Dear Alpha Consumer,
I'm self-employed, and I've read that it is very difficult for self-employed people to get a mortgage without putting down 20 percent of the home's purchase price. I've tried calling lenders to find out whether this is true. They all say to call them back after I've been working for myself for over a year (it's now been about five months) but won't go into detail about what will happen then. Is there anything you can tell me?
When it comes to taking out a mortgage, self-employed people face obstacles that their cubicle-contained neighbors do not. It's harder to prove how much income a self-employed person has since he usually lacks a weekly paycheck. What's more, some of the money coming in may be going to business costs. So lenders often charge a premium to entrepreneurs. You do have options, though, and waiting a year may not be the best one.
One popular move for self-employed home buyers is to take out a "stated income loan," which is based on how much you say your income is instead of how much you can prove it is. Because it's a riskier loan from the lender's perspective—people can lie about their stated income, or it can fall off suddenly—the interest rate is usually half a point or so higher. Other factors, such as a really high credit score or putting down a large chunk as a down payment, can help reduce that rate, says Luke Currier, a mortgage consultant and founding member of the National Association of Responsible Loan Officers.
But because of the mortgage meltdown this year, fewer lenders are willing to take on risky borrowers, making stated income loans harder to find and more expensive. They still exist, says Currier, but come with more stringent restrictions, such as a higher credit score or larger down payment. "In rough terms, risk premiums have about doubled since earlier this year, so these people who can't document their incomes are going to have to pay the higher price for that now," says Jack Guttentag, professor of finance emeritus at the Wharton School of the University of Pennsylvania. The rise in risk premiums means that lenders are more concerned that borrowers will default on their loans. To compensate for that added risk, they charge higher rates.
LendingTree's Allison Vail says even with stated income loans, some lenders require that the borrower have worked out of one location for at least two years.
The other option for the self-employed—a regular loan with full documentation of income—usually requires at least one year's worth of tax returns, Vail says, and in some cases two years.
But that doesn't mean you should sit around and wait. Vail recommends checking your credit score, which will affect your interest rate, and keeping good financial records so you are ready when it's time to apply for the loan. To improve your credit score, focus on paying down debt and making on-time monthly payments.
Loan offerings are also constantly changing, says Ed Jeffry, another mortgage consultant and also a founding member of NARLO. If the mortgage crisis settles down, lenders may be more willing to bet on riskier borrowers again. Jeffry suggests finding a mortgage expert or broker in your area who can keep up with new offerings and market changes. The best way to find a good one, he says, is to do a Web search for "mortgage expert" in your local area and select someone who has published articles and joined professional associations. "Waiting a year may be really bad advice. There's no way to determine what interest rates will be 12 months from now," he says.
The positive spin? Guttentag says that in many countries, the self-employed aren't able to take out mortgages at all.