New American Funding Blog

A Guide to Applying for a Mortgage While Self-Employed

By Courtney Lynch   |  May 5, 2015

Ensure that you are presenting your best case when applying for a home loan.

A study done by Zillow in December indicated that if a borrower is self-employed, he or she typically receives 40 percent fewer loan quotes than the average borrower. Interestingly, this occurs regardless of the fact that on average, self-employed individuals report 81 percent more in their annual incomes. 

"Self-employed borrowers will no doubt face headwinds when trying to get a loan," said Erin Lantz, Zillow's vice president of mortgages. "Low credit scores, coupled with a mountain of paperwork lenders must complete specifically for self-employed borrowers, make them unattractive," 

Low credit scores tend to be the primary culprit here. However, Lantz pointed out self-employed individuals are in a better financial situation to pay back a borrowed loan. Shopping around and applying for mortgages with a specific game plan is crucial for the self-employed potential homebuyer. 

High-risk mortgages are high-cost 

If a lender determines that supplying you with a home loan is a gamble, this could cost you quite a bit of extra money. Monthly interest rates might heighten due to uncertainty in your repayment of a loan. The Home Buying Institute noted that risk-based pricing is often used by lenders to determine the interest rate on a home mortgage. 

Lowering your interest rate

If you want to lower your interest rate, look at the factors noted below and find ways to ensure that a lender finds less risk when providing you with a home loan. If your credit score is a weak spot, look to improve your number. Also, consider paying off debts to improve your DTI.

Saving more money for a larger down​ payment is another way to ensure that your interest rate remains lower. Have a money saving plan ahead of time. Consider setting a goal downpayment of at least 20 percent. Paying more money up front is a great way to lower your interest rate and ultimately save you money over time. 

Credit score and other determining factors

As previously stated, a low credit score can immediately dismiss your application from the minds of potential lenders or brokers. Zillow noted that credit scores at or above 740 are most appealingand may work in your favor when you're applying for a home loan. Speak with your personal loan officer to determine if you qualify for various credit score exceptions that are available.

Also note that there are other factors that dictate your home mortgage eligibility. Showing your strengths in these other applicable areas is crucial during this process. 

Other facets that decide whether you are a qualified candidate for a mortgage include: 

  1. Reserves following closing
  2. Occupancy type
  3. Type of property
  4. Debt-to-income ratio
  5. Loan amount applied for 
  6. Loan-to-value ratio

Reserves following closing

This is a factor that may strengthen your mortgage application if you are self-employed. After closing a home purchase, lenders prefer to see at least two to six months of housing costs in your bank account. This indicates that for that amount of time, you will be able to continue paying a monthly mortgage bill if your income slowed down at all.

Occupancy type 

Again, owner-occupied single-family homes are a favorite among lenders. Risky loans come in the form of second homes and rented property.

Debt-to-income ratio 

This is another factor where a great deal of strength in your mortgage application can come from. Your DTI is determined by finding what percentage of your income would finance the proposed monthly cost for housing and all other debt. Typically, 43 percent is the highest DTI ratio you can possess. 

Type of property 

Whether you are considering a condo or single-family home, the type of real estate you invest in can affect your mortgage eligibility. Single-family homes are typically a lower risk for lenders, according to Zillow. This type of property would be more attractive when applying for a home mortgage. 

Loan amount applied for 

The amount of money that you are requesting from a mortgage company or independent lender has a direct effect on the amount of risk involved with providing you with money. More expensive homes are riskier than more affordable homes. 

Typically, a home loan of $417,000 is sold to a government-backed mortgage company such as Freddie Mac or Fannie Mae. If a home loan exceeds that amount, lenders will keep that loan in their own books. 

Loan product applied for

You can apply for a variety of loans. Long-term loans, such as a 30-year fixed-rate mortgage, typically have a higher interest rate but are seen as a less risky loan on the lender's end. While a short-term loan may offer a lower interest rate, it might not be as appealing to a mortgage company.  

Loan-to-value ratio 

LTV ratios indicate the amount of money designated for a down payment in comparison to the finances provided by the lender. A larger down​ payment will help keep your LTV ratio low. A good LTV ratio is more likely to be attractive to mortgage companies.

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