Mortgage Approval for Self-Employed and Freelance Borrowers

Oct 31, 2010
Karen Berger

Tax Forms are Needed for Self-Employed Applicants - Karen Berger

The days of stated income mortgages are over. Self-employed borrowers must meet the same standards as employed borrowers for a loan to be approved.

The standard, traditional mortgage is heavily weighted in favor of traditionally employed borrowers. Lenders calculate how much to lend based on the ratio between the applicant's income, already existing debt, and the amount to be borrowed. Income is verified with pay stubs (usually three months' worth) and perhaps a letter from the employer stating that the person is a full-time employee and is expected to continue in his or her employment

But self-employed borrowers have additional hurdles to clear.

Stated Income Mortgages: R.I.P.

Until the mortgage crisis of 2008 - 2009, stated income mortgages were the weapon of choice for many self-employed borrows. Self-employed people often have difficult-to-prove income streams because of factors such as cash payments, or high fluctuations owing to seasonal factors, or high business deductions from capital investments (which may make their taxable income lower even though the business may be profitable).

For a short while, the mortgage industry recognized that some of these potential borrowers were actually good credit risks. Lenders offered low-documentation mortgages where borrowers paid a slightly higher interest rate to offset the risk, and everyone went home happy- the self-employed borrower to a new house.

But there was a problem with these loans, and it's explained by their nickname: 'liar's loans." People simply made up income numbers. And then they ended up defaulting. Indeed, abuse of sub-prime loans was one of the driving factors of the recent mortgage meltdown.

The result: No more stated income loans.

Traditional Mortgages for Self-Employed Business Owners

Self-employed borrowers can still qualify for mortgages, but the requirements are much more rigid. Before you go house-hunting, have a meeting with a mortgage broker to find out as much as you can about whether you will qualify, how much you will qualify for, and what mortgage paperwork you will have to provide to seal the deal.

The business must be well-established and should have been in existence for at least three years, as proven by income tax records and business documents.
The business should have shown a profit over those last three years, to establish that the borrower has a stable source of income that can reasonably be predicted to continue into the future.
The applicant should have all the required documentation, including, if required, contracts of future work or audited accounting statements.
The applicant will also be required to provide all the other paperwork required of a borrower such as bank statements and credit references. In addition, some lenders require membership in a professional association, Chamber of Commerce, or business advertising to prove the ongoing nature of an active business.

The advantage of a conventional mortgage is that it is usually offers the lowest interest rates available, assuming the applicant's FICO score (credit rating) is acceptable.

The disadvantage is that it requires the self-employed borrower to submit tax returns proving income. And it requires mortgage applicants to meet the same loan-to-income ratio as conventionally employed borrowers. If you've just purchased a new vehicle for your business and taken it as a deduction, you might have reduced your taxable income to a nice low number- but guess what just happened to your loan-to-income ratio? It might have popped over the allowable limits.

Lenders will also want to see reasonable consistency regarding when the money comes in. If your business is surviving hand-to-mouth with severe fluctuations and cash flow problems, lenders are going to wonder whether they'll see their money. If nothing else is working in your favor, get a part-time job with a steady paycheck. Added to your self-employment income, the regular check might tip the balance in your favor.

It's not easy to get a mortgage as a self-employed borrower, but it is possible. It just takes a little planning, a lot of paperwork, good credit, and a watertight mortgage application.