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Self-employed borrowers must be prepared to rigorously document that they are able to repay the debt they plan to take on. This isn’t always easy: Major obstacles you might face may include fluctuating income, the lack of a W-2 statement and difficulty when it comes to employment verification.
While these are certainly challenging obstacles to overcome, they are not impossible. If you’re self-employed, you can still get a mortgage – but the process will likely be tougher than if you were earning a corporate paycheck. We cover some tips on how to improve your odds of qualifying for a mortgage as a self-employed applicant.
- Maximize your income, minimize your debt
- Keep your credit high and avoid any unnecessary applications
- Put more money down
- Consider Alternative Financing Methods
Maximize your income, minimize your debt
One of the ways you can improve your application is by maximizing your debt-to-income ratio. Debt-to-income ratio (DTI) is very important when it comes to qualifying for a mortgage. This ratio measures the sum of your monthly debt payments divided by your gross monthly income.
For example, if your monthly debts are $4,000 and your gross monthly income is $8,000, your debt-to-income ratio is 50%. However, during underwriting, most lenders like to see no more than a 43% DTI if they are to approve an applicant for a qualified mortgage. While there are a few exceptions – mostly from smaller lenders – that 43% figure is fairly hard and fast.
The easiest way to improve this ratio is to deal with your debt. This includes any recurring bills, outstanding loans or other money that you owe. The credit bureau Experian recommends two different approaches: debt avalanche and debt snowball.
The debt avalanche is useful for those who make more money than they owe. With this method, you pay down high-interest debt by first focusing on the loan carrying the highest APR, working your way through your cards in descending order of APRs. Doing this reduces the amount of total interest you will pay. Over the long-term this method often saves the most money if used diligently.
The debt snowball can work well if you don't have a lot of extra cash to pay off your monthly debts. Here, you make the minimum payments on all cards, using any extra cash to pay off the debts with the lowest balance. The trade-off here is that you will likely pay more in interest, but you'll have more cash on hand from month-to-month.
Keep your credit high and avoid any unnecessary applications
A solid credit score is key if you’re going to be approved for any sort of loan. That’s why you need to pay attention to your credit utilization ratio. In general, this refers to how much of your total limit you’re using on credit cards or lines of credit. This is a major component of your credit score, comprising as much as 30% depending on the way it’s calculated.
A lower utilization ratio communicates to the lender that you are a responsible borrower who is capable of repaying debt. It also improves your chances of receiving a favorable mortgage offer with good terms.
Minimizing your credit use in the months leading up to your application
The weeks before you apply for a mortgage is not the time for big-ticket purchases. Cutting your credit use tells lenders that you’re not in over your head when it comes to debt – and that you can handle a major financial commitment like a mortgage.
Put more money down
Here we’re talking about your loan-to-value ratio, which is the amount you wish to borrow as a percentage of the home’s value. You run the risk of being turned down for a mortgage should the lender find the LTV too high, so you need to make sure that it’s as low as possible.
Since your LTV must be under 80% if you want to avoid paying private mortgage insurance, you will need to make a down payment of 20% or greater to avoid this fee. Borrowing less money upfront also means lower monthly payments until the loan is paid off.
Should you find you’re falling short on your own, you might also consider bringing in gift funds from family members. Keep in mind, though, that while gift funds can make the difference between a deal and no deal, there are restrictions. The two types of parties that may give gift funds are personal connections – friends or family – and nonprofit or government groups designed to help hopeful homeowners.
Consider Alternative Financing Methods
It may be time to think outside the box here. A few ideas:
No-income verification mortgages
Also known as stated-income loans, are based on criteria other than the standard income documentation. These factors include home equity, liquid assets and cash flow – and they can make the home loan process easier for self-employed applicants. Certain private lenders are willing to offer these while employing other methods for asset and income verification. Keep in mind that you will likely face a higher interest rate using these loans.
Finding a cosigner for your home loan.
While anyone can fill this bill, it’s best to choose someone close to you as it is a major obligation. Your cosigner should have good credit, a low debt-to-income ratio and a solid income. Moreover, they should feel confident that you will be able to repay the loan – after all, it’s their credit on the line, too.