The mortgage application process follows the same basic procedures for every borrower. Underwriters make a credit decision based on an analysis of several factors, which include, in part –
- Income/Employment & Assets
- Credit Worthiness/Credit History
- Property
When integrated and underwritten, the information provided by these areas of an applicant’s life combines to allow an underwriter to make qualified credit decisions regarding the borrower’s capacity to repay the loan on time. The property is also reviewed, because, as collateral, it must meet underwriting guidelines.
Self-employed borrowers seeking mortgage approval often face challenges during the mortgage process because self-employed income sources tend to require additional documentation compared to salaried/W2 borrowers.
The income and employment for self-employed borrowers tend to be more complex, so it is verified differently. This generally translates to the provision of additional documentation to help the underwriter determine if an applicant meets the loan’s qualifications.
What Does a Lender Look for with Regard to Self-employed Borrowers?
Self-employed mortgage applicants are advised to anticipate that lenders will likely want to document, depending on the nature of the self-employed business, the following –
- Proof of income for the past few years.
- The ability of the business to generate enough income.
- Self-employment borrower’s financial strength, to name a few.
Proof of Income
Like any income used to qualify a borrower, self-employment income must be appropriately verified if it is to be used for qualification purposes. Self-employment can take many forms – as a full-time freelance job, alternate/extra income generated from work as an independent contractor, or from a side gig.
The exact required documents depend on the borrower’s scenario. Still, the required documents may include, in part, personal (1040s) and/or business tax returns (1120s), balance sheet, and Year-to-Date Profit & Loss (P&L) Statement, for example.
History of Employment
Reviewing a borrower’s employment history is a critical underwriting component. This information determines an applicant’s ability to maintain steady employment. Most lenders want a minimum of two years of ongoing self-employment within the same/similar industry outside extraordinary circumstances. In addition to standard tax documents, self-employed borrowers can provide the following to document their work history –
- A CPA’s letter.
- A relevant business license, if applicable.
- Evidence of insurance coverage, among others.
Note, though; newer self-employed applicants may be able to provide W2s to complete a minimum of two years of employment.
Debt-to-Income Ratio
All borrowers must meet industry-established Debt-to-Income ratios to qualify for a mortgage. Lenders qualify self-employed borrowers based on their net (not gross) income. This gets a bit tricky because self-employed borrowers can legitimately deduct expenses against their taxable income. Still, these deductions reduce one’s net income, which may impact one’s ability to qualify for a mortgage.
In addition, many self-employed borrowers have non-cash expenses (i.e., depreciation) that can be added back for qualification purposes.
The Bottom-Line
Self-employed borrowers need to work with a mortgage professional who can assist in making well-educated decisions regarding the more complex nature of the analysis of self-employment income and employment.
