If you are self employed, it may feel difficult to try to obtain the mortgage financing you need. Some loan programs have very strict regulations for self employed clients, with documents that can be difficult to obtain if you are a small business. From 2 years of work history, to profit and loss schedules, it can seem overwhelming.
As California has a large gig working community, self employed individuals are the backbone of many industries throughout the state. From operating a business to a side hustle, many Californians generate a substantial part of their income from self employment work. So, what are your options if this is your situation?
This will depend on the specifics of the work you do, and how long you’ve been doing it. Each loan program in the mortgage world has different pros and cons, and can have guidelines that vary drastically.
If you have owned your business or worked as a self employed individual for more than 2 years, claiming a lot of income (with the tax returns to back it up) it may be possible to do a conventional or government loan. These loans, whether for a purchase or to pull cash out, tend to have better terms (pricing wise) than some of their non-traditional counterparts. However, many self employed individuals may not have that sort of work history or claim enough income on their taxes to qualify. In these circumstances, we look at other options.
Option #1: Bank Statement Loans
If you are bank account rich but paystub poor, this is a great option for mortgage financing. Whether you are looking to pull funds out of your equity, or purchase a home, bank statement loans will rely on your current assets as qualifying income. If you have a high amount of liquid assets, such as funds in a bank account, a bank statement loan may help you qualify for mortgage financing. For a home purchase, if you are looking into a bank statement loan, be prepared to make a larger down payment than a conventional or government loan may require. This amount is usually above 10% down, as a general minimum. However, this can vary lender by lender.
Commissioned individuals tend to be the most common clientele for bank statement loans, as well as those with trust funds where they hold a majority of their assets. Whether through an inheritance or through infrequent commission deposits, they are often sitting on a large figure in their bank account that they may not want to liquidate or utilize for their real estate ventures – even if they have the funds to purchase a home in all cash. Similarly, they may want to leverage their existing real estate to fund other business ventures, by pulling cash out of the equity in an existing property. In these situations, it may be tough to qualify for a traditional loan when their money is not received consistently, and lenders have a hard time predicting their ability to pay the loan. This is where bank statement loans come in handy, which are designed for these exact circumstances.
Option #2: DSCR Loans
If your main source of income is real estate, as a landlord or short term rental owner, you may run into issues qualifying for traditional financing – due to the dreaded “debt-to-income ratios”.” If you have a mortgage on multiple properties, a lender may look at your debt to income ratios and tell you that they are too high – as all your income is swallowed up by property write-offs and mortgage expenses. With a DSCR loan, instead the lender looks only at the one property they are lending on – and makes sure that the mortgage expense is not greater than the market value of rent.
This loan utilizes the common sense that if the property can generate a certain amount of income a month that meets or exceeds the mortgage expense, there should be no issue in repaying the loan. Thus, to qualify, the lender will look at the market value rent of the property and use that to qualify you for the loan.
Option #3: Private Equity/Hard Money Loans
If you are self-employed, and don’t claim as much money on your tax returns, a private equity loan (also known as a hard money loan) may be a beneficial option for temporary financing. These types of loans work best for three different scenarios.
- If you own a small business and are looking to pull funds out of your existing property, in order to invest into your business, a hard money loan may be able to help provide financing. These loans are temporary loans, usually 2-5 years in length, so you would utilize funds to help boost your income and refinance into a traditional loan before the hard money loan ends. These loans are stated income loans, so instead of providing income documentation, your loan officer will rely on the figure you put on the application. So, for those who may have had a difficult few years with Covid and need funds to help get their business back on track, or for those who are just starting and might not have multiple years of work history to show, it may be a beneficial option.
- If you own an investment property and cannot qualify through DSCR, whether due to low credit scores or because you are remodeling the property – so it does not show its true market value – a hard money loan may also be a good option. In this situation, the hard money loan would give you funds to remodel the property, or allow you to receive funds while working on your credit, and then you would look at refinancing the loan into a DSCR or conventional loan program before the loan term ended. Hard money loans are also beneficial for those who need funds quickly, as they are significantly faster than their counterpart loan programs (such as DSCR or traditional financing options).
- If you fix and flip homes, hard money is one of the more common ways to get financing for your ventures. Some of the perks of hard money loans, such as stated income, fast closing times, and the temporary nature of the loan – are huge benefits to those who fix and flip homes. Fix and flip hard money lending can be a little different than regular hard money lending though for a purchase, as lenders like to see experience doing fix and flips, an LLC, and higher credit scores. There are options for first time fix and flippers, but usually it will require a higher down payment for a purchase. If you already own the property, and are just looking to get financing to finish up the project, then this is less of a worry.
Over the past decade, the lending world has changed drastically as the world around it has grown. This means that for self employed individuals, there are a lot of different options; with how much growth the small business market has seen over the years. Finding the right loan program for your circumstances is the trickiest part about it, but a seasoned loan officer can help guide you through that process. At Independent Home Finance Inc., we have decades of experience and have helped countless self employed Californians meet their goals. Reach out today for a free consultation, at our number above.