Residential Magazine

Dig Deep Into the Details

Self-employed borrowers aren’t tricky to qualify if you follow this blueprint

By Tyler Stone

One of the most significant challenges you may face as a mortgage originator is helping self-employed borrowers navigate the homebuying process and qualify for a mortgage. Unlike typical W-2 employees, self-employed individuals have unique financial situations that can make it difficult to obtain a traditional mortgage.

With the rise of the gig economy and an increasing number of people starting their own businesses, originators shouldn’t overlook this group of clients who are looking to purchase homes. It’s important to understand the right approach and best practices for helping these entrepreneurial clients achieve their homeownership dreams.

Financial details

The first step in working with these clients is to understand their unique financial situations. Self-employed borrowers may have fluctuating income or may write off expenses on their tax returns, which can lower their taxable income.

As a mortgage originator, it’s important to understand the applicant’s business model and how they generate revenue to accurately determine their qualifying income. Then you can work with an underwriter to find out if they’ll consider any add-backs for a wide range of business expenses.

“If you have any questions about the client’s tax returns, don’t hesitate to ask for clarification. You’re there for guidance.”

Traditional W-2 employees, depending on their employer, generally have consistent levels of income over time. On the other hand, self-employed individuals may have varying levels of income from year to year, or within the same year, which can pose challenges in qualifying for a mortgage.

If the applicant doesn’t have a regular paycheck coming in each month, it can be difficult for a lender to verify how much money they make, available savings for a downpayment and any necessary cash reserves. As their originator, it is your responsibility to gather as much information as possible about your client’s finances and income (both personal and business) to best serve their needs.

Another major consideration is the borrower’s debt-to-income (DTI) ratio. For self-employed workers, calculating the DTI can be more complicated than it is for traditional W-2 employees. Originators need to ensure their borrower’s DTI is within acceptable limits of the loan program in question. Lenders typically prefer a DTI of no more than 43%, although some may be willing to go higher. If the DTI doesn’t fall where it should, encourage the client to lower the ratio by paying off debts, reducing expenses or increasing their income by writing off fewer expenses.

“Make sure your clients know that credit-building best practices are critical in qualifying for a mortgage that best fits their circumstances.”

One of the best ways to understand a self-employed borrower’s financial situation is to review their tax returns. These provide a wealth of information about an individual’s income, expenses and overall financial health. It’s wise for originators and borrowers to sit down and carefully review these items together. Look for any inconsistencies or red flags that may impact their ability to qualify for a mortgage. If you have any questions about the client’s tax returns, don’t hesitate to ask for clarification. You’re there for guidance.

Proper documentation

Another key factor in understanding your self-employed borrower’s financial situation is to have proper documentation. Entrepreneurs are required to provide more documentation than W-2 wage earners.

They’ll need to provide past tax returns (such as K-1 forms), profit-and-loss statements, balance sheets and bank statements. Additionally, a lender may require some or all of the following information:

  • Business debts and monthly payment amounts
  • Assets such as savings and investment accounts
  • Additional sources of income (alimony, Social Security, etc.)
  • Evidence of their business entity or self-employment status (business license, client testimonials, accountant statements, etc.)
  • Evidence of recent mortgage or rent payments

Encourage your self-employed borrowers to keep accurate records of their income and expenses. Keeping detailed records helps these clients qualify for the right mortgage and makes the homebuying process smoother.

As their originator, it’s helpful to provide your clients with resources and tools to help them track their finances. For example, you might recommend they use accounting software or work with a financial planner to manage their finances effectively. This also applies to helping them improve their DTI ratio.

Credit scores

Along with understanding your client’s financial situation and having the correct documentation, it’s critical to help them improve their credit score. A borrower’s credit score is important for any loan application, but it’s especially important for those who are self-employed. A solid credit score can help offset any concerns about fluctuating income or tax returns with write-offs.

A strong score is also essential for locking in the best interest rate, but it can be more challenging for entrepreneurs to build their credit than it is for traditional W-2 employees. You should work with your clients to help them build their credit. Have they established their business credit? Do they pay their bills on time? Have they taken on too much debt?

Make sure your clients know that credit-building best practices are critical in qualifying for a mortgage that best fits their circumstances. It’s also helpful for brokers in building strong relationships with lenders. Even if a borrower already has a good score, it doesn’t hurt to encourage them to keep at it. Reinforce the fact that consistently paying their bills on time, keeping their credit utilization low and monitoring their credit report will help to boost their score.

Loan types

There are many types of mortgages available. It’s important to help your self-employed clients choose the right type to fit their needs.

Some self-employed borrowers may benefit from a fixed-rate loan, which offers consistent monthly payments and a stable interest rate (for those with a more stable income). Other borrowers, however, may prefer an adjustable-rate mortgage, which has a lower initial interest rate but is likely to fluctuate over time.

Additionally, some borrowers may benefit from a government-backed mortgage from the Federal Housing Administration or the U.S. Department of Veterans Affairs. These loans have more flexible requirements and lower downpayment barriers, which can make them attractive options for entrepreneurial types who may not qualify for conventional mortgages.

It’s important to note, however, that government-backed mortgages may have additional fees and requirements, such as mortgage insurance premiums. It’s crucial for originators to help their clients understand the pros and cons of each type of loan, then choose the smartest option for their needs.

● ● ●

Working with self-employed borrowers can be more difficult than working with W-2 wage earners. But by understanding their financial situation, organizing the proper documentation, reviewing their credit scores and explaining the different types of mortgages that can work for their circumstances, you can help them qualify for financing and navigate the daunting home purchase process.

The bonus comes in the form of winning a lifelong client. By offering excellent service and advice, you’ll not only help these people achieve their homeownership dreams, you’ll also build long-lasting relationships with them as a trusted loan adviser. ●


  • Tyler Stone

    Tyler Stone is the founder and president of Capstone Financial, which specializes in privately funded loans for commercial and fix-and-flip investment properties. A national direct lender launched in 2010, Capstone has simplified underwriting processes for first-lien position investment and bridge financing. Programs range from streamlined fix-and-flip rehab loans to one-off funding for “makes-sense” deals.

You might also like...