In general, lenders want to see consistency and reliability in a borrower’s income. This can be a challenge for self-employed borrowers, who often have variable and inconsistent revenue streams.
Lenders may use tax returns and recent bank statements to verify income for self-employed borrowers. They’ll also consider a borrower’s debt-to-income ratio and credit score.
What is a Self-Employed Person?
A Self-Employed Person is someone who debt review loans online earns their primary income from self-made activities as opposed to working for a company or another individual (an employer). People who are self-employed often have the freedom and creativity to pursue new ideas and find solutions to problems.
However, working as a self-employed person comes with some challenges, including inconsistent income and the responsibility for managing and paying your own taxes. Additionally, self-employed individuals typically do not receive employer-sponsored benefits such as health insurance or retirement savings.
A self-employed person can choose to operate a sole proprietorship, partnership, corporation or limited liability company. All of these business structures require the self-employed to report their income and pay taxes based on how much they earn.
What Documents Do Lenders Need for a Self-Employed Loan?
Lenders often require extra documentation from self-employed people to verify that their income is steady. In addition to a W-2, they may ask for two years of personal tax returns and business tax returns, as well as Schedule Cs, 1099s and profit-and-loss statements.
Borrowers should keep their business records clean and organized, so that it is easy for the lender to see how much money they are making. Also, separate your personal and business expenses.
How Do Lenders Determine Self-Employed Borrowers’ Income?
If you’re a self-employed person, lenders may consider you a riskier borrower because your income can fluctuate. In this case, a lender will conduct a thorough review of your business to determine its stability and the likelihood that your income will remain at that level over time.
Lenders typically look first at tax returns to verify your income. They subtract out deductions that aren’t actually incurred by your business, such as depreciation, to calculate your qualifying income for the mortgage.
How Do Lenders Determine Self-Employed Borrowers’ Debt-To-Income Ratio?
Lenders use your debt-to-income ratio to determine how much of your monthly income is spent on debt payments, including your mortgage payment. A debt-to-income ratio that’s lower than 45% can help you qualify for a mortgage.
If your debt-to-income ratio is higher than 45%, you’ll have to pay down some of your current debts before you can qualify for a mortgage. Large tax write-offs can also lower your income in a lender’s eyes, so it’s important to know what your DTI is before you begin the home loan process.
Whether you’re self-employed or have a traditional job, lenders want to ensure that your business will continue to produce consistent and predictable income for at least 3 years before approving a loan. This might include asking for several years of your business tax returns and a letter from your certified public accountant if you’ll be taking money out of your business to fund the down payment or closing costs.
How Do Lenders Determine Self-Employed Borrowers’ Credit Score?
Lenders determine borrowers’ credit score by reviewing their financial history. This includes the amount of debt they have and how well they’ve paid it back.
Whether you’re self-employed or an employee, you should review your credit report before applying for a mortgage. This will help you spot any errors or mistakes on your report that could negatively impact your ability to get a mortgage.
Lenders will also review your Debt-To-Income Ratio, which measures how much income you need to pay your monthly obligations compared to how much you earn. This can be tricky for self-employed borrowers because you may have to charge business expenses on your personal credit cards, which can increase your credit utilization.
How Do Lenders Determine Self-Employed Borrowers’ Payment History?
Lenders evaluate borrowers’ credit, debt, income and assets to determine whether they can afford the payments on their mortgage. Self-employed borrowers may need to provide extra documentation, such as tax returns, to prove their cash flow.
During underwriting, lenders also look at how much your business income fluctuates from year to year and whether you’re taking on too much debt.
While most conventional loans require two years of tax returns, some lenders offer alternative programs that count a borrower’s business cash flow instead of their total annual income. This type of loan, known as a bank statement loan, can be a great option for self-employed borrowers who don’t have the time or resources to get those 1-2 years of tax returns.