How to get a mortgage when you’re self-employed

Getting a mortgage when self-employed to refinance or buy a house can be challenging. Income verification for traditional loans is often done through tax returns, but legitimate deductions related to your business that lower your tax bill may mean your income is understated. This can pose problems when you apply.

To get around this, lenders may offer bank statement loans in addition to traditional mortgage options. While money shown on bank statements is often viewed as a type of asset, bank statement loans use the cash flow from the bank statements to prove income. We’ll go over your loan options as well as how best to prepare.

Key takeaways:

• Self-employed borrowers will be asked to provide additional documents to prove consistent income, the health of their business, and their creditworthiness.
• Preparation is key to ensure a smooth underwriting process and increase approval odds.
• Comparing mortgage types and rates is important to ensure you get the financing you need.

Qualifying for a mortgage when you’re self-employed

The mortgage qualification process is often referred to as mortgage underwriting. It’s the job of the underwriter to determine if the level of risk associated with the loan is acceptable to the lender. The underwriter looks at several factors including:

• Employment: This verification is meant to make sure you have consistent work from which to derive income. We’ll get into proof for the self-employed later. There are also sometimes special rules for seasonal employment.
• Credit check: Because some loan options involve qualifying your income with less traditional means, higher credit scores may be required.
• Debt-to-income ratio (DTI): DTI compares your monthly payments on things like your home, car and other loans and lines of credit to your gross monthly income to determine the monthly payment you can afford.
• Assets: Understanding your savings lets your lender know how much you have available for a down payment and closing costs.
• Cash reserves: This helps determine the number of months you could make your mortgage payment if you were to lose income.

What are lenders looking for from self-employed borrowers?

The underwriting process for self-employed borrowers has the same goals as it would for anyone else. The main difference is how you show your ability to qualify.

In general, lenders will want to see the following to approve you for a mortgage:

• Income stability
• The location and nature of your self-employment
• The financial strength of your business
• The likelihood that your business can generate sufficient income in the future

Understanding loan options

Let’s take a look at the two common paths toward qualifying for a mortgage as a self-employed borrower.

Bank statement loans

Bank statement loans treat the cash flow shown monthly as income for the purposes of qualification. This is likely to be preferable for many self-employed borrowers because the income shown on tax returns is often lower due to related business expenses and deductions.

While these deductions lower what is owed to the government, they may also limit the amount that can be used qualify for a mortgage. The cash flow into your accounts from your bank statements is likely to be higher.

For our bank statement loans, clients have to have at least 25% ownership in the business. If your personal account isn't used to fund the business, you can qualify with that account. In this case, you’re qualifying with what you’re paying yourself from the business.

Alternatively, you can qualify with business accounts, but you have to own at least 50% of the business. If you do use your personal account to support the business, this may be your only option because your personal account is considered a business account.

To qualify for this loan option, the business has to have been open for at least 2 years.

In either case, you qualify based on the most recent 12 months of bank statements.

Because of the nontraditional qualification methods, these loans may be considered a bit riskier by lenders, and you can expect more stringent qualification requirements. While these will vary widely, here are some basic guidelines from Rocket Mortgage^® for a primary residence:

• Minimum down payment or equity: 10% – 40% depending on the loan purpose, number of units, loan amount and credit score
• Units: One to four
• Loan amount: Maximum is either $1.5 million or $2 million depending on credit score and down payment or equity
• Credit score: 660 – 760 based on down payment or equity and loan amount
• DTI: 45%

Traditional loan options

Traditional loan options are those from major mortgage investors like Fannie Mae or Freddie Mac and government agencies like the FHA and VA. These don’t qualify with bank statements but rather based on tax documents. When a client is self-employed, that means the following types of documents:

• 1099s
• K-1s
• Form 1120
• Form 1065
• Form 1120S
• Schedule E
• Schedule C
• All pages of personal and business tax returns for the last 2 years

While income could be challenging, there are advantages to these loans as well:

Down payments on primary residences are usually 5% or lower. VA loans typically don’t require a down payment. ¹

DTI can be more flexible, especially on FHA and VA loans.

Qualifying credit scores are usually between 580-620.

How lenders evaluate self-employment income

Regardless of which type of loan you’re getting, lenders look at gross income, business expenses, and broader trends in your income.

Net income vs. gross income

Net income is the amount of money you make (or lose) off your business after all expenses are accounted for. For example, if you have $200,000 in revenue, but $80,000 in expenses, your net income would be $120,000.

If you’re self-employed, this is also your gross income that lenders use to qualify you for a loan. Your gross income in this case is your net income before any taxes are paid on it.

Business expenses

Business expenses take into account everything related to the overhead of your business that’s not related to the cost of production. This might include:

• Rent or a mortgage on your space
• Employee benefits and salaries
• Equipment
• Utilities

With our bank statement loans, business expenses still matter because we apply an expense factor based on the number of employees you have and whether it’s a service or physical product business.

The expense factor can be 20% – 80% of your business income. You may also submit a statement from a third-party CPA or tax preparer.

Income trends and projections

Lenders want to know your income level is likely to continue so they can be sure you’re a good risk, so they’ll look at the trends in things like profit and loss statements and tax returns.

Having paperwork ready to answer questions will make the process go more smoothly.

What documents do you need to provide?

You’ll need to provide documentation verifying both employment and income. Again, it’s a great idea to have these things ready to go ahead of time to help speed things up.

Employment verification

Unlike when you’re a W-2 employee, when you’re self-employed, you’re responsible for confirming your own employment. In addition to the documents below, to qualify to use the income from bank statements, you need to show a 2-year history of operation through:

• Business license
• Tax preparer letter
• Secretary of State filing

Your percentage of business ownership can be based on a letter from a certified public accountant (CPA), attorney, enrolled agent, or certified tax preparer. You can also show your operating agreement.

Acceptable documents that you can submit to verify your employment include:

• A letter from a licensed CPA
• A letter from a professional organization that verifies your membership
• A state or federal business license you hold
• A “doing business as” (DBA) certificate

Income and asset documentation

When it comes to verifying income and assets for your monthly payment, down payment and closing costs, it’s helpful to have documentation on all of the following so your lender can provide the most potential qualification options:

• Personal tax returns: These are 1040s along with 1099s, K-1s, W-2s and tax schedules.
• Business tax returns: These are tax returns related to the business you own. Forms and schedules depend on your business structure.
• Bank statements: Depending on the type of loan you’re getting, bank statements may be used to show either income or savings for a down payment, reserves, and closing costs.
• Assets you own: if you have stocks, bonds or other investments, these could be liquidated for reserves or closing costs.
• Retirement accounts: You may be allowed to pull from these in certain circumstances for a down payment. If you’re nearing retirement, your lender may qualify you based on asset depletion. Asset depletion is the idea that regular withdrawals from your retirement act as income that can be used to make your mortgage payment.

If you’ve been self-employed for less than 2 years

If you’ve been self-employed for less than 2 years, it’s still possible to get a mortgage. But you should know that you won’t be able to use bank statements to prove income. More traditional verification through tax returns is necessary.

In addition, lenders want to see the following:

• 12 consecutive months of business activity: This shows the business is at least well-established. There is a minimum track record that the lender can go off of.
• 24 months in the same line of work: Even if your business is relatively new, if you had previously worked with a company in the same business before opening up shop a year ago, it shows the lender you have experience. For example, maybe you spent years as an electrician with a W-2 before setting off on your own.
• Proof of education: Education shows that you have long term commitment to this. You’ve worked to understand the dynamics of the industry.
• Professional certifications: Lenders may look at professional certifications to get an idea of work you’re trained to do. In some cases, a certification may be legally required based on the industry you’re in.

6 tips for self-employed mortgage applicants

We’ve gone over the basics, but how can you get ready as a self-employed mortgage applicant? Talk with one of our Home Loan Experts about your personal circumstances and check out these tips.

Tip 1: Lower your DTI

Debt-to-income ratio determines the monthly payment you can afford. DTI is a comparison of your monthly debt payments compared to your gross monthly income.

The DTI calculation is:

• Minimum monthly debt payments ÷ pretax monthly income ×100
• The lower your DTI percentage, the more room you have in your budget for a higher mortgage payment.
• If you plan on getting a mortgage soon, the fastest way to lower your DTI is to pay off debts with the highest monthly payment. If your purchase or refinance is a little further off, you may prefer to pay off the debts with the highest interest rate first.

Tip 2: Review your credit reports and habits

Not only is there a minimum credit score to qualify for a home loan, but it plays a big role in getting the best possible mortgage rate. Bottom line: the higher the better.

A few basic tips to keep your credit and check:

• Look for errors on your credit report. You don’t want to be held responsible for mistakes of the credit bureau or fraudulent items.
• Keep your credit utilization under 30% of your total revolving balances.
• Don’t open new lines of credit.

Tip 3: Keep business and personal expenses separate

Keeping personal and business accounts separate allows lenders to be sure of the amount you would personally have available to make a mortgage payment. You can show through a personal account the amount you’re paying yourself. It also allows you to do a bank statement loan with as little as 25% ownership.

Beyond this, inform your lender of any one-time expenses. You should also be prepared to give an idea of your expense factor based on your number of employees and the type of work you do. Doing these things will allow your lender to make sure they’re qualifying your income accurately.

Tip 4: Compare different mortgage types

It’s important to consider what type of mortgage is best for you. Bank statement loans allow you to show bank statements as proof of income which may indicate more qualifying income to a lender. On the other hand, more traditional mortgage loans may let you to qualify with a lower credit score and down payment.

If you qualify for several options, it may come down to the mortgage rate.

Tip 5: Consider making a larger down payment

A down payment is money paid up front at the close of your loan. The bigger your down payment, the less of a risk your lender is taking, so you may get a better rate.

Crucially for self-employed borrowers, a bigger down payment also means a lower monthly payment, which may be helpful if you don’t show as much income based on taxes.

Down payment assistance is money from third-party organizations that can be used toward your down payment and closing costs. It may be in the form of grants or deferred, forgivable, or traditional loans. Check with your lender to be sure they accept assistance from the provider before moving forward.

Tip 6: Consider applying with a co-signer or co-borrower

A co-borrower is someone who agrees to take responsibility for the loan with you. From a mortgage qualification perspective, a co-borrower and a co-signer are the same thing.

The advantage of this is that they can add their income to your application to help you qualify if you show a lower income due to self-employment. The ideal co-borrower is someone with a high income and low debt.

FAQ

Those are the basics, but let’s take a run at some other questions you may have.

How many years of tax returns do I need?

It’s always a good idea to have 2 years of tax returns available.

Do lenders look at gross or net income for self-employed borrowers?

Lenders look at net income after accounting for all expenses you have in running the business. There’s also an expense factor built in. For self-employed individuals, this is synonymous with gross income because we’re looking at it before taxes.

Can I use business income to qualify for a mortgage?

You can. It may be verified to bank statements or tax returns.

Can an LLC get a 30-year mortgage?

Some lenders may allow you to close a 30-year mortgage in an LLC. Rocket Mortgage doesn’t do these loans currently.

The bottom line: Your self-employment can be a path to homeownership

Getting a mortgage while self-employed does have its hurdles, but you can get both bank statement loans and traditional financing. To give yourself the most options, separate your business and personal accounts, have records of your business operation, and tax returns going back 2 years.

Every situation is different, so we recommend speaking with one of our Home Loan Experts. You can get your application started online.

¹ Rocket Mortgage is a VA-approved lender, not endorsed or sponsored by the Dept. of Veterans Affairs or any government agency.