want to take on more debt.

Liquid Savings and Assets Count

Income is only one of the things your lender will consider. When you apply for a self-employed mortgage in California, you will need to show proof that you have the down payment, fees and enough money in the bank to as reserves for future mortgage payments. Lenders will look to your personal finances for this rather than your business finances.

Your Credit Score Must Be Up to Snuff

In addition to your income and your assets, lenders will also consider your credit score. Usually they consider your FICO score, which may range from 300 to 850.

Here’s a translation of credit scores:

  • 800-850 – Exceptional
  • 740-799 – Very Good
  • 670-739 – Good
  • 580-669 – Fair
  • 500-579 – Poor
  • 500 or Below – Very Poor

Most people have credit scores somewhere between 600 and 750.

Go to AnnualCreditReport.com to check your credit reports once a year for free. (Until April 20, 2022, you can check every week for free with the three major credit bureaus as a concession to the Covid-19 pandemic.)

The credit score you will need for mortgage approval varies by the type of mortgage. If you’re score is over 740, you should have clear sailing. 620 is the minimum for a conventional loan, but some loans will accept FICO scores as low as 580.

All Lenders Are Not the Same

If you are self-employed, you should look for a lender with flexibility and experience. We probably don’t need to tell you that large banks are not exactly known for that. Online lenders and smaller banks typically favor wage earning borrowers who represent less riskier loans.

More often than not, your best option is to work with a mortgage broker who is experienced helping self-employed clients as preparation is the ultimate key. They know the ins and outs, can save you time and can keep you from falling into an abyss of paperwork with lenders who are never going to give you a mortgage. A good mortgage broker who has worked with a number of self-employed clients already knows many good loan options and can present them to you quickly.

We Can Help

If you are self-employed and looking for a self-employed mortgage in California or want to know your options, contact us at Loan Professors, a mortgage marketplace with access to the nation’s top 100 (and counting) wholesale lenders. We are a Mortgage Brokerage located in Los Angeles, who specializes in getting mortgage loans for our self-employed clients.

Call us at (800) 653-8987 or email us at Hello@LoanProfessors.com for a no obligation discussion about how you can own your dream home.