What is the best mortgage options for self-employed borrowers with a low down payment and high debt-to-income ratio?
Getting a mortgage as a self-employed borrower is challenging and qualifying with a low down payment and high debt-to-income ratio can make getting approved even more difficult.
In many cases, self-employed applicants can qualify for a mortgage with a bank statement loan program but these programs usually require a down payment of at least 10%, which may not work if you have limited financial resources. Plus, bank statement programs typically use more challenging qualification requirements including a lower debt-to-income ratio and higher minimum credit score.
The loan program that does the best job of meeting your three requirements -- 1) self-employed applicant, 2) low down payment and 3) high debt-to-income ratio -- is the FHA mortgage program. An FHA loan offers multiple features that directly address your priorities.
First, self-employed applicants are eligible for FHA mortgages. You are typically required to demonstrate a two year self-employed job history, as evidenced by your tax returns, to qualify for the program. A self-employed job history between one and two years may be allowed if you previously worked in a similar field and earn the same or greater monthly gross income, as evidenced by your tax returns.
The lender averages your income over the time period for the tax returns you provide to determine your monthly gross income. For example, if you show $46,000 in self-employed income in one year and $50,000 in income the following year, the lender uses $4,000 in monthly gross income ($46,000 + $50,000 = $96,000 (total income) / 24 months = $4,000 per month) to determine the mortgage you qualify for.
Use our FHA MORTGAGE QUALIFICATION CALCULATORto determine the FHA loan you can afford
Please note that when you apply for an FHA loan, self-employed borrowers are also usually required to provide business tax returns for two years unless the business is at least five years old.
An FHA mortgage also enables you to buy a home with a low down payment, which meets your second priority. The FHA program requires a down payment of only 3.5%, even if you are a self-employed applicant. So if you want to buy a home for $100,000 you are only required to put down $3,500.
The FHA mortgage program is provided by approved lenders such as banks, mortgage brokers and credit unions. We recommend that you contact multiple FHA lenders in the table below to compare mortgage terms and learn more about program eligibility requirements. Shopping multiple lenders is also the best way to save money on your mortgage.
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FHA mortgages also permit lenders to use a higher debt-to-income ratio. Although the standard debt-to-income ratio for an FHA loan is 43%, which is consistent with other mortgage programs, lenders can apply a ratio of 50% or higher in certain situations, which enables you to qualify for a higher loan amount.
Applicants with compensating factors such as high credit scores, extensive employment histories, significant financial reserves or additional income sources that are not included in your loan application may be eligible for a higher debt-to-income ratio. Please note that qualifying for an FHA loan with a higher ratio requires additional work and documentation by the lender -- called manual underwriting -- which not all lenders are willing to do.
Other benefits of the FHA mortgage program include more flexible qualification requirements and lower mortgage rates. You can qualify for an FHA loan with a credit score as low as 580 if you make a down payment of 3.5% of the property purchase price and a score of only 500 if you make a down payment of at least 10%.
Review our FHA Mortgage Guide
Additionally, FHA mortgage rates tend to be 0.250% to 0.750% lower than conventional loan rates because the program is backed by the government and borrowers pay mortgage insurance. The lower your mortgage, the lower your monthly payment and higher the mortgage you qualify for.
The downside to the FHA program is that you are required to pay an upfront and monthly FHA mortgage insurance premium (MIP) which is an additional closing cost and ongoing fee on top of your mortgage payment. The upfront FHA MIP is 1.75% of your loan amount while the monthly fee is calculated based on your loan-to-value (LTV) ratio, mortgage amount and length of your loan.
The FHA program also applies mortgage limits which may restrict the loan you are eligible for. FHA mortgage limits vary by county and the number of units in the property.
Despite these extra costs and considerations, an FHA mortgage offers the features and flexibility that fit your financing goals. While qualifying for a mortgage as a self-employed applicant with a low down payment and high debt-to-income ratio is certainly not easy, the FHA program is your best mortgage option.
Use the FREEandCLEAR Lender Directory to search over 3,900 lenders by loan program. For example, find top-rated lenders in your state that offer FHA mortgages.
Sources
"II.A.4.c.x. Self-Employment Income (TOTAL)." FHA Single Family Housing Policy Handbook 4000.1. Federal Housing Administration, January 2 2020. Web.
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