The American Dream. We’ve all heard of it. Most of us want it. And while many people’s dreams may vary when it comes to careers, family, etc., one thing can typically be found on everyone’s bucket list: a dream home of one’s own. In the past, the ability to purchase a dream home required having a consistent income, which traditionally meant working a full-time job. But the definition of “job” has changed for many people in recent years and continues to do so as each year passes. More and more people have become self-employed via the gig economy, or by starting their own business. Hence, they don’t always experience consistent income or enjoy the more traditional benefits of being a full-time employee. The good news is that this doesn’t mean self-employed people have to miss out on the dream of homeownership – they just have to go about the process a little differently.
Proof of Income
Typical full-time employees can easily show proof of income through their employer. With pay stubs and other documentation from an employer, lenders can verify a borrower’s income and history of income. Self-employed individuals, on the other hand, will need to rely on their own records to verify income. Now, if a person is self-employed, they’re probably already good at staying organized. So, what are lenders typically looking for to verify the income of self-employed professionals?
The financial strength of the person’s business
The ability of the person’s business to generate income in the future
A lender will expect an explanation for a financial history with periods of little to no income (a common occurrence for the self-employed). Hence, because the income of a self-employed person can tend to be at inconsistent intervals, typically proof of income over a longer period of time is required of the self-employed individual versus the full-time employee buyer.
In addition to proof of steady income, a lender will likely also ask for documentation (emails or letters) from current clients, which serves to establish likelihood of the ability to continue to generate further income. Other key documentation could include providing any state or other business license(s), DBA (doing business as) documentation, evidence of insurance for your business, or a record of a licensed certified personal accountant (CPA).
Lenders will also want to see full tax returns so they can develop a better understanding of the self-employed professional’s actual income. This means providing two years of personal and business tax returns (including profit and loss form). Also, if someone has been self-employed for less than two years, typically they will need to be able to prove having worked a minimum of 12 consecutive months as a self-employed professional to qualify for a mortgage.
Generally speaking, a good credit score(Opens in a new window) is always a great way to help secure a mortgage. This is no different for those who are self-employed. Borrowers should consider paying off existing debts to help gradually raise their score. A credit score of at least 640 for both an FHA and conventional loan is ideal.
One of the more important factors in the ability to get approved for a mortgage is debt-to-income ratio (DTI). DTI is the percentage of one’s gross monthly income paid toward monthly debts (think credit cards, car payments or other loans). Lenders prefer lower DTIs because it indicates less risk of repayment. A DTI of less than 43% is considered acceptable by most lenders. The self-employed individual who is at over 50% should consider ways to reduce debt before applying.
While the way people earn and make a living continues to change as more people opt for self-employment, fortunately, this does not negatively impact the ability to achieve the American Dream of homeownership. And while the self-employed may have to provide more information to get approved, the joys of owning their own home make the extra effort worth it. Our team of trusted partners at Guardian Mortgage are ready to partner with these individuals and help answer any questions they might have.