According to Fannie Mae underwriting guidelines, any mortgage applicant with a 25% or greater ownership stake in a business is considered to be self-employed. While most anyone can lose their job at any time, Fannie Mae and most lenders consider self-employed borrowers to be a higher risk than W-2 employees. Key factors for any successful loan application are income stability and income verification, two areas where self-employed applicants may struggle in providing documentation. If you're self-employed, these issues can make you a less attractive mortgage candidate, resulting in higher interest rates and tighter underwriting requirements. But there are steps you can take to ensure your application is successful.
In good economic times, lenders may be lenient with income verification. Low documentation loans, sometimes called stated income or stated asset mortgages, make it easy to get a mortgage without having to verify your independent income. Fannie Mae and Freddie Mac, the largest loan buyers in the U.S. mortgage market, have strict requirements for self-employed income verification and lenders must comply if they want to sell their loans on the secondary market. Low documentation loans are difficult to find, so borrowers should have detailed proof of income. The best way to prove your self-employment income is with your last two years of tax returns and financial statements on your business.
Minimizing consumer debt will lower your debt-to-income ratio, which is your total monthly payments divided by monthly income. Because self-employment income tends to fluctuate, a lower ratio will make lenders more comfortable with the loan. Lenders normally offer lower interest rates to applicants with good credit scores. Protect your credit history by making all payments on time. Minimize other borrowing as much as possible, especially unsecured debt such as credit cards and revolving credit lines. Any factors like these that can help you get a lower interest rate will result in a lower mortgage payment, and thereby a lower debt-to-income ratio.
Don't wait until the last minute to start working on your documentation. Schedule a meeting with your lender to determine how much income is needed for your loan amount. Small business owners usually claim maximum tax deductions to keep income lower for tax reasons, but this can jeopardize approval. You may need to sacrifice tax deductions to increase qualifying income.
Consider Secondary Income
It may not always be possible, but having a secondary income source can strengthen your chances of approval. A W-2 income joint applicant, for example, can be especially helpful if your self-employment income has fluctuated in recent years. Lenders normally use a two-year income average. Other secondary sources, such as a salaried part-time job, will improve your chances.
Based in Atlanta, Steve Walker has a 28-year background in commercial and retail banking. Throughout his career, Walker has written extensively on behalf of his small business clients, analyzing their financial condition and making recommendations on their borrowing options. He holds a Bachelors degree in business administration from Furman University.