Some traditionalists will proclaim that “you can’t get a mortgage if you’re self-employed.” While mortgages for the self-employed are indeed more difficult to obtain, the prospect isn’t hopeless. You simply need to prepare more and go into the process knowing to expect some hassles. The problem with lending to the self-employed is that they do not have a third party to verify their income. People who are employees have a pay stub they can show to lenders to show that the employer pays a certain amount each hour, week, or month. Mortgage brokers can, and often do, call to verify this income. For those seeking a self employed mortgage, no such third-party system exists, meaning the IRS serves as the verification system. Lenders who will consider self-employed people for mortgages usually ask for the past two to five years of tax returns. The lender is looking for some independent verification of income, which these returns can provide.

While tax returns show what self-employed people made in the last couple of years, they cannot address another problem lenders have with self-employment. A business is not doing well right now simply because it did so last year. Because of the potential for drastic ups and downs in income, many brokers will ask for self-employed applicants to provide a balance sheet for their business. When examining the balance sheet, the lender is looking to find out whether the business is running at a profit or loss and how consistent the income looks.

Finding a Mortgage For Self Employed People

Lenders feel they are taking a significant risk when granting a mortgages for the self employed. When lenders get the required documentation of income and business health, they often use an underwriter to consider the financial picture of the applicant. This underwriter often comes back with additional requirements for the self-employed. These requirements may include a substantial down payment; the 20 percent down payment rule is not always waived for the self-employed as it has been in previous years for the employed. Underwriters also may require higher cash reserves, meaning someone who is self-employed needs to have more money immediately available in cash or savings accounts than someone with a steady job.

Limited Documentation Options

For self-employed folks who do not want to go through the lengthy process of verifying pay for the past few years, or for people with much higher earnings right now, a limited documentation mortgage may be an option. Though increasingly rare, limited documentation mortgages are an end-run around the requirements of traditional mortgages. These mortgages will allow stated income, meaning the borrow signs documents saying she or he earns a certain amount. The lending institution does little to check up on these numbers.

Though limited documentation mortgages are simple to process, they come with some notable drawbacks. For starters, they typically require significantly higher credit scores than even a traditional mortgage, making them a stretch for many people. These mortgages also usually come with higher interest rates, meaning the borrower will be paying back more money over the life of the loan. Still, in some instances, these mortgages are the best choice for the self-employed.

Buying and Selling Mortgages

Some of the 2008 financial crisis revolved around mortgage-backed securities. In simple terms, these securities were groups, or packages, of mortgages. Lenders sold these mortgages to third parties. These parties took the mortgages on the risk that enough of the people would repay the mortgages to make the purchase profitable.

Mortgage-backed securities are rated based on the overall credit and loan situation of the loan holders. People who are self-employed made up a big portion of the mortgages bought and sold. For someone who is repaying a mortgage without problems, the selling generally means nothing. For others, though, the sell of the mortgage can mean higher fees and penalties and concerns if the third party purchaser doesn’t make it.

Fannie Mae and Freddie Mac, the two previously quasi-government agencies tasked with backing mortgages, purchased billions of dollars of self-employed mortgages through a program called Alt-A. Through this program, Fannie Mae and Freddie Mac secured more than $500 billion in mortgages. While many of the mortgage holders were responsible and forthright self-employed people, enough were not that these two companies faced serious financial problems from the purchase of these mortgages. This scare means lenders are looking harder at giving mortgages for the self employed.

Navigating the Process

If you are facing trying to get a mortgage while self-employed, be prepared. Go into the process knowing what you will be likely to have to provide. Get certified copies of your bank statements, tax return copies, and a company balance sheet before you head to a lender. Some lenders also require a household budget, so make sure to have this information available as well along with statements from other creditors. Ask questions at each lender you consider to get the general vibe for self-employed mortgages to find a lender who seems willing to work with you.