Content articles
When you are self-employed, it’s often harder to get a loan than when you work a traditional job. This is because you don’t have regular pay stubs to provide proof of income.
To prove your income, lenders may request tax statements and/or bank account documents. They may also look at your debt-to-income ratio and credit history.
How do lenders determine your income?
Lenders want to ensure that you can afford your monthly mortgage payments, so they examine your income to see if it’s enough to cover those costs. Typically, they want to see two years of tax returns. They’ll look at both your gross and net income, and they’ll also look at your debt-to-income ratio.
Many people have different income sources, from a regular salary to commissions or bonuses. Regardless of your business structure, most lenders follow the same “28% rule,” which states that no more than 28% of your gross monthly income should go toward housing costs.
Salaried employees have the simplest loans for bad credit income calculation: The underwriter takes your current yearly salary and breaks it down to a per-month number. They’ll then add in any overtime or bonus money you’ve earned over the past two years and average it out. If your hourly earnings have declined, that will be a red flag to the underwriter.
For freelancers, independent contractors, and business owners, the calculations can get more complicated. A mortgage lender wants to see your profit-and-loss statements and tax returns, as well as your bank statements to evaluate your cash flow. They’ll want to make sure your business is stable and that you have sufficient cash reserves to make loan payments in the event of a financial crisis. Conventional mortgages follow guidelines set by Fannie Mae and Freddie Mac, which often require two years of self-employment income to qualify, though one year may be acceptable in some cases.
What are the options for self-employed people who don’t have W2s or pay stubs?
Often, self-employed people who don’t have W-2s or pay stubs can prove their income with bank statements. As long as these documents show consistent, verifiable deposits, a lender can verify this income to determine eligibility for a loan.
Lenders may also ask for tax returns to determine a borrower’s income. However, if a borrower has strong credit and a solid history of financial stability, they may be able to overcome this hurdle.
Another option for those who do not have traditional proof of income is a Simplified Employee Pension (SEP) account. Similar to a SIMPLE or solo 401(k), this account allows business owners to contribute 25 percent of their earned income, up to the annual maximum contribution. This account is beneficial for freelance workers, sole proprietors, and realtors, since it enables them to save on a tax-deferred basis without the need to file a Form W-2.
In addition, some mortgage lenders offer a variety of options for those who do not have W-2s or pay stubs. These loans, known as “bank statement” or “income verified” loans, can help make homeownership more accessible for self-employed people. These loans are available from Fannie Mae and Freddie Mac, as well as some private lenders. Typically, these loans require a 20 percent down payment and have strict approval requirements. They may also have a higher interest rate than other mortgage products.
How do you prove your income?
Many lenders, establishments and organizations require proof of income before they can grant an applicant a loan or pre-approve them for something. This includes utilities, banks, car loans, mortgages, credit cards and subsidized healthcare. While this is easy for employed individuals because they can produce a pay stub or W2, it can be more challenging for freelancers.
If you are self-employed, it is important to keep meticulous records that show the source of your earnings. This may include payments through payment processors, gig-working apps and even cash payments. Keeping these records will help you properly report your income on your taxes and avoid paying penalties.
The most reliable proof of income for self-employed individuals is their federal tax returns. This legal document is conclusive proof of all earnings within a year and can be used by lenders as income verification. Other forms of income proof include profit and loss statements and bank statements showing money coming in and out of the business.
In addition, if you receive cash payments from clients, it is wise to deposit them into your business account or issue receipts for each transaction. This will make it easier for you to prove your income when applying for a loan or renting an apartment. Keeping detailed records will also help you track your business performance over time, making it easier to predict how much you can afford to spend on your loan.
