When applying for a home loan, small business owners face a different and often more complicated set of hurdles than a W2 employee. While the application process may ask more of self-employed applicants, it’s not insurmountable. Here are a few tips and things to know as a small business owner looking to buy a home.
Why Getting a Loan is More Difficult for Small Business Owners
When evaluating borrowers, lenders value stability in income and low risk. Self-employed borrowers can’t verify their income as easily as a W2 employee, and there is often fluctuation in a business owner’s income stream. These elements can make lenders question the ability of self-employed borrowers to be able to pay back their loans.
Tax returns are also used to prove income in the loan application process, and small business owners tend to use plenty of business expenses to reduce their taxable income. If a business owner makes $5,000 a month but writes off $1,500 in expenses, lenders will determine their qualifying amount using their net profit of $3,500. This lower net profit means less buying power. However, lenders can add certain expenses, such as write-offs for the use of a home office and depreciation, back into a small business owner’s income.
Steps to Take as a Business Owner
If you are self-employed, it’s crucial to make yourself an attractive loan candidate so you can qualify for the best loan and rates. Here are some ways to do this:
- Consider limiting your write-offs: If looking to buy in the next two years, this may be a good idea to increase what is considered your net profit.
- Prepare a year-to-date Profit and Loss statements or your bank statements: These are ways for lenders to assess your income in place of paycheck stubs.
- Improve your debt to income ratio and credit score: This will help make up for the disadvantage of unpredictable income.
- Save a larger down payment: The goal is 20% or more, but you can still get a loan with less than that. Lenders see borrowers with more equity in a home as having a lower risk of walking away from the loan.
- Consider a co-signer/joint mortgage: If your spouse, significant other, or parent is a W2 employee, they can help you qualify for a loan as a co-signer or joint mortgage holder.
Other Home Loan Options
At the end of the process, you may find a conventional loan is not the answer you’re looking for. Ask your lender about other mortgage products, such as non-QM loans. These portfolio lenders don’t have to conform to the same application standards as conventional loans and are more open to small business owners as borrowers. A traditional mortgage might use tax returns as income proof, whereas a portfolio lender can use alternative documentation. This can include a business license, 12 months of business bank statements, or even a letter from the business owner’s CPA.
Consult With Us for your Best Fit
The loan application process is different for small business owners, but we can help. Let us use our experience and industry knowledge to walk you through the process. We have successfully worked with small business owners to get the home loan they need, and we can help you too. Get in touch at teamfleck@fairwaymc.com to begin your exciting journey toward homeownership!