Obtaining A Loan When Self-Employed
It can indeed be more challenging to secure a loan when you’re self-employed, but it’s not impossible.
Regardless of how you earn your income, lenders need assurance that you are likely to repay the loan, whether it’s a mortgage, a home-equity loan, or a HELOC (home equity line of credit). Banks also want to ensure that if you default, the property can be sold for enough to cover the remaining balance.
Self-employment complicates this process. Even if you have sufficient income to afford a mortgage and a home equity loan, proving this can be more difficult.
“Lenders usually look for a steady income that’s easily verifiable,” says Matt Vernon, head of consumer lending for Bank of America. “Freelancers often have fluctuating pay, irregular schedules, and may not have the typical paperwork like pay stubs that lenders prefer.”
However, obtaining a loan is still possible; it just requires extra planning and documentation.
Vernon explains that lenders typically want to see at least two years of self-employment history. So, if you need to renovate your kitchen, you might consider delaying the project to improve your chances of qualifying—or postponing your departure from a traditional job.
If delaying isn’t feasible, experts suggest registering and licensing your freelance business as soon as possible to enhance its credibility with lenders. Additionally, securing long-term contracts and maintaining a diverse client base can be beneficial for those new to self-employment.
“Qualifying depends on how long the freelancer has consistently earned income from their trade and their earnings after business expenses,” says Sam Garcia, CEO of Home Equity Lending News. Carefully track your expenses, income, and taxes with software or an accountant to present organized documentation to a lender.
Since freelance income may vary throughout the year, it might not fit neatly into lender models, even if it exceeds that of a traditional employee. “For instance, if your sales are seasonal,” says Patricia Maguire-Feltch, a national sales executive with Chase Home Lending, “it helps to have a substantial cash reserve to show lenders that you can manage payments even if your business faces a downturn.”
Lenders view home-equity loans and HELOCs differently from first mortgages, which can make qualifying easier, especially if you have a good credit score.
“HELOCs are not subject to the same regulations as mortgage lending post-financial crisis,” Garcia says. “First-mortgage lenders must ensure the applicant can repay the loan, but this doesn’t apply to revolving HELOCs, providing more flexibility.”
This flexibility means loan qualification standards for home-equity loans or HELOCs can be more lenient than for first mortgages. Additionally, loan amounts are typically smaller, reducing the risk for lenders.
These factors can streamline the process. Instead of tax returns to verify income, lenders might accept recent bank statements. They might also use automated home valuations instead of in-person appraisals and conduct basic title searches rather than full ones.
However, if you fail to repay, there’s a greater risk that the second loan won’t be covered by sale proceeds, adding to the lender’s risk. Thus, home equity lines and loans often require higher credit scores for favorable terms, Vernon notes.
Before deciding on freelancing, consider your renovation timeline and consult a lender to explore your options. As with any loan, higher income and credit scores will make it easier to qualify and secure a lower rate.
