Getting or refinancing a mortgage when you're self-employed can be a real challenge these days. With the virtual disappearance of stated income loans, it's become much more difficult for anyone who doesn't get a regular paycheck to qualify for a home loan. But it still can be done.
Stated income/stated asset loans, also known as Alt-A mortgages, used to be one of the most common ways for the self-employed to obtain a mortgage. You simply told the bank what your income was and the bank took your word for it. When housing values were rising, it really wasn't that big of a risk for the lender.
But Alt-A mortgages got a bad reputation as "liar loans" during the housing bubble, when they were abused to exaggerate incomes for borrowers who otherwise would never qualify for a loan. When the housing market and economy went sour, stated income/asset loans accounted for some of the highest rates of defaults and foreclosures, and most banks simply stopped offering them.
Proof of income is key
But for the self-employed, what that really means is that you're going to have to be more thorough documenting your income when applying for a mortgage - the same rules apply to refinancing a mortgage as well. And if you're in business for yourself, you're probably already accustomed to filing tax reports and documenting expenses, so documenting your income for a mortgage application won't be that much different.
Generally, you're going to need to show detailed financial records for the past two years, as well as tax returns. You'll probably need to file either IRS form 4506 or 8821; the former requests that a copy of your return be sent directly to the bank, for a fee; the latter allows the bank to inspect your return, for no charge. The bank may also want documentation on clients, investments, business financial records and perhaps a statement from your accountant, as well as a month or two of receipts to demonstrate current income.
One problem the self-employed sometimes have is that deductions for business expenses reduce their stated income on their tax returns. If you're planning to buy a house next year or down the road, check with your accountant to see what can be done to avoid this effect while still getting the deductions you're entitled to - you may want to defer some expenses to the following year, for example.
It also helps to be able to show that you have financial reserves or investments on hand as a cushion in the event of a business downturn. In addition, it's a good idea to pay off any consumer debt or at least consolidate it into a single low-interest loan with a reduced monthly payment to improve your cash flow.
Broker may offer more options
When shopping for a mortgage, the self-employed can often benefit by working with a mortgage broker. A broker will be familiar with large numbers of lenders, including major banks and small local institutions, and can help you identify ones that are best suited to your circumstances.
As a self-employed person, you probably won't be able to get the lowest interest rates that are available to those who draw a paycheck - banks often charge about a quarter of a percentage point more for mortgage loans to the self-employed. You'll need to come up with a substantial down payment as well - at least 20 percent, preferably more.
And, of course, you'll need excellent credit - preferably 720, 740 or more. You can still get a mortgage with lower scores, but you'll find that interest rates go up fast as credit scores go down.
If your spouse has a job that provides a regular paycheck and a W-2, it sometimes helps to have them be the primary applicant on the mortgage, with the self-employed partner as a secondary applicant. Another option, particularly for young people with a relatively new business, is to get a parent or other relative to co-sign the loan for you; of course, this means they're liable for the loan if you're unable to keep up with the payments, so this needs to be approached with caution.
Getting a mortgage for anyone these days is considerably tougher than it was in the past. But with good credit and proper documentation, it can be done. Banks still need to lend and make money - they're just being more cautious about how they do it these days.