Being your own boss can be one of the greatest conveniences in the world until you're ready to buy a home.
Although being self-employed gives you control over your working hours, salary and overall employment experience, it may not be as beneficial when you're attempting to get a mortgage. Whether you're a freelancer or entrepreneur, the common setback is showing your income history. Unlike someone who works for a business as an employee, you likely don't have a consistent amount on your paychecks. If you are a freelance videographer, for example, winter may be a slower time for business because of the cold weather. However, when spring and summer come around, you could have new jobs lined up each week.
With these income fluctuations in mind, there are some parts of the mortgage application process that are going to be different than if you weren't self-employed. Here are some things you should know:
- There will be more paperwork. Due to government regulations that are aimed at protecting consumers from bad mortgages, you'll have to complete more documents to verify your ability to repay the loan amount.
- You'll receive more scrutiny from lenders. The aforementioned regulations have also made lenders more critical of self-employed individuals who seemingly present more risk than other borrowers.
- You may not get the most favorable terms. Because you appear to be a riskier borrower, lenders will likely give you a higher interest rate. There's also a chance you'll have to provide a higher down payment.
Steps for getting around the pitfalls of being self-employed
As a self-employed borrower, these challenges can make it hard to find a lender who is willing to work with you and offer terms that you can afford. However, this is not to say there aren't measures you can take to improve your chances of getting approved. Here are some tips for appearing as a more attractive self-employed borrower:
- Give it some time if you're getting started with your business. Lenders like to see that you've been self-employed for at least two years. Although you're likely not interested in postponing your home purchase, it may be better to delay your aspirations until you can ensure your business is off the ground.
- Pay off your consumer debt. Much of the additional scrutiny you'll receive from lenders will be directed at your debt-to-income ratio. Reduce your outstanding balances, as doing so makes you appear more capable to afford monthly mortgage bills.
- Improve your credit score. While this is another factor that isn't limited to self-employed individuals, it is all the more crucial given the challenges you'll face. This step can take some time, which means you could have to delay your home buying goals depending on your current credit standing.
- Have cash reserves. If you're an entrepreneur and your business were to go under, do you have enough money saved to support yourself for a few months? Providing proof of these emergency funds can help you get approved for a mortgage.
- Apply with a coborrower. Talking to a lender with a spouse, friend or other person who appears as a less risky borrower can help you reach your goal of owning a home faster.
With the additional precautions that need to be taken, plan to spend additional time on your home buying journey. Between visiting multiple lenders to find one that is familiar with the challenges of self-employed borrowers and following the aforementioned tips, don't forget that you'll need to visit open houses, negotiate with sellers and order a home inspection to ensure the property you find is in the best shape possible.