Taking out a loan, especially a mortgage, when you’re self-employed is hard. Because lenders see self-employment income as risky and unpredictable, the lending standards are a lot harsher for us than for other workers.
Before the mortgage crisis, freelancers had an easier time getting major loans. Many banks offered “no doc” or “low doc” loans that required little to no income documentation.
Now, you can expect to show two to three years of tax returns, bank statements, and maybe even client contracts to get approved for a loan. Banks want to be certain you can actually afford to repay what you borrow.
Here are a few things you can do to be the best possible self-employed loan candidate.
Improve your credit score
Credit matters much more for self-employed workers, since we don’t have a “reliable” source of income. Check your credit score (via myFICO.com) several months before you start loan shopping to see where you stand. Above 720 is best, but you can probably be approved with a score above 660 if you’re stellar in all the other areas. (Lower credit scores typically result in higher interest rates.)
Two good ways to improve your credit score are to pay off past due balances and to make timely payments on all your other accounts.
Make a big down payment
The more you can put toward your purchase – whether auto or loan – the smaller the loan you’ll need. Making a down payment of 20% or more greatly improves your chances of being approved.
Have several months of loan payments in a savings account
Lenders will feel more comfortable giving you a loan if they know you have some financial reserves. Of course, the money will come in handy if you face an income shortage and you’re unable to make loan payments for a period of time.
Pay off other debt
If you’re already spending a lot of money on debt each month, then you’re less likely to be approved. With a mortgage, your housing expenses plus other debt payments would ideally be less than 36% of your monthly income. Only 28% of your income should go toward mortgage-related expenses, leaving 6% for student loan, credit card, auto loan, and other debt payments.
Increase your taxable income
You don’t have to make more money to achieve this, but you will have to pay more taxes. Naturally, you want to take as many tax deductions as possible to lower the amount of income tax you pay. Unfortunately, the same low income that eased your tax burden can keep you from buying a home. Take fewer tax deductions a 2-3 years before the big loan, then go back to regular deductions.
Get a cosigner
Getting a loan with someone who has standard employment will improve the chances of approval. The co-applicant should also have a good credit score and low amount of debt, too.
The bright side of cosigning is that using both of your incomes may allow you to qualify for a bigger loan. The downside is dealing with the joint loan if the two of you decide to dissolve your relationship.
Talk to the lender before making an application to find out whether they typically give loans to self-employed workers. That way, you can narrow down your applications to the most-likely lenders.
If you've been approved for a loan based on your freelance writing income, share some tips!