Introduction

The dream of homeownership has always been a quintessential part of the American dream. Yet, for those who are self-employed, this dream often comes with unique hurdles and complexities. Obtaining a residential mortgage as a self-employed individual can be a daunting task, laden with challenges that may not be apparent to those with traditional employment. In this article, we will delve into the intricate world of self-employed income and the hurdles it presents when seeking a residential mortgage.

Income Documentation

One of the primary challenges faced by self-employed individuals when applying for a residential mortgage is the need to provide comprehensive and reliable income documentation. Unlike salaried employees who can simply present pay stubs and W-2 forms, self-employed individuals must navigate a maze of financial records.

To qualify for a mortgage, lenders typically request two years of both personal and business tax returns. These tax returns should be meticulously prepared, showcasing consistent income. However, self-employed individuals often employ various tax deductions and credits to minimize their tax liability.

While this is a savvy financial move, it can inadvertently lower their reported income, making it more challenging to qualify for a mortgage with favorable terms. Remember that the mortgage that you are trying to get is likely supported by the Federal government so the income that you pay Federal taxes on will be what is used to qualify you for the loan. Try to minimize your expenses and deductions to maximize your income to qualify for the mortgage.

Fluctuating Income

Another substantial hurdle for self-employed individuals is the irregularity of income. Unlike employees with a fixed salary, the income of self-employed individuals can vary significantly from month to month and year to year. For this reason, lenders will look backward for two years of income to see that it is consistent and not project income into the future. The use of two years tax returns will likely understate your present income if it has been rising over the last two years.

Lenders typically calculate an income based on the past two years’ tax return using the following formula:

1. If income is rising from one tax year to the next, then take the average of the two years; or
2. If income is declining from one year to the next, take the income from the most recent tax year.

To mitigate this challenge, self-employed mortgage applicants may need to provide additional documentation, such as profit and loss statements or business financials, to demonstrate their ability to meet mortgage obligations, despite income fluctuations.

The lender will always use tax returns over profit and loss statements. Please do yourself of filing your tax returns right away after the end of the year and show as much taxable income as possible!

Creditworthiness

Creditworthiness is a crucial factor in the mortgage approval process. Self-employed individuals often find themselves in a precarious situation when it comes to creditworthiness. They may have a lower credit score due to the nature of their income or personal financial challenges.

To overcome this challenge, self-employed borrowers should work on improving their credit score before applying for a mortgage. Paying off debts, maintaining low credit card balances, and addressing any errors on their credit report can help boost their creditworthiness and increase their chances of securing a mortgage with favorable terms.

Also, if there are certain debts that are being paid out of the business, make sure that you tell your lender right away so that they can try to remove these from your loan profile.

Down Payment Requirements

Down payment requirements for self-employed individuals can be more demanding compared to salaried employees. Lenders often require larger down payments as a means of mitigating the perceived risk associated with self-employment income. This can be a significant obstacle for those who have invested a substantial portion of their income back into their business.

For example, Lakeside Bank offers a portfolio loan that may offer some flexibility for self-employed borrowers compared to conventional and FHA loans. However, the portfolio loan requires a 20% down payment.

Complex Business Structures

Many self-employed individuals operate their businesses as sole proprietorships or partnerships. While these structures are common, they can pose challenges during the mortgage application process. Lenders may require additional documentation, such as business licenses, partnership agreements, or articles of incorporation, to verify the legitimacy of the business and assess its financial stability. Also, the lender will likely need two years of tax returns for every LLC or S-Corp that you have.
To navigate this challenge, it’s essential to maintain organized and up-to-date business records. Providing clear and complete documentation can expedite the mortgage approval process and enhance the lender’s confidence in the borrower’s financial stability.

Debt-to-Income Ratio

Lenders assess a borrower’s debt-to-income (DTI) ratio to determine their ability to manage mortgage payments. A high DTI ratio can be a barrier to mortgage approval. For self-employed individuals, calculating their DTI ratio can be complex due to the irregularity of income and varying business expenses.

To address this challenge, self-employed applicants should work on reducing their existing debts and increasing their income where possible. It’s also advisable to consult with a Lakeside Bank mortgage loan consultant who specializes in working with self-employed borrowers, as they can guide you through the process with a high degree of competency.

Conclusion

While securing a residential mortgage can be challenging for self-employed individuals, it is by no means an insurmountable task. With careful financial planning, meticulous record-keeping, and the guidance of your Lakeside Bank mortgage loan consultant, self-employed individuals can navigate these challenges and achieve their dream of homeownership.

The key takeaway is that preparation is paramount. Self-employed individuals should take proactive steps to strengthen their financial position, including improving creditworthiness, saving for a down payment, and maintaining organized business records. By doing so, they can increase their chances of not only obtaining a mortgage but also securing one with favorable terms and interest rates, making their homeownership dreams a reality.