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How to Get a Mortgage Loan If You’re Self-Employed With Fluctuating Income

By Mary McCoy

home mortgage optionsEven with tighter regulations on property financing, folks with “normal” income from an employer can be approved for a home mortgage loan fairly easily. You simply have to prove that you have steady paychecks, a credit score of 640 or above, and enough money in the bank to cover your down payment.

However, if you’re a business owner or are self-employed, qualifying for property financing isn’t as simple. Regardless of your income, new federal regulations require self-employed individuals to jump through a number of hoops to obtain home loans, which means you may need to think outside the box to find the financing you need.

New Regulations for Qualified Financing

After the U.S. real estate bubble burst in 2008 – setting off a credit crisis and a devastating recession – the Federal Government took a look at mortgage lending practices and determined that something had to change. As a result of those changes, consumers immediately found it increasingly difficult to obtain home financing.

The regulations are still being rolled out. In 2014, the Consumer Financial Protection Bureau established standards for “qualified mortgages” as part of the Dodd-Frank lending reforms. According to the New York Times, these loans are often challenging to gain approval for if you don’t work a conventional job.

However, the market is dominated by them. They are considered by the government to be solid and fair for both consumers and lenders alike. And, furthermore, mortgage companies are highly motivated to offer them, since doing so protects them from legal recourse should a loan go bad.

In order to get a qualified mortgage, you’re required to have the following:

  • Income Verification. It’s not enough to have a padded bank account – you need to prove that you have a steady stream of income. If you are paid sporadically but in large chunks, these paychecks are typically averaged out over the course of two years to give lenders a good idea of your monthly take-home.
  • Debt-to-Income Ratio. Your debt-to-income ratio cannot exceed 43%. For the purposes of mortgage qualification, this figure is calculated by dividing your recurring monthly debt by your recurring average monthly income. Of course, this is problematic if you’ve taken out loans to start or support your business.
  • Two Years of Personal and Business Tax Returns for the Self-Employed. Unfortunately, tax write-offs may come back to take a giant chunk out of your qualifying income when all is said and done, which is why lenders want to review your full returns. For instance, let’s say your self-employment income was $75,000 per year for the past two years, but your business write-offs were $50,000 each year. Lenders look at this as a yearly income of $25,000 – which would make it difficult to qualify for much of anything.
  • Analysis of Income Trends. Be prepared to explain dips in income. Even if your income looks good when averaged over two years, you have to explain any declining trends prior to qualifying.
  • Additional Financial Assets and History. Mortgage companies often want you to have a credit score of at least 640 to qualify for an FHA loan (a loan insured by the Federal Housing Authority), but your score needs to be closer to 700 for a conventional loan. The total down payment required ranges from about 3% to 20% of the price of the home, depending on the mortgage product (FHA loans usually require a smaller down payment than conventional loans). High down payments can be very challenging to come by if you’ve invested your liquid assets in your business.

All of these requirements can make it much more challenging to find financing if you’re self-employed or a business owner, even if you’re great with money and have significant savings.

home mortgage options

Alternatives to Traditional Property Financing

Even if it seems like you’d never be able to own your own property due to the new regulations for qualified loans, all is not lost. Other options may make it possible for you to find home financing.

1. Assistance From Family Members

While certainly not an option for everyone, some self-employed individuals rely on family members for home loans. Let’s say you’ve been self-employed for a year and earn a good income but cannot secure a qualified mortgage product because you don’t have two years of stable income. In this situation, family members with solid income (and a hefty streak of generosity) may be willing to co-sign your loan. The property belongs to you and you make payments on the mortgage, but your family members guarantee the loan.

Some mortgage companies even allow you to refinance the property into your name once you have your required two years of proof. Of course, this option can prove problematic for family dynamics if your business goes south or you default on the loan, so broach it cautiously.

2. Seller Financing

Sellers who own their property outright may choose to offer financing on their own either because the market is weak (they can’t find a buyer), or they’re interested in producing an income stream from their investment. The terms of a loan are written into a promissory note, and your monthly payments go directly to the seller.

These arrangements usually have a higher interest rate than bank loans, but they can cut overall costs by eliminating mortgage origination fees and other lending fees. You do need to be prepared to explain to the seller why you’re a trustworthy candidate when you weren’t a strong enough candidate for a traditional bank loan. In these instances, a sizable down payment, large bank account, and strong revenue streams can do the talking for you.

3. Rent-to-Own

A rent-to-own property can be a good option if you’re waiting for your two years of income proof before obtaining a qualified mortgage product. In these agreements, you enter into a lease and pay rent just like you would for any rental property. However, the rent is typically a little higher than market value, and this “extra” goes toward building a down payment which you can use at the end of the lease term to purchase the property. If you choose not to buy the house at the end of your lease, this surplus usually stays with the landlord.

The benefit of this option is to save up your down payment for a one- or two-year period, build your business, pad your income, and deal with any other issues that might block you from a qualified mortgage product, such as bad credit.

4. Investment Accounts or Insurance Policies

If you’ve got retirement accounts or insurance policies, you may be able to borrow against them. However, all of the following options require you to either build your retirement account or cash value insurance policy back to its previous size if you don’t want to shortchange the benefits they’re meant to offer. Also, remember that you lose out on earnings when your retirement money is used for a home rather than allowed to grow in your accounts.

Life Insurance
If you own a cash-value life insurance policy, such as a whole life or universal life policy, it’s possible to borrow against its cash value. As you pay into the policy over time, the cash value builds as it earns dividends and interest. You probably won’t even have to answer any questions about taking out a loan, but you do need a plan to pay it back (as you would with any loan).

Furthermore, you need to think long and hard about the risks associated with borrowing from a life insurance policy, particularly if the unthinkable happens and your family is left with a lower payout because the cash value is tied up in a loan. Rules vary based on the policy you own, so talk to your insurance company before making any decisions.

IRA
At any time, you can withdraw your contributions from a Roth IRA without taxes or penalty. (If you’re older than 59 1/2 years of age, you can withdraw funds tax- and penalty-free for any purpose.) However, even if you’re younger than 59 1/2 and contributed less than $10,000 to your Roth, you can withdraw up to $10,000 without tax or penalty to use toward the purchase, repair, or remodel of a first home.

To be considered a first-time homebuyer, you must not have owned a home for the past two years. Any earnings withdrawn must be used within 120 days, and those earnings must have been in the account for at least five years to avoid both an early withdrawal penalty of 10% and income taxes on the withdrawal. If earnings have been in the account for fewer than five years, you won’t be assessed the 10% penalty, but you do need to pay ordinary income tax.

You can also withdraw up to $10,000 from a traditional IRA, including SEP-IRAs, and avoid the 10% penalty if the money is used for the same purpose and is spent within 120 days. (If you’re older than 59 1/2, you can withdraw IRA funds for any purpose without penalty.) However, you do have to pay income tax on the withdrawal.

Furthermore, the $10,000 early withdrawal allowance is a lifetime limit on withdrawals from any IRA – including the Roth IRA – for buying (and repairing or remodeling) a first home. In other words, the sum of withdrawals from any combination of IRA accounts cannot exceed $10,000.

401k
While you can borrow against your 401k, it’s a risky option. Unlike withdrawing funds from your 401k – which is a bad idea unless done so in utter desperation – a loan against your 401k can get you cash up to half of your account value, with a maximum of $50,000.

For instance, if your account value is $50,000, you can only borrow $25,000 for a down payment. You do pay interest – but it’s paid back to yourself. However, the interest rate is variable – based on the prime rate – which could be a problem if prime spikes above its current level of 3.25%. Since a 401k loan term is typically five years (but some are up to 15 years) you need to be sure you can afford the monthly payments for the duration. Additionally, if you lose your job, you have as few as 60 days to repay the loan – otherwise, the unpaid amount may be taxed as ordinary income and assessed a 10% early withdrawal penalty if you’re under 59 1/2 years old.

5. Shop Around for Non-qualified Mortgage Products

It is possible to find lenders willing to think outside the “qualified mortgage” box if you demonstrate that you’re a low-risk candidate. Unqualified mortgage products include no-documentation loans, interest-only loans, and payment option loans.

For instance, say that your business loans have pushed you over the debt-to-income ratio for a qualified mortgage. If you have a 40% down payment, a great credit score, and several years of solid income, you can likely find a lender. However, because of the lender’s legal and financial risks associated with unqualified products, you typically pay a higher interest rate for this kind of product.

home mortgage options

Final Word

Just because you followed your dream to own a business doesn’t mean you have to abandon your dream of owning a home. Even if you have to wait two years to adequately prove your income, the time you invest in making yourself a good candidate for a loan could end up paying significant dividends. Use your time to set aside money for a larger down payment and boost your credit score so you can qualify for the best product out there when it’s time to buy.

What additional options can you suggest to find financing for a home while maintaining a self-employed status?

Mary McCoy
Mary McCoy, LMSW is a licensed social worker who works closely with individuals, families, and organizations in crisis. She knows first-hand how financial choices can prevent and mitigate crises, and she's therefore passionate about equipping people with the information they need to make solid financial decisions for themselves and their loved ones. When Mary isn't on her soap box, you can find her hiking, jogging, yoga-ing, or frolicking with her family.

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