The gig economy is bigger than it’s ever been. The pandemic has allowed many individuals to explore their passions, which meant freelancing for some and starting their very own business for others. If you are a business owner, an independent contractor or a freelancer and planning to buy a home at any point in your life, you should know how to navigate the mortgage guidelines today so you can maximize the loan amount and minimize the interest rate you qualify for when the time to buy a home comes. So, what does it mean to be self-employed and what mortgage guidelines do you need to be aware of?
Definition of “self-employed” in the mortgage lending world.
Self-employed borrowers are subject to some additional requirements that W-2 or salaried borrowers aren’t required to complete, so it’s important to first understand whether your mortgage lender will deem you to be self-employed.
If you own 25% or more of a business or you are not a W-2 employee (meaning you are paid as an independent contractor), you are deemed “self-employed”. There is an exception to this definition for business owners who own a business but have a salaried position at a company they do not own. For instance - if you own a small business but you have a full time job at Apple that pays $150,000 a year, you may need to provide your lender additional information on your business, but you are not “self-employed” for purposes of qualifying your income.
Additional Requirements for self-employed borrowers.
Self-employed borrowers have the same requirements as any other borrower when it comes to meeting mortgage qualifications such as debt-to-income thresholds and credit score requirements. However, there are 2 significant additional requirements that self-employed borrowers face when looking to qualify a loan.
First, almost every lender requires a self-employed borrower to have at least 2 years of steady self-employment income to qualify for a home loan. There is an exception to the 2-year rule if the borrower can show a that they have been self-employed for at least a year and before becoming self-employed, you worked in a similar line of work and the income in the new role is greater than or equal to the income from the W-2 position. If you just became self-employed and have been self-employed for less than a year, a lender will not be able to qualify your income even if you’ve been in a similar line of work for the last 15 years!
Self-employed borrowers also need to provide more documentation than W-2 borrowers, so it’s important to be organized. Different lenders may require more or less documentation, but as a general rule, a self-employed borrower should be prepared to deliver the following:
- Your latest balance sheets and profit-loss statements
- The last two years of your personal tax filings
- The previous two years of your business tax filings
When it comes to providing income documentation, it’s important to understand how the lender will review your file. First, significant declines in year over year income (for the business and/or you personally) can dramatically impact the loan amount you qualify for. Second, lenders use only taxable income to calculate the loan amount you qualify for, so if you run all of your expenses through your business to maximize taxable benefits, you may be sacrificing some of your eligible loan amount.
If, after providing initial documentation, your lender requires more evidence to document the length of your self-employment or your income each year, getting your lender in contact with your CPA can be the fastest way to get the lender everything they need.
Why do self-employed borrowers have more requirements than W-2 borrowers?
The reason self-employed borrowers face more requirements than W-2 borrowers is because self-employed borrowers pose a greater risk of fraud and default to the lender. Without proper documentation, self-employed borrowers could dramatically inflate their personal income and that of their business, and the lender would be unable to verify their statements. For W-2 borrowers, the lender is required to obtain employer verification, verifying income and employment status of the W-2 borrower right before closing, so there is no need to obtain additional documentation. Self-employed borrowers are also viewed as higher risk borrowers because the lender is counting not just on the success of the individual borrower, but also on the success of the business. The additional documentation helps to bridge the gap and provide greater comfort to the lender.
So, what’s next?
Traditionally, because of these added regulations, self-employed borrowers have a harder time qualifying for the loan they are looking for than W-2 borrowers. Because LendFriend is a local lender based in Austin, we’ve helped more than our fair share of freelancers and small business owners qualify for the loan they needed to buy their dream home. If you want to discuss your loan options and get qualified as a self-employed borrower, give us a call at 512.881.5099 or apply now, and one of our loan officers will be in touch as soon as we receive the application.
