Refinancing your mortgage can be an effective way to lower your monthly payments or tap into the equity you’ve established in your home. But when you’re self-employed, the process tends to be a little more complicated than for borrowers whose income is reported on a W-2.
We’ll walk you through what you need to know about refinancing as a self-employed homeowner, including a few of the most common issues and some steps you can take to increase your likelihood of being approved.
Key Takeaways
- Self-employed borrowers need to provide more documentation to verify their income, including up to two years of bank statements and both personal and business tax returns.
- Lenders look for income stability, and self-employed homeowners whose earnings vary from year to year may have a harder time getting approved for a refinance.
- Qualifying self-employment income is based on taxable after-deduction earnings. As such, deductions to lower your tax burden can impact your ability to refinance your home.
Mortgage Refinancing for the Self-Employed: The Basics
Let’s start off by defining what self-employment means in the mortgage world, and why being self-employed can make refinancing a little bit more of a challenge.
What Do Lenders Consider “Self-Employed”?
If your primary source of income is not reported on a W-2 Wage and Tax Statement, lenders are likely to consider you to be self-employed.
This can include:
- Small business owners
- Freelancers
- Contract workers
- Gig workers
- Independent consultants
According to the Bureau of Labor Statistics, more than 16.8 million individuals are classified as self-employed in the United States.
Why Is Refinancing More Difficult If You’re Self-Employed?
Being self-employed can be rewarding, but it can also be risky, and lenders are averse to risk. Full-time wage and salary employees typically have a reliable and predictable stream of income. When you’re self-employed, you aren’t necessarily assured this level of earning stability.
As such, lenders are more cautious when it comes to verifying that self-employed applicants have and will likely maintain the ability to repay their loans. You’ll still be held to the same general refinancing requirements as any other borrower, but expect a greater level of scrutiny when it comes to documenting your income.
What Lenders Look for When You’re Self-Employed
What, exactly, are lenders looking for when you’re self-employed? Here’s how the qualification process differs from that of W-2 earners.
Business/Work History and Stability
Mortgage companies typically want to see two full years of work history from self-employed borrowers. This helps to paint a better picture of your earnings over time and offers more assurance that the income can be expected to continue going forward.
They’ll also look for stability in your earnings. Ideally, your income should remain relatively consistent – or slightly higher – from one year to the next. You can still get approved to refinance if there’s variance in your reported annual incomes, but expect lenders to skew towards the lower figure for their calculations.
Income Documentation
While the typical borrower may only need to provide a couple of pay stubs, W-2s, and filed tax returns, a greater level of income documentation is usually required from self-employed applicants.
This can include needing to provide:
- Both personal and business tax returns
- Balance sheets
- Profit and loss statements
- Bank statements from both personal and business accounts
- Business licenses
Keep in mind, however, that these requirements can vary depending on the nature of your self-employment.
Related: Income Requirements When Refinancing Your Mortgage
Cash Reserves
To mitigate some of the risks associated with self-employed income, lenders may expect you to have a sizable amount of cash in reserve. This helps to reinforce that you would still maintain the ability to repay your mortgage, even if you saw a temporary decline or interruption in your earnings.
When it comes to cash reserves, it’s not uncommon for mortgage companies to want self-employed borrowers to have access to between six and twelve months of their proposed housing expenses.
Proceeds from a cash-out refinance typically are not considered reserves.
Other Eligibility Requirements for Refinancing
Apart from providing proof of your self-employment income and ability to repay your loan, you’ll still need to meet the same other eligibility requirements as any homeowner looking to refinance their mortgage.
This can include:
- Credit Score: Minimum scores can range from 580 to 620+, depending on the program and the lender you’re refinancing through.
- Debt-to-Income (DTI) Ratio: Program limits can range from 44% to 56.9%, although lenders often prefer you keep your total debts below 45% of your qualifying income.
- Loan-to-Value (LTV) Ratio: Conventional rate-and-term refinances are possible for up to 97% of your home’s value, while the FHA lets you refinance as much as 97.75%. For a cash-out refinance, both of these programs limit your new loan to 80%.
Common Challenges for Self-Employed Borrowers
We touched on a couple of these issues above, but let’s go over the three most common challenges encountered by self-employed borrowers trying to refinance their home loans.
1. Deductions That Reduce Qualifying Income
In most cases, the biggest challenge faced by self-employed borrowers is how mortgage companies determine their qualifying income.
One of the benefits of working for yourself is being able to take deductions to reduce your overall tax burden. However, it’s this final taxable income that lenders use for their calculations. If you’ve written off too much of your earnings – even if you have healthy finances and a good cash flow – it may be difficult to get your refinance approved.
2. Unsteady Year-to-Year Income
Having a reported income that differs from one year to the next doesn’t inherently disqualify you from refinancing your home, but expect lenders to put more weight on the lesser amount – especially if your most recent tax return shows a decline from the previous year.
Again, this is based on your total taxable income, after deductions, and not your actual revenue.
3. Additional Documentation Requirements
Compared to W-2 earners, self-employed borrowers generally spend a lot more time assembling the additional documentation needed to prove their earnings.
For example, while other borrowers may only need to provide a few recent pay stubs and last year’s W-2, self-employed applicants may need up to two years of signed and filed tax returns, both personal and business.
Refinance Options for Self-Employed Homeowners
All major types of loans allow for self-employed borrowers. This includes refinances through conventional lenders and government-backed programs such as the FHA, VA, and USDA.
The majority of homeowners opt for a conventional refinance. However, your loan officer will help you determine the best option for your individual situation. Let’s take a brief look at how these loan types differ so you’ll have an idea of what to expect.
Conventional Refinance
Conventional refinances follow the guidelines established by Fannie Mae and Freddie Mac and typically have fewer restrictions than government-backed alternatives. While you can qualify with a credit score of 620, some lenders will have higher minimums, especially if you’re getting a cash-out refinance.
DTI limits are capped at 50% for conventional refinances, and applicants borrowing more than 80% of their home’s value will be required to pay for private mortgage insurance.
The lending process is often more straightforward for conventional loans compared to other standard refinances, which is ideal for self-employed homeowners already facing more stringent underwriting.
FHA Refinance
FHA loans are backed by the Federal Housing Administration and are designed for homeowners with lower credit scores or higher debt-to-income ratios. Program guidelines allow for a credit score as low as 580 and a DTI as high as 56.9%.
This higher DTI limit can help self-employed borrowers with large write-offs, and therefore low adjusted income reported on their taxes.
The downside with FHA refinances is that they come with an upfront mortgage insurance premium of 1.75% of your loan balance and an ongoing mortgage insurance premium – often for the life of the loan – averaging around 0.55% annually for most borrowers.
However, current FHA loan holders may qualify for an FHA streamline refinance. This allows you to adjust your interest rate and the terms of your loan without having to obtain an appraisal or reverify your income, which can greatly simplify the refinancing process for self-employed homeowners.
VA Refinance
VA refinances are available to eligible veterans and active-duty servicemembers and often have some of the lowest interest rates on the market. Credit score and DTI requirements vary by lender, as VA guidelines set no program-wide standards.
If you currently have a VA-backed mortgage, you may be eligible to refinance through the Interest Rate Reduction Refinance Loan (IRRRL) streamline program. Similar to that of the FHA, this streamline loan does not require you to obtain an appraisal or reverify your income in most cases.
There are no mortgage insurance requirements with VA loans. However, most borrowers will be responsible for a VA funding fee of 0.5% for IRRRL refinances, and 2.15% to 3.3% for VA cash-out refinances or when refinancing into the program with a different type of mortgage.
USDA Refinance
USDA refinances are only available to homeowners who currently have a USDA-backed loan. This program is unique in that it does not offer a cash-out refinance option, meaning that most people refinancing a USDA mortgage do so with a Streamlined or Streamlined-Assist refi.
As with the other types of streamline loans, this drastically simplifies the qualification process for eligible self-employed borrowers by eliminating the need to reverify their income in most cases.
Bank Statement Refinances
Bank statement refinances are a popular alternative for self-employed homeowners who cannot qualify for other mortgage programs due to low reported income on their taxes.
Rather than focusing on tax documentation, lenders instead look at up to two years of bank statements to analyze your finances and determine your ability to repay the new mortgage.
Since they use a non-traditional method for verifying your income, bank statement refinances are considered to be riskier non-qualified mortgages and typically have higher interest rates than the other options we’ve covered.
How to Strengthen Your Refi Application
Worried that you may not qualify to refinance as a self-employed borrower?
While there may be little you can do if you don’t have a long enough business history or have written off too many deductions on your taxes, applicants on the cusp of approval can improve their chances by taking these steps to strengthen their refi application:
- Raise Your Credit Score: If you’re planning to refinance in the near future, there’s only so much you can do to raise your credit score quickly. However, 30% of your score is based on credit balances compared to limits. Lowering the percentage of your available credit limit from, say, 50% to 10% can help boost your score quickly.
- Use Your Home’s Equity to Improve Your DTI: Concerned that your debt level may be too high to get approved? Consider using a portion of the funds from a cash-out refinance to pay off accounts at closing. This will reduce your monthly expenses and lower your total debt-to-income ratio.
- Maintain Detailed Financial Records: Since more emphasis is put on verifying the income of self-employment borrowers, maintaining detailed financial records can help paint a better picture of your finances and ability to repay the loan. This could include having documentation of ongoing contracts and regularly billed invoices.
- Consider Adding a Co-Borrower With a W-2: If your reported income is low or inconsistent, consider adding a co-borrower who has earnings reported on a W-2. This can help to offset some of the instability associated with self-employed income, but keep in mind that any debts the co-borrower must be counted.
How to Refinance as a Self-Employed Borrower: Step-by-Step
What does the refinancing process look like for self-employed borrowers? Let’s break it down into five distinct steps and walk through what you need to know about each.
1. Evaluate Your Financial Readiness
Verify that accounts on your credit report are accurate. Assess your taxable income and how it stacks up against your debt obligations. Write down the goals you’d like to accomplish with your refinance.
2. Gather Documentation
Gather two years of bank statements, personal and business tax returns, profit and loss statements, and any other relevant documents that can help provide a more accurate picture of your finances.
3. Shop Around
Want to get the best deal on your refinance? Make sure to get written refinance quotes with at least three lenders. Different mortgage companies have different rates and fees, and shopping around helps to ensure you’re not overpaying for your loan.
Plus, receiving multiple loan estimates gives you the ability to use the best one to try to negotiate an even better deal with the other companies to earn your business.
One caveat: Some lenders have more experience working with self-employed borrowers than others. Make sure the companies you’re dealing with are well-versed in handling the unique lending challenges associated with self-employment.
4. Go forward with the Refinance
Give your chosen lender the go-ahead to continue with your mortgage.
Your loan file will go into underwriting, where the underwriters will take a more in-depth look at your financial profile. You’ll likely have already submitted most of your documents during the preapproval process. However, you may still be asked for additional paperwork as needed.
In most cases, you’ll also need to have an appraisal of your home to determine its current market value. Your lender will help schedule this for you.
5. Close on the Loan
After underwriting is complete and your loan has been cleared to close, your loan officer will give you a closing date to sign off on all of the paperwork and make your refinance official. This is when you’ll pay your closing costs, if they’re not being wrapped into your mortgage.
If you’re doing a cash-out refinance, those funds will typically be disbursed to you around three business days after you close.
Refinance Your Home With Refi.com
Refinancing as a self-employed homeowner comes with a number of challenges not faced by other borrowers, but the process can still be pretty simple when you’re working with the right lender.
At Refi.com, we’re experienced in helping applicants with self-employment income navigate the refinance process. Ready to get started refinancing your home? Apply with Refi.com today.
