Self-employed borrowers often feel at a disadvantage when looking for a home loan. Without a W-2, they often feel that they cannot get a loan. With stated income loans gone by the wayside, where does this leave those working for themselves?
The good news is that there are plenty of options for borrowers working for themselves. It all comes down to your tax returns and what they say. If you claim a net loss or barely any income, it could be difficult to get a standard loan. You may have to turn to subprime or alternative documentation loans. This isn’t the end of the world, though, as these loans have come a long way in recent years.
Keep reading to learn your options for a loan as a self-employed borrower.
Conventional Loans
If there’s one loan everyone turns to first, it’s the conventional loan. It’s probably for good reason since this loan program often has the lowest interest rates and the best terms. While they also have the strictest guidelines, the rules have lightened up in recent years.
Today, Fannie Mae allows self-employed borrowers to secure a conventional loan with just one year of working for themselves. This is a change from the old 2-year requirement that made it difficult for those working for themselves to get a loan. What the conventional lender will look for is consistency in your income and your line of work.
Here’s how that works. Let’s say previously you worked as a financial analyst and have now decided to open your own car wash. There’s not a lot of similarity between the two industries with the exception that you are able to keep the books. A lender might think of your situation as risky and want a longer ownership history out of you before considering you for a loan.
Now, on the other hand, if you worked in the car wash industry, maybe as a manager or district manager and then decided to open your own car wash, it’s a different story. You have experience in the industry. You know what it takes to make it work. A lender might look at this as a lower risk and allow you to apply after just one year of self-employment.
Keep in mind, though, that Fannie Mae will only use the income reported on your tax returns. That means if you reported a loss, that’s what the lender will use for income. This could hurt some borrowers that take advantage of the many write-offs available to the self-employed.
FHA Loans
The FHA also offers the self-employed the opportunity to secure a loan. Their guidelines, while a little more flexible in terms of credit scores and debt ratios, is a little stricter when it comes to the length of time you must work for yourself.
The FHA requires you to own your own business for at least two years before they will consider your income for an FHA loan. In addition, you must show a steady increase or at least stability over the last two years. If there was more than 20% decline in your income from one year to the next, it could make you ineligible for an FHA loan. Like Fannie Mae, though, the FHA will require proof that you have the knowledge/experience to succeed in the chosen industry.
The FHA works in much the same way as Fannie Mae in regards to the tax returns. They will only use your adjusted gross income reported for your income. This could make it hard for those with a lot of write-offs to qualify for the loan.
The AlternativeDocumentation Loan for the Self-Employed
If your adjusted gross income is too low for you to qualify for either of the above loans, you have one more option – the alternative documentation loan. This is a subprime loan, which means the lender that underwrites the loan also keeps it on their books.
This can work to your favor since the lender keeps the loan, they don’t have investors giving their input. In other words, the lender can make up their own rules. They can grant exceptions and allow you to prove your income in an alternative fashion. This typically means with your bank statements. If you can prove to the lender that you make a certain amount of money on specific dates each month, they may use it for qualifying purposes.
The kicker is that the income must be consistent and it must be reasonable for the business you own. The lender will look up the normal income for someone in y our industry and compare it to the income that you show to make sure it falls in line with what you say.
These loans often require slightly higher down payments in order to offset the risk of using bank statements rather than tax returns. Lenders still must abide by the Ability to Repay Rules, which require lenders to get enough proof beyond a reasonable doubt that you can afford the loan they are proposing.
There are many options for the self-employed borrower to secure a mortgage today. It may not be the same stated income loans that we know from the past, but there are many available options. Check with several lenders to see which options are available to you as a self-employed borrower to make sure you get the deal that is best for you.