Mortgage basics for small-business ownersDecember 2016 / Share
Applying and getting approved for a home loan requires a laundry list of paperwork, but that's not just because the lender wants to be annoying. In reality, the pile of forms that borrowers need when applying for a mortgage works to their benefit, since it helps lenders understand that person's financial situation and what kind of loan is right for them.
"Being self-employed does not exclude anyone from securing a mortgage."
A major part of financial health is income, which is why most home loan applications require recent pay stubs, income tax returns and other pertinent information. For the average salaried worker, this isn't hard to provide. For a small business owner or self-employed borrower, however, this process can become a little more complicated. But despite the extra legwork involved, there's no law that says self-employed workers can't get approved for a quality mortgage. If this applies to you, here's what you need to know.
Looking to start a business in the U.S.? You're in good company. According to the U.S. Bureau of Labor Statistics, there were nearly 700,000 registered companies in the country less than a year old. These small businesses, startups and entrepreneurs were responsible for adding around 1 million jobs in 2015, accounting for approximately 46 percent of all employment in the U.S.
If you think you have the next big idea for a blockbuster corporation, or just feel confident that you know how to improve an age-old business model, it might be time to start your own company. But if you looked at some of the more sobering BLS entrepreneurship data, you could have second thoughts. On average, around half of all businesses do not last more than five years, while only 20 percent can be expected to make it 20 years.
The challenges of beginning a business venture shouldn't dissuade anyone from realizing their opportunities, but it takes a great deal of planning to get a company off the ground and on a path toward success.
While self-employed borrowers may have a few different requirements compared to traditional employees, much of what they need to bring to a lender remains the same. This usually includes:
- Two most recent tax returns
- List of assets and debts
- Proof of income
The ways in which lenders acquire this information, though, are often different from the normal borrower. To get the tax forms, lenders often request them from the IRS directly, which requires self-employed applicants to fill out a Form 4506-T and authorize the release of this information. Today's financial institutions also don't rely on bank statements to see proof of income and assets. Also, the debt-to-income ratio is a common formula used to calculate a borrower's financial stability, and it too is a little different for the self-employed. Lenders often first look at DTI on the front end, which includes debt related to necessities like housing, and then the back end, which looks at recurring debt like student loans, credit cards and child support.
All in all, lenders tend to be more cautious with business owners or self-employed mortgage seekers. This is due to the different ways these individuals' income is recorded. For instance, business owners are able to deduct many expenses from their taxable income, which can make their true cash flow harder to discern.
Despite some additional roadblocks, owning a business or earning a living as a freelancer does not exclude anyone from getting a mortgage. Many warn that borrowers need stable finances and a high credit score to even have a chance at being approved for a home loan, but this is generally the case for everyone. A healthy financial outlook and the documentation to prove it is the most certain path to a mortgage for just about everyone.
Preconceived yet inaccurate ideas of what kind of loans self-employed borrowers can get also persist. It's a common belief that a Federal Housing Administration loan is inaccessible to most self-employed borrowers. This simply isn't true, but FHA loans do come with some of the same strict requirements as most other conventional loans3. In this case, the same diligent attitude is still the best way to approach any nonconventional loan.
Owning one's own business or working as a freelancer can be enough of a hassle, so it's understandable why these workers may be hesitant to seek out a mortgage. However, the path to a good home loan isn't much different from that of any other hopeful homebuyer. Perseverance in the search for a dependable lender and an affordable loan remains the perfect recipe for a low-stress and ultimately rewarding experience.
For more information on mortgages, contact your local Vectra Bank.
The information provided is presented for general informational purposes only and does not constitute tax, legal or business advice.