The Self-Employed Borrower’s Guide to Getting a Mortgage

A recent Zillow study revealed that self-employed borrowers receive 40 percent fewer home purchase loan quotes, despite reporting that they make 81 percent more money than other potential borrowers.

A key reason is that self-employed borrowers are twice as likely as non-self-employed borrowers to report they have a credit score below 680. But credit scores are only one piece of the loan approval puzzle, so don’t be discouraged if you’re self-employed. You just need to present your case to lenders in more detail. Here’s a quick guide for doing so.

Loan approval decision factors

When approving loans, lenders evaluate eight core factors, for which they have guidelines about what they will and won’t accept. But they also weigh the combined factors, and are sometimes willing to make an exception for a weaker factor if another factor is stronger.

These eight loan approval factors are the root of all the “heavy paperwork” you hear about with self-employed mortgages. If you understand these factors and work with your loan officer to present your profile in a way that emphasizes your greatest strengths, the process is much less daunting. You’ll also want to understand which types of lenders are most willing to make exceptions.

  1. Credit score. Scores of 740 or above will be eligible for all loan programs and the best rates. Scores from 700-740 will still be eligible for most programs, but rates will rise slightly. Scores below 700 will render some loan options ineligible, and rates will be higher. Ask your loan officer whether credit score exceptions are available if other items in the list below are strong “compensating factors.”
  2. Occupancy. For lenders, owner-occupied properties are the lowest risk with the best rates. Second homes are slightly more risky, but have the same rates as owner-occupied homes. Rental properties are the most risky, with the highest rates.
  3. Property type. Single family homes are the least risky to lenders. Condos carry risk because the homeowners association must be in good financial health, while two-to-four unit properties are even more risky — unless you’re going to live in one unit and rent out the others.
  4. Loan product. Rates are highest for the longest fixed period (e.g., 30-year fixed), but lenders also consider long-term fixed loans less risky. Using a short-term adjustable rate mortgage (e.g., 5-year ARM) to help qualify because the rate is lower doesn’t necessarily reduce your risk profile in a lender’s eyes.
  5. Loan amount. Your lender will usually sell loans up to $417,000 to Fannie Mae and Freddie Mac, which means they’ll be less likely to make big exceptions on these loans because loan factors must fit Fannie/Freddie parameters. Loans above $417,000 are often kept on a lender’s balance sheet, which means exceptions are more likely.
  6. Loan-to-value ratio. This is the percent of loan you’re requesting relative to the value of the home. If you’re looking for exceptions in other areas, you want this ratio to be as low as possible — in other words, you’ll need a larger down payment.
  7. Debt-to-income ratio (DTI). This is your proposed monthly housing cost plus all other monthly debt as a percentage of your income. Your DTI ratio can be as high as 43 percent. All lenders will calculate it by averaging net income from your most recent two (personal and business) tax returns and your year-to-date income and expenses. But there is always nuance in interpreting how self-employed income is calculated, so find a loan officer who’s an expert at analyzing tax returns and business financial statements — they can identify and calculate all acceptable income for you. Low DTI is a critical compensating factor to get exceptions in other areas.
  8. Reserves after you close. Reserves are calculated with full value of liquid accounts, and 60 percent of retirement accounts. Lenders generally look for a minimum of two to six months’ worth of monthly housing cost left over in your bank accounts after you close a home purchase, and may require significantly more reserves if you’re seeking an exception in another area. Lenders may also ask you to move those reserves to their bank in exchange for making exceptions.