Self-employed borrowers face unique circumstances. Lenders look at you as risky because you don’t work for someone else. Your income is dependent on how your company does. When you work for someone else, there’s a bit more consistency and reliability in your income.
This doesn’t mean it’s impossible to get a mortgage as a self-employed borrower, though. You have options; it comes down to proving that you are an attractive borrower, which means showing low debt ratios.
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What are the Required Debt Ratios?
Contrary to popular belief, self-employed borrowers don’t have their own debt ratio requirements. You have to meet the same eligibility requirements as an employed borrower. Here’s the difference – low debt ratios make you look less risky. This factor may encourage lenders to approve your loan.
Each loan program requires different debt ratio maximums:
– Conventional 28% housing ratio and 36% total debt ratio
– FHA 31% housing ratio and 41% total debt ratio
– VA no housing ratio and 41% total debt ratio
– USDA 29% housing ratio and 41% total debt ratio
How do you Calculate Self-Employment Income?
The problem for most self-employed borrowers is how the income is calculated. Unlike a W-2 employee where the lender can take the total income and divide it by 12, self-employed borrowers don’t have a W-2. Instead, lenders have to rely on your tax returns.
Typically, they want tax returns for self-employment for the last two years. They use the 24-month average to determine your average monthly income. Here’s the kicker, though. Lenders take into consideration your adjusted gross income or your income after deductions and credits. Self-employed borrowers often take a large number of write-offs in an effort to decrease their tax liability. This may hurt your chances of approval since less income creates a higher debt ratio.
Lenders take your AGI from your last two years of tax returns to come up with your average income. They’ll also require a current YTD Profit & Loss Statement that shows your income is on par to meet what your tax returns show that you make.
Can you Get a Mortgage if You’re Self-Employed for 1 Year?
Because lenders look at your last two years of income, it may be harder to get a mortgage with only one year of self-employment. Lenders may consider it if you:
– Have a history of working in the industry you started a business
– Prove that you have the education/knowledge to run a business in the industry
If you only have one year of self-employment, though, lenders may require low debt ratios to lower the risk of default.
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What are Compensating Factors?
As a self-employed borrower, you’ll need compensating factors. These are factors that make up for your self-employment. This could mean any of the following:
– High credit scores beyond what the program requires
– Lower debt ratios than the program requires
– Higher down payments than the minimum program requirements
In other words, lenders want to know that you are a good risk. If you have a high credit score, it shows that you’re financially responsible. This gives lenders a reason to consider your application. They know that you handle your finances well despite being self-employed.
Low debt ratios are something all lenders want. The lower your debt ratio, the less money you need every month. This gives lenders reassurance should you have a ‘bad’ month. You should still be able to pay your mortgage.
Finally, a large down payment gives you ‘skin in the game.’ When you invest your own money in the home, you show lenders that you are invested in it. Most borrowers that have their own money invested will do whatever it takes to make sure they make their mortgage payment.
The bottom line is that self-employed borrowers need the same debt ratios or expense ratios as regularly employed borrowers. It comes down to the big picture. What level of risk do you pose to a lender? Are you a high risk of default or do your compensating factors make up for the fact that you are self-employed?
