How to Get a Mortgage for Freelancers
Homeownership is something that most people dream of. Painting the walls the color you want, choosing flooring and appliances, planting a garden … these are things you can’t do when you rent.
Real estate is an excellent investment, but before you can buy a home, you’ll need to get pre-approved for a mortgage.
Getting a mortgage can be a bit tricky for freelancers, gig economy workers, business owners, and other self-employed people.
Tricky, but not impossible!
Can a Freelancer Get a Mortgage?
Freelancers can get a mortgage.
However, the process of doing so is slightly more complicated than it is for traditional employees who receive a W2 from their employer.
Mortgage lenders want to give conventional loans to people who are low risk. Qualifying for a home loan requires proof of income, and for employed people, that’s as easy as showing a few pay stubs or a W2.
Proving freelance income is a bit more complicated.
Many mortgage lenders and banks view freelancers as high risk, simply for the fact that they can’t submit W2s or pay stubs with their loan applications. There is a stigma that freelancers are less stable financially, even though we all know many freelancers who make more than W2 employees!
No matter how much you earn as a freelancer, the mortgage application process can be challenging.
What You Need to Get a Mortgage as a Freelancer
Mortgage loan lenders look at several key factors when determining who is eligible for a mortgage and who is not.
Before you apply for a conventional mortgage, consider the following four things:
A High Credit Score
To get a mortgage, you need good credit. This holds for both freelance loan applicants and employed applicants.
Credit scores range from 300 to 850. The higher the score, the better. The lower the score, the less likely you are to qualify for a mortgage (or any other type of loan).
A score of 670 to 739 is considered good. Then, a score of 740 to 799 is very good. A score of 800 or above is excellent.
For some, a score under 670 won’t automatically disqualify you from getting approved for a mortgage. Just be aware that with a lower score, you might have to pay a higher interest rate.
If you’re not sure what your credit score is, request your credit report. If your score is less than 600, you’ll need to build that up or find an alternative mortgage loan option. (More on that coming up!)
A Low Debt-to-Income Ratio
Your debt-to-income ratio, or DTI, is a function of how much you owe and how much you earn. The lower, the better.
Lenders want to know that you owe less per month than you make, and they use your DTI to determine this. Your DTI should be less than 36% to qualify for a mortgage.
To figure out your DTI, calculate your total gross income for the month.
Then add up monthly, recurring bills, including:
- Car payment
- Credit card payments
- Student loan payments
Utilities, cell phone bills, cable bills, and health insurance costs are not a part of the equation, as these aren’t long-term debts. Technically, you could drop any of them at any time, so don’t factor these into your DTI debts.
To calculate your debt-to-income ratio, divide your total monthly debts by your gross monthly income.
For example, let’s say you earn $5,000 per month, and your recurring monthly debts are $1,800. Divide 1800 by 5,000, and your DTI is 0.36, which is 36%.
Low Credit Utilization
Your credit use rate is another contributing factor that mortgage lenders use to determine if you’re “mortgage worthy.” This score is calculated as a percentage and depends on how much of your credit line is open compared to how much you’re using.
The lower the percentage, the less of a risk you’ll be in the eyes of a lender.
For example, if you have a $10,000 line of credit on one credit card and your balance is $8,000, your credit utilization score is 80%. That’s not good.
You’d be better off having four credit cards with $10,000 lines of credit on each and a $2,000 balance on each. That would make your credit line $40,000, your balance $8,000, and your credit utilization score only 20%.
Lenders like to see that you have open lines of credit and aren’t maxing them out or using a high percentage of the amount you have. The credit utilization rate works in tandem with your credit score, and you can lower your credit use rate simply by opening more lines of credit.
Keep in mind:
Every time you apply for a new line of credit, your credit score takes a little ding. Therefore the strategy of opening more lines of credit to boost your score only works if you have a good score already.
Even with an excellent credit history, you’ll still need a steady stream of self-employment income to qualify for a mortgage. It goes without saying that the more you make, the easier getting your mortgage loan will be.
Here’s where it gets tricky for freelancers.
One of the perks of being an independent contractor is deducting every single business expense at tax time. This lowers our taxable income and reduces the amount of taxes we owe.
Paying less in taxes is always a good thing, right?
In this case, maybe not.
Taking all possible business deductions on your tax return puts more money in your pocket. You can save that money for a down payment on your house or use it to pay down credit card balances and lower your credit utilization score.
On the other hand, taking fewer business deductions shows lenders that you have a higher income, which will improve your debt to income ratio.
The goal is always to be more appealing in the eyes of a lender. Do this by carefully analyzing your finances and putting a tax strategy in place that will make you a more desirable candidate for a loan.
Actions to Make Getting a Mortgage Easier When You’re Self Employed
There are various ways self-employed individuals can make getting a mortgage a bit easier. Here are some tips that you can use to make your dreams of becoming a homeowner a reality.
Wait Until You’ve Been in Business at Least Two Years
Mortgage brokers want to know that you can sustain yourself on your freelancer income. The longer you’ve been in business for yourself, the easier it is to prove this.
Most lenders won’t even consider giving a self-employed individual a mortgage unless they show proof of income for at least two years. If you’ve only been a freelancer for the past year, wait another year before applying for a mortgage.
Prove That You Have a Steady Income
Proving that you’ve had freelance income over the past two years isn’t enough. You need to show that your income is steady and ongoing.
Showing a mortgage lender your business license or LLC registration doesn’t prove that you’re a functioning, income-earning freelancer today or that you’ll be one next month. You’ll need more than that.
Here are some other documents you can provide your lender to prove that your income is steady:
- Statements that show monthly bank deposits
- Multiple years of tax return
- Profit and loss statements from recent months
- Copies of current invoices that prove you are in business
Save as Much Money as Possible
You have to make a down payment to buy a home, and most lenders want you to put down 20%.
The more money you can save for a down payment, the less you’ll have to borrow. The less you have to borrow, the lower your monthly mortgage payments.
Home sellers love cash buyers, so the more cash you have to put down, the better. In a hot housing market, this can be the difference between losing the house to another buyer or encouraging the seller to accept your bid.
Besides your down payment, save for closing costs. Closing costs typically range from 3% to 6% of the home price.
Get a Mortgage With Your Spouse
Applying for a mortgage with your spouse can be pretty helpful, especially if your spouse is a traditional employee who receives a W2.
As unfair as this is to single people, applying as a pair can make you seem less risky in the eyes of a mortgage lender.
Tap Into Your Existing Equity
If you already own a home and have equity in that home, you’re a step ahead of first-time home buyers.
Equity equals cash — cash that you can use to cover your closing costs and make a bigger down payment.
If you have a good track record of paying your mortgage on time, consider applying for your new mortgage through your existing lender. Your good mortgage payment history is an asset, and your loan officer will be more likely to approve you for a new loan.
How to Find a Mortgage Lender
Many self-employed borrowers go the traditional route and apply for mortgages through large national banks like Chase or Wells Fargo. The problem is that these banks have strict rules about who can and can’t get a mortgage.
If you do your regular banking with a national bank, applying for a loan through that same bank can be an advantage. That’s because they already know how much you deposit into your account each month.
Consider Applying for a Mortgage With a Regional Bank
Small, local banks and credit unions also offer mortgage loan programs and competitive mortgage rates. Unlike national banks, regional lenders often have more flexibility to decide who can and can’t get approved.
Online Lenders are Also an Option
Of all the different mortgage lenders, online lender standards tend to be much less strict than those of national banks, credit unions, or regional banks.
This can make it easier to get approved for a mortgage as a freelancer, but online loan lenders tend to charge higher interest rates.
Before applying for a mortgage with an online lender, use an online comparison site to see how much different lenders charge in interest. Check those rates against the national averages to know if the online rate is reasonable or not.
Consider Alternative Loan Options
Conventional mortgage loans aren’t your only option. As a freelancer, you may qualify for an FHA loan, a VA loan, or a low-doc loan.
An FHA loan is a Federal Housing Administration Loan insured by the federal government. It’s a viable option for people with low credit scores that can’t get approved for a conventional mortgage.
An FHA loan is also a good option if you don’t have a lot of money saved for a down payment. You can put down as little as 3.5% with an FHA loan.
VA loans are mortgages backed by the U.S. Department of Veterans Affairs. If you are a veteran of the U.S. military, applying for a VA loan is the way to go.
Because VA loans don’t typically require any down payment at all.
Low-doc loans are alternative mortgage programs that require little documentation. Some require you to provide as little as two months of valid bank statements as proof of income and financial stability.
If you’re a freelancer looking to buy a home, create a strategy for how to do so and include the following:
- Cut your spending and save as much as you can
- Pay down credit cards
- Decrease your debt-to-income ratio and improve your credit score
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