How to get a mortgage for self employed clients

You are self-employed and you want to realize your dream of homeownership. However, the standard financial documents you need during a mortgage loan application—your proof of income, your tax returns, and your employment verification—are all over the place.

Will this impact your ability to get a mortgage? Does being employed versus being self-employed matter when applying? What do mortgage lenders look for when determining what constitutes a self-employed borrower?

Don’t panic.

While you will certainly need to get organized, being a self-employed borrower is not that much different from the more traditional type of borrower. Here is everything you need to know if you are a self-employed borrower.  To our usual audience of mortgage professionals, this article can serve as an educational piece to pass on to anyone you are working with that is trying to get a self-employed mortgage.

Is it hard to get a mortgage if you are self-employed?

The short answer is: Yes. If you are self-employed, it can be more difficult to get approved for a mortgage than if you have an employer. The reason it can be harder is that it is more difficult for mortgage lenders to get a sense of your income.

When you are employed, you can simply show lenders your pay stubs. When you are self-employed, lenders have to delve more deeply into your finances to determine if your income is reliable and if you can afford mortgage payments. Plus, there are other pitfalls.

Lenders often see self-employed buyers as being risky borrowers because lenders look first at tax returns to determine income. And since nearly all self-employed homebuyers deliberately lighten their tax burden by using deductions and write-offs to decrease their net income on paper, lenders see them as having unpredictable incomes.

Of course, being self-employed is in no way indicative of having an unreliable income. For instance, even employed homebuyers can quit their employment after receiving the mortgage. Keep in mind that mortgage lenders will not be any less likely to approve your mortgage application—you will just have to be better organized.

If you are self-employed, what you need to do is prepare yourself financially to colour yourself in the best possible light for lenders. In fact, this financial preparation does not differ so much from being employed and getting a mortgage.

How to prepare yourself for a self-employed mortgage application

Here is how to prepare yourself for a mortgage application if you are self-employed:

1. Optimize your credit score
2. Ensure you have a healthy debt-to-income ratio
3. Prove that you have a steady income
4. Save, save, save
5. Make a large down payment
6. Prepare all your financial documents
7. Make your income history readily available

Here is a closer look at each:

1. Optimize your credit score

A strong credit score history is integral to most financial transactions, especially a self-employed mortgage. The reason is that it gives lenders a good insight into how well (or poorly) you have dealt with debt in the past and if you have a history of making payments.

2. Ensure you have a healthy debt-to-income ratio

Your debt-to-income ratio is the portion of your income that you put toward your debt payments every month. Lenders usually look at your DTI to determine if you will have enough income remaining to make added mortgage payments.

Before you apply for a mortgage, you should pay off credit card or car loan debts, if you can afford to and if you are concerned that your DTI is too high.

3. Prove that you have a steady income

As a self-employed borrower, proving that you have a steady income may be the most critical preparation. Remember: You will qualify for a home loan if you can generate steady income, whether employed or self-employed.

Bank statements and tax returns are the more common ways to prove a steady income. Regardless, you will just have to ensure that you can prove your income with solid paperwork.

4. Save, save, save

While not totally necessary, saving big can help you out when you apply for a mortgage. If nothing else, it will provide you with more options, such as reducing the amount of debt you take on by making a large down payment, for example.

5. Make a large down payment

Lenders generally view you as less of a risk if you make a larger down payment, since by doing so you will have less debt to repay. Additionally, your monthly mortgage payments will be less, and you will have less money borrowed if you default. Having a down payment of over 20% can also save you from having to pay personal mortgage insurance.

Not only will a large down payment likely make it easier for you to qualify for a home loan, but it will also give you access to better terms such as a lower interest rate.

6. Prepare all your financial documents

The mortgage professional you are working with will let you know which financial documents you have to provide. While it can vary, bank statements and tax returns are most requested, so ensure you have those handy.

Since self-employed homebuyers usually have more complex sources of income, they typically have to dig more deeply, which may mean connecting your accountant with your lender or provided more proof of income.

7. Make your income history readily available

Most lenders will want to see your income history for at least the past year. For that information, lenders will most likely review your tax return. For this reason, you might want to change your approach to ensure you have a tax return that shows a strong net income, especially if you are in the habit of using a lot of write-offs.

Bank statements are another way to prove your income. For these, lenders usually as for up to 24 months' worth of bank statements to calculate your average monthly income, based on deposits into your account(s).  

How do I show self-employed income for a mortgage?

To show self-employed income for a mortgage, you will likely need to show a history of uninterrupted self-employment income, commonly for at least the past two years.

The types of documentation most lenders will look for break into two categories, such as:

• Employment verification
• Income documentation

Let’s take a closer look at each:

Employment verification

Employment verification will help you to prove that you are self-employed. One way to get employment verification is to show letters or emails from these sources:

• Licensed certified personal accountant
• Current clients
• Any business or state license that you hold
• Insurance for your business
• A Doing Business As
• Professional organization that can verify your membership

Income documentation

You will be one step closer to getting approved for a mortgage if you have proof of a reliable income. Be warned, however, that your previous income will also affect your ability to get a mortgage even if you currently make steady money.

The proof of income that most lenders ask for includes the following documentation:

• Personal tax returns
• Profit and loss statements
• Bank statements, i.e., monthly or quarterly documents that verify for your lender that you have enough money for a down payment

Self-employed for under two years

If you have been self-employed for less than two years, you will still be able to secure a mortgage; your business just must be active for at least 12-consecutive months. Additionally, your most recent two years of employment, even non-self-employment, must be verified.

In this case, lenders usually do an in-depth review of your training and education to determine if your business will likely continue a track record of stability.

Is it better to be employed or self-employed for a mortgage?

Mortgage lenders need to know that anyone they approve for a mortgage will be able to repay the loan. It is therefore up to you, the borrower, to prove to your lender that you are more than financially capable of making the mortgage repayments.

From lenders’ perspective, it is easier to determine your financial standing if you are employed rather than self-employed. Here is a quick breakdown of employed borrowers and self-employed borrowers:

Employed mortgage

Typically, employed borrowers have a contracted salary with their employer and are easily able to produce employment verification and income documentation. Lenders use this information to determine how much income the borrower has to make their mortgage repayments.

Not only that, but the employed borrowers' taxes are more neatly organized: at the end of every month, tax is deducted from their salary and the rest comprises their net income. In other words, these automatic calculations make it easier for lenders to determine if you qualify for a home loan and for how much.

Self-employed mortgage

For self-employed borrowers, ensuring their finances are as neatly organized and determining profit can be slightly more complicated, both for the borrower and the lender. As previously mentioned, this does not necessarily mean that you are less likely to be approved for a home loan—it simply means you will likely have to more work throughout the process.

The reason is that expenses, taxes, dividends, invoices, bills and more can make it hard to prove to a lender that the money you earn will be enough to consistently make mortgage repayments.

Remember: Organization is critical. If you want to purchase a property soon, you must start organizing your income and finances. This also means anticipating questions your potential lender will ask you about your income.

How to organize your finances for a self-employed mortgage

If you are self-employed and need to organize your finances for a mortgage loan application, the following strategies may be helpful including:

• Hiring an accountant: You may be required, by some lenders, to hire a qualified accountant to prepare your financial information. This is especially common if your accounts are complicated.
• Understanding your figures: It is important that you yourself understand your finances. If you own your own business and fail to demonstrate a thorough understanding of the financial side, most lenders will be reluctant to approve your mortgage loan.
• Using accounting software: This tool help you understand your own figures, but it will also keep all your financial information in the same place. This will not only keep you organized and provide insight for lenders into how your business is performing, but it will also provide evidence to lenders that you will be able to make the repayments.

Do self-employed buyers pay higher mortgage rates?

No, not necessarily. In fact, there are certain scenarios where self-employed homebuyers will pay lower mortgage rates than employed homebuyers.

Take, for example, interest rates. Interest rates that self-employed borrowers pay on their mortgage may be the same or sometimes lower than the interest rate of an employed borrower. Credit scores, down payment, and the length of the mortgage each impact interest rates.

For instance: If you are a self-employed borrower and make a 20% down payment for a 15-year mortgage, you may wind up with an interest rate that is lower than an employed borrower with a lower credit score who, for instance, puts down 10% on a 30-year mortgage.

Read more: Current Mortgage Rates in the USA

What do mortgage companies look at for self-employed mortgages

Mortgage companies will typically determine your eligibility based on income that is consistent, stable, and continuous. In other words, you will be eligible for mortgage financing as a self-employed borrower if you are one of the following:

• Earn a freelance income
• Are a business owner
• Do contract work
• Do season work
• Perform gig work and side jobs

Either of these types of income can be considered as additional funds on top of a primary income source or on their own merit.

Occasionally, lenders will also count unemployment income for seasonal or contract workers with a documented history of getting off-season unemployment. Regardless, loan officers have to determine any source of income as ongoing, i.e., that the income is likely to continue for three years’ minimum after closing. If your income is viewed as declining, it will make your chances with a mortgage lender worse.

To determine your business’s stability and the chances that the income it generates will continue at the same level, loan officers might also conduct a review for self-employed borrowers. One issue that can threaten your chance of approval is if you are in a declining industry, like a home builder during a housing crash or a restaurateur during the COVID-19 pandemic.

While being a self-employed borrower may be a little more complicated for both you and the lender, if you are well organized, it likely will not make a difference to your being approved or the type of mortgage loan you will receive.

All mortgage lenders need to know is that you will repay the loan. To prove that you can do that, ensure your financial documents—such as proof of income, tax returns, and employment verification—are in order. Remember: organize, organize, organize. If you can do that, you will realize your dream of home ownership, just like anybody else.

Are you self-employed and trying to get a mortgage? Or do you already have one? Let us know about your experiences in the comments section below.