Home Equity Loan Approval When You’re Self-Employed

If you’re self-employed and seeking a home equity loan, you might be wondering how to qualify for a loan from lenders who want to see a consistent paycheck. Whether you’re self-employed or working for someone else, you’ll still have to go through a formal application process and meet certain eligibility requirements if you want to take out a home equity loan.

Are You Considered Self-Employed?

Before you apply for a home equity loan, take a moment to make sure the Internal Revenue Service (IRS) considers you self-employed. If you’re an independent contractor or a business owner, then the IRS usually considers you self-employed. Independent contractors use Form 1099-NEC to document nonemployment income. If you receive a W-2, you’re an employee.

If you’re trying to determine whether you’re an independent contractor or an employee, the IRS uses the three categories below to distinguish independent contractors from employees.

• Behavioral: If the company controls your hours and how you do your work, you’re an employee.
• Financial: If you pay your own expenses and send invoices for the work you’ve done, you’re probably an independent contractor.
• Type of relationship: If there’s a written contract, the work you’re doing is ongoing and key to the business and you receive benefits, you’re probably an employee.

I’m Self-Employed: How Do I Qualify For A Home Equity Loan?

To qualify for a home equity loan, you need to meet the lender’s requirements. Though each lender may have slightly different criteria, the requirements for self-employed borrowers are often very similar and focus on evaluating your ability to repay the loan and your home’s market value.

Minimum Equity Requirements

Most mortgage lenders look for at least 15% – 20% equity in your home before you can take out a home equity loan. This requirement remains the same regardless of whether you’re self-employed or working for someone else.

Income Verification

Lenders want to make sure you can consistently make the monthly payments on your home equity loan, which is why you’ll have to prove you have steady income. If you’re self-employed, most lenders will ask you for at least 2 years of both your personal and business tax returns. They might also request additional information about your business, including profit and loss statements or balance sheets.

If you’ve been self-employed for less than 2 years, you may be able to combine the W-2 from your old job with your current self-employment income. In some cases, you may be able to work around the income requirement by showing the lender statements from your bank accounts or investment accounts.

Credit Check

Like most mortgages, a home equity loan application will include a credit check for self-employed (and employed) borrowers. Though the minimum score can vary from 580 – 620, some lenders might require a credit score of at least 680.

A Low Debt-to-Income Ratio

Another important number lenders consider when you apply for a home equity loan is your debt-to-income (DTI) ratio. Your DTI ratio tells lenders how much debt you have relative to your pretax income. Most lenders prefer a DTI ratio of 43% or less, though some will permit a DTI ratio as high as 50%.

Home Appraisal

A home equity loan is secured by the value of your property, which is why lenders often require a home appraisal before approving one. Since an appraisal is based on your home’s current market value and not your income or credit history, your employment status won’t affect your home’s appraised value.

Differences In A Home Equity Loan When You're Self-Employed

Do you want to know how applying for a home equity loan as someone who’s self-employed might differ from someone who’s employed? Here are the answers to some common questions you might have.

Is Qualifying More Difficult If I’m Self-Employed?

Though it can be more difficult to qualify for a home equity loan if you’re self-employed, it’s still possible. Since it’s more difficult for lenders to evaluate your income when you’re self-employed, they may want to see a longer income history, a lower DTI ratio, a higher credit score or additional proof of assets before approving your home equity loan application.

Will Home Equity Loan Rates Be Higher If I’m Self-Employed?

Lenders sometimes view self-employed individuals as higher-risk borrowers than those who are employed and earn a consistent paycheck from someone else. While self-employed applicants may see slightly higher interest rates on their home equity loans, that’s not always the case.

Mortgage lenders take many factors into account and self-employment income is just one of them. For example, a self-employed borrower with a high credit score and low DTI ratio might get a lower interest rate than someone who’s traditionally employed but has a lower credit score and higher DTI ratio.

Home Equity Loan Alternatives When You’re Self-Employed

If you’re self-employed and decide a home equity loan isn’t right for you, there are still several other options for you to consider, including:

No Doc Or No Income Verification Home Equity Loans

Every loan requires some level of documentation, but some home equity loans will allow you to qualify without traditional income verification, such as pay stubs and tax returns. Instead, the lender relies more heavily on other aspects of your application, such as your credit score or bank statements.

These loans are more specialized and not offered by all lenders. They also tend to come with a higher interest rate than home equity loans approved with verifiable income. For more information on no doc home equity loans, see if your lender offers this option or search online for a company that does.

Home Equity Lines Of Credit (HELOC)

Like a home equity loan, a home equity line of credit (HELOC) is another type of second mortgage. A HELOC is a revolving line of credit that allows you to borrow money against the equity in your home, and it uses your property as collateral.

Though the application process is similar to a home equity loan, there are a few key differences. First, a HELOC has a variable interest rate, which can change during the life of the loan. Second, a HELOC has a draw period and a repayment period, while home equity loans require repayment of principal and interest immediately. Lastly, with a HELOC, you can borrow money incrementally whenever you need it, rather than the single lump sum you get from a home equity loan.

Cash-Out Refinance

A cash-out refinance is different from a home equity loan because it replaces your existing first mortgage. You’ll have to qualify for a new loan, which will have different terms than your previous mortgage. Since lenders tend to view a first mortgage as less risky than a second mortgage, qualifying for a cash-out refinance may be easier than qualifying for a home equity loan.

Personal Loans

A personal loan lets you borrow a lump sum of money and often doesn’t require any collateral. Personal loans are generally approved much faster than home equity loans and can offer greater overall flexibility. On the flip side, they usually come with higher interest rates (especially if the loan isn’t secured with some type of collateral) and lower borrowing limits.

Conventional Business Loans

Since many self-employed individuals are also business owners, a business loan could be a great alternative to a home equity loan. Business loans may require a personal guarantee, and will usually check both your personal and business credit scores. They’ll also need to verify the financials of your business such as bank statements and balance sheets.

SBA Loans

The U.S. Small Business Administration (SBA) offers a variety of loan programs to help support small businesses in the U.S. These loans can offer some attractive options to self-employed business owners. But they do come with some limitations, like how you can use the funds. If you have business expenses, want to purchase assets or just need additional working capital for your business, an SBA loan might be a great alternative to a home equity loan.

The Bottom Line

Qualifying for a home equity loan can look a little different when you’re self-employed. Fortunately, it’s not your only borrowing option. If you have a good credit score, a low DTI ratio and can prove you’ve earned a consistent income while self-employed, most lenders will still view your application favorably. Since lenders may have a more difficult time verifying your income when you’re self-employed, be ready to share some more extensive documentation of your business’s financials.

Looking to tap into your home’s equity to cover business or personal expenses? Apply for a home equity loan online today.