If you’ve been wondering how to prove income when self employed to get a mortgage, you’re not alone. In the U.S., self-employed individuals make up 10.1% of the workforce, or nearly 16.2 million people, as of January 2023. This demographic represents a significant chunk of the workforce that’s often overlooked by conventional lenders.
Even though the median net worth of self-employed families was $380,000 compared to $90,000 for other worker families, it’s still far more difficult for someone who’s self-employed to qualify for a conventional loan.
For those wondering how to prove income when self-employed, understanding your options can make all the difference in buying your dream home. In this guide, we’ll be covering the different types of mortgage options you have and what you’ll need to qualify for them.
Disclaimer: While we are unable to provide personalized financial advice, we can share relevant statistics, educational resources, and additional insights to help expand your financial knowledge. Our goal is to empower you with the information and tools needed to make informed decisions when it comes to purchasing, refinancing, and real estate investing in general, whether for financial or personal reasons.
Understanding Self Employed Mortgages
Getting approved for a mortgage as a self-employed individual or 1099 contractor often requires a different approach than for those with a W2 income. Without a traditional paycheck, self-employed borrowers need to provide alternative documentation and consider different mortgage options that better fit their needs. These mortgage types, often called non-qualified mortgages (non-QM), are designed to accommodate unique income sources that may not fit the traditional mold.
Loan Options for Self Employed Borrowers
Here’s a look at some common non-QM mortgage options available for self-employed individuals:
- Bank Statement Loans: Instead of tax returns, these loans rely on monthly bank statements to show income. Lenders typically review 12 to 24 months of bank statements to confirm your income stability.
- Profit & Loss (P&L) Statement Loans: If you own a business, you can qualify for a P&L loan using a CPA-prepared P&L statement.
- Interest-Only Loans: With an interest-only mortgage, borrowers pay only the interest for an initial period, reducing monthly payments and freeing up cash flow. This can be a great option for self-employed individuals who need short-term financial flexibility.
- Debt Service Coverage Ratio (DSCR) Loans: Ideal for real estate investors, DSCR loans use the rental income produced by an investment property to qualify for the loan, rather than the borrower’s personal income. This option makes it easier for investors to leverage rental cash flow to secure financing.
- Asset Depletion Loans: Asset depletion loans allow you to use your liquid assets to qualify for a mortgage. Affordability is based on the total value of your liquid assets divided by as little as 60 months.
Each of these non-QM loan options will give you much more flexibility to prove your income in a way that aligns with your unique financial situation, making it possible to qualify for a mortgage even without any traditional income documents.
What Is Considered Self Employment by the IRS?
The IRS considers you self-employed if you work for yourself rather than as someone else’s employee. This covers a wide variety of setups, from freelancers and gig workers to small business owners and independent contractors. Whether you’re running a side hustle, working as a sole proprietor, or even part of a partnership, the IRS sees you as self-employed.
For tax purposes, some LLC or S corporation members also fall under this category. The IRS requires that anyone self-employed report their earnings and pay self-employment taxes (covering both Social Security and Medicare) even if you don’t have a formal business set up.
How Do Lenders Calculate Self Employment Income for a Mortgage?
Depending on the lender and the type of loan you apply for, self-employment income may be calculated a little differently. However, all self-employed mortgage lenders are generally looking for the same thing, no matter which lender or loan you choose: consistent cash flow and overall financial stability.
Below, we’ve summarized how self-employment income is calculated based on a select few types of loans for self employed borrowers:
- Bank Statement Loans: Typically, lenders will ask for 12 to 24 months worth of bank statements to calculate your average monthly deposit amount as your income.
- P&L Loans: P&L statements outline a business’ income and expenses, which gives lenders a solid overview of how it’s doing financially.
- DSCR Loans: Lenders calculate a rental property’s DSCR by dividing the Net Operating Income (NOI) by the annual mortgage payments. A DSCR of 1.0 or over means the property is making enough income to pay for itself. Some lenders, like us at Defy, allow DSCRs as low as 0.75.
How to Get a Self Employed Mortgage
Self Employed Mortgage Requirements vs. Conventional Mortgage Requirements
When it comes to getting a mortgage, self-employed borrowers face a different set of requirements than traditional W2 employees. While conventional mortgage applicants usually just need pay stubs, W2s, and a credit check, self-employed borrowers sometimes have to go the extra mile to prove their income stability and reliability and/or need to provide other alternative documentation.
Instead of a simple pay stub, self-employed applicants might need to provide two years of tax returns, a year or more of bank statements, or even profit and loss statements from their business. This is because self-employment income is often less predictable, so lenders look for additional proof that you can handle a mortgage over the long term. While the documentation may look a little different, these requirements allow lenders to get a fuller picture of your finances, especially if you don’t have a traditional paycheck.
How to Prove Income When Self Employed and Determine Eligibility
Determining eligibility for a self-employed mortgage involves proving income stability and a strong financial track record. Generally, lenders require documentation that shows a consistent income over the past two years, which can include tax returns, bank statements, and profit and loss statements.
They want to see that your income is steady or growing and that you can comfortably manage monthly payments over time. Your credit score, debt-to-income (DTI) ratio, and savings are also typically considered to gauge your overall finances. Using these factors instead of traditional income documents can help lenders evaluate if you can handle a mortgage despite having potentially fluctuating self-employment income.
Getting Pre-Approved and Finding the Right Lender
If you’re thinking of getting a self-employed mortgage, getting pre-approved is typically the first step. Not only does it give you a better idea of how much you qualify for, the interest rate, and the down payment required but it also shows sellers that you’re a serious buyer.
When choosing a self-employed mortgage lender, look for one with experience in working with self-employed clients since they’ll understand how to evaluate non-traditional income sources and documentation better than inexperienced lenders. Flexibility and access to a wide range of mortgage options can also go a long way when it comes to finding a mortgage that suits you.
For borrowers that don’t fit the traditional mold – Defy Mortgage has got you covered. We offer several non-QM loan options to fit your unique needs. Book a call with us today to learn how we can help you go through the mortgage process with confidence.
Improving Your Chances of Getting a Mortgage When You’re Self-Employed
Note: While we are unable to provide personalized financial advice, we can share relevant statistics, educational resources, and additional insights to help expand your financial knowledge.
Improving your chances of getting a mortgage when you’re self-employed often requires a bit more preparation, but with the right steps, you can strengthen your application. Here are some tips to help boost your eligibility:
- Improve your credit score since lenders place a lot of weight on credit scores when reviewing mortgage applications.
- Build up cash reserves to show lenders you can handle mortgage payments even if there’s a temporary dip in your income.
- Increase income consistency if possible to give lenders confidence that your income is reliable.
- Lower your debt-to-income (DTI) ratio since lenders favor borrowers who demonstrate they can comfortably manage debt.
How to Prove Income When Self Employed FAQs:
- What documents do I need to prove income if I’m self-employed?
The answer to this question depends on what type of self-employed mortgage you apply for. Below, we’ve listed the documents you would need to apply for each loan type with us at Defy:
- Bank Statement Loan: 12-24 months of bank statements.
- DSCR Loan: A DSCR ratio of 0.75, three months cash reserve, and proof of rental income.
- P&L Loan: Minimum two years of P&L statements with your business being at least two years old.
- Asset Depletion Loan: Proof of liquid assets. Determine loan eligibility based on liquid assets from your investment and bank accounts, not your income. Eligible assets typically include one’s most liquid assets: Savings and checking accounts, investment portfolios: stocks, bonds, mutual funds and retirement accounts: IRAs and 401k (depending on age)
- Can I get a mortgage if my self-employment income varies each month?
Yes! You can get a mortgage even with variable self-employment income. With a bank statement loan, lenders calculate your average monthly deposit amount to determine your eligibility.
- Do I need a higher credit score if I’m self-employed?
Not necessarily! Credit score requirements vary by lender, but you can qualify for self-employed mortgages with a minimum credit score of 620.
- Will I need to provide both personal and business bank statements?
The exact types of documents required will depend on the lender, but generally, if you apply for a specific loan type, such as a bank statement loan or P&L loan, lenders tend to look at just the required documents for that loan.
