What To Know About Home Equity Loans For Self-Employed Borrowers
If you own a home and need to pay for a home improvement project, consolidate your debts, seed a business venture or fund an investment, a home equity loan could be right for you. If you’re self-employed, getting approval can require extra steps to assure the lender you have enough steady income to repay the loan. Read on to learn more about the process, how to improve your chances of getting a loan, and alternatives to getting a home equity loan.
Key Takeaways:
- Self-employed homeowners need to provide lenders with more documentation of their income and finances than those working for a traditional employer.
- Showing a steady income, avoiding debt, having a good credit score, and having a low debt-to-income ratio will improve your chances of approval.
- Alternatives to a home equity loan include a home equity line of credit, a cash-out refinance or a personal loan.
Home Equity Loan Requirements For Self-Employed Borrowers
If you apply for a home equity loan and work for yourself, you’ll have to document and demonstrate that you have enough income to repay the loan. Lenders generally will require more documentation from self-employed homeowners to satisfy that requirement.
“Self-employed people generally have multiple income streams and do not receive regular pay stubs like salaried employees,” says Brent Chandler, CEO of FormFree, a digital lending platform based in Athens, Georgia. “Lenders frequently ask for thorough income data, such as tax returns, profit and loss statements, and bank statements.”
Lenders also want proof your business is stable, such as having been in operation for a specific number of years or showing steady revenue growth.
“Newer enterprises or those with variable income may have a more difficult time qualifying,” Chandler says.
Here are the typical eligibility requirements for home equity loans for self-employed borrowers:
- Proof of income. “This usually involves providing two years of tax returns, which showcase earnings and demonstrate income stability,” says Dennis Shirshikov, adjunct professor of economics at City University of New York.
- Minimum credit score. While some government-backed loans allow homeowners to refinance with a credit score as low as 500, conventional loans typically require a score of at least 620. Some lenders may require one as high as 700.
- Maximum debt-to-income ratio. Your DTI ratio should generally be no more than 40%. “As a general rule of thumb, your DTI should be under 43%,” says Yuval Elkeslasi, a private mortgage lender in Miami. “This way, new debt payments don’t overwhelm your financial capacity.”
- Sufficient documentation. This can include bank statements, profit-and-loss statements, your two most recent income tax returns, or a certified public accountant’s letter verifying your business’s legitimacy and financial health.
- Sufficient home equity. Your lender will carefully consider how much home equity you have. Most lenders prefer you have a loan-to-value ratio below 85%, meaning your loan amount plus the existing mortgage balance should not exceed 85% of your home’s current appraised value.
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Tips On Qualifying For A Home Equity Loan When You’re Self-Employed
To improve your chances of getting a home equity loan when self-employed, review your finances and see how well you can meet the following recommendations.
Show Proof Of Steady Income
The more stable your income, the better. “Lenders will look for income stability on a month-to-month basis and prefer income streams that have been around for at least two years,” says Martin Orefice, CEO of Rent To Own Labs, a real-estate search site based out of Orlando, Florida. “You’ll have to provide necessary proof of this income in the form of bank statements, tax returns, and profit and loss statements.”
Avoid Additional Debt
Don’t apply for new credit accounts or lines of credit before pursuing a home equity loan. You also should try to decrease your outstanding debt. “Having a lot of debt can increase your DTI ratio, which lenders frown upon,” says Elkeslasi. “Your goal should be to pay off your existing debts, particularly any high-interest credit cards or loans. This will improve your DTI ratio.” In addition, keep your credit card balances low to prevent spikes in your credit utilization ratio, which can reduce your credit score and DTI ratio.
Check Your Credit
Access and review your free annual credit report for accuracy before applying. If you spot any errors or inconsistencies in your reports, address them with TransUnion, Equifax, and Experian – the three major credit bureaus.
“Take steps, as well, to improve your credit score if needed. This can be done by paying off outstanding debts and avoiding late payments,” Chandler says.
You may be able to check your credit score for free via a credit card provider, bank, or other financial institution you have an account with. Alternatively, you can pay for a credit score service or credit scoring website.
Compare Multiple Lenders
You increase your chances of hitting a bullseye by throwing more darts at the dartboard. The same goes for a home equity loan.
“Shopping around and comparing offers from multiple lenders can likely secure you a better interest rate and more preferred terms,” Shirshikov says. “It can also increase your odds of finding a lender more willing to work with a self-employed borrower.”
Consider A Co-Signer                                                      Â
If you’re worried your income or credit history is insufficient, you can consider applying for a home equity loan with a co-signer with solid credit and a desirable income to improve your likelihood of loan approval.
A co-signer agrees to take responsibility for your home equity loan if you don’t repay your debt on time or if you default. Having a co-signer decreases the lender’s risk, which means they will be more inclined to approve the financing. Just be sure the co-signer understands their responsibilities before they agree.
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Pros And Cons Of Home Equity Loans For Self-Employed Borrowers
If your finances are in good shape, you’ll want to consider the advantages and drawbacks of taking out a home equity loan before deciding if applying for one is right for you.
Home Equity Loan Pros And Cons
| Advantages | Drawbacks |
|---|---|
| The interest rate is fixed. The rates on most home equity loans are fixed for the life of the loan, so you’ll know what you will be paying every month. | Your home is collateral. You risk losing your home if you fail to repay your debt as agreed. |
| Lower interest rates. Home equity loans commonly offer lower interest rates than other financing types, including personal loans or credit cards. | Closing costs and other fees. Home equity loans typically include closing costs, origination fees, and other charges similar to a mortgage loan. |
| No limits on use. You are allowed to use the loan funds for any lawful purpose. | It can reduce your credit score. Applying for a home equity loan can temporarily lower your credit score due to credit inquiries. Missed or late payments can also damage your credit. |
| Possible tax deductions. The interest you pay on a home equity loan may be tax deductible if you use the funds for qualifying expenses. | Long-term debt commitment. Home equity loans commonly have repayment terms of five to 30 years. Â |
| Lump sum upfront. Shortly after closing, you’ll receive 100% of the funds you borrow. | Reduces your equity. Borrowing reduces your home equity, which can limit your ability to refinance or sell your home at a profit. |
Alternatives To Home Equity Loans For Self-Employed Borrowers
There’s more than one way to borrow funds – with or without using your home equity.
Home Equity Line Of Credit
A HELOC offers a flexible credit line that enables you to borrow your home equity as needed instead of taking the lump sum upfront. Best of all, you pay interest only on what you spend.
“One of the main drawbacks of a HELOC, however, is that it likely comes with a variable interest rate,” says Elkeslasi. “This can lead to unpredictable payment amounts if interest rates rise.”
Cash-Out Refinance
A cash-out refinance involves taking out a new mortgage based on your home’s current market value, paying off your original mortgage and keeping the difference in cash. You repay the money you borrow as part of your new mortgage payment.
“A cash-out refi can charge a lower interest rate than a home equity loan, but it extends the term of your debt likely for a lot longer than you would repay a home equity loan,” says Shrishikov. “Common refinance terms are 15 to 30 years. That means you could end up paying more in total interest over the life of this loan.”
Personal Loan
Perhaps the quickest way to get instant funds is via a personal loan. If it’s unsecured, you won’t have to put up collateral and won’t be tapping your home’s equity. But count on paying a higher interest rate with a shorter repayment term than other types of loans.
The First Step To Buying A Home
Find a lender that will work with your unique financial situation.
FAQ
Here are answers to common questions about getting a home equity loan when self-employed.
The Bottom Line
If you work for yourself, getting a home equity loan may be more challenging. But if you can show you have sufficient income and your overall finances are in good shape, you should have plenty of loan offers to choose from. Make sure you compare your options and understand the costs and effects of the loan on your finances before you decide to sign on the dotted line.
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