5 Things to Know When Buying a Home with an Irregular Income
Shopping for a lender and securing a mortgage might be one of the more nerve-wracking aspects of buying a home. Finding your dream property is one hurdle; convincing a lender you’re a good financial risk is another.
That might seem impossible for millions of American homebuyers with irregular incomes, such as small-business owners, freelancers, independent contractors, those who work on commission, are self-employed, or whose cash flow fluctuates monthly for whatever reason.
Mortgage lenders like to see consistency in your income history, but it’s not the only marker used to determine your creditworthiness. You may need to meet certain requirements or provide your lender with additional documentation to demonstrate your financial stability. However, obtaining a mortgage, even if your income varies year-over-year, is achievable.
Prepare Your Paperwork
The bottom line is that mortgage lenders want to see documentation that shows you consistently pay your bills and that you have the financial wherewithal to handle a mortgage on time every month. Some key criteria lenders use to make that assessment include your employment history, credit score, payment history, liquid assets, and debt-to-income ratio.
Every lender is different regarding required paperwork, but in general, you should be prepared to provide, at minimum, two years of both personal and, if applicable, business tax returns, bank statements, and profit and loss statements if you’re self-employed. Organize and document additional sources of income such as bonuses, commission statements, overtime pay, income from part-time work, or other investments. Lenders like to see consistent patterns of income increasing over time as an indicator of your financial stability.
A home seller’s realtor may ask for assurance that you have the necessary capital to make good on a home offer and complete the transaction. This is called proof of funds and can include documentation of a bank account, money market, a mature CD, or a line of credit.
Lenders might also ask for additional financial documents or proof of income not typically required from home buyers with predictable paychecks and W-2s. This could include anything from copies of your business license, insurance, and required permits, to current client contracts or retainer agreements, letters of explanation for income gaps, or a letter from an employer explaining the company’s bonus structure. You might be asked for an extended employment history, tax returns, or copies of your business plan.
Be ready to provide any requested documents without delay. Remember, your lender will make their decision based on your overall financial landscape, especially as a first-time home buyer. Providing them with clear and accurate data makes for a smoother process.
Improve Your Chances of Getting Approved
You can increase the likelihood of getting approved for a mortgage by showing the lender you’re fiscally responsible and practice creditworthy habits. Consider the following strategies to support your mortgage application.
Boost your reserves
A savings account with several months of mortgage payments and emergency funds can help to alleviate a lender’s concerns about your irregular income and ability to cover the loan payments. A significant savings balance also indicates you have the means to make a hefty down payment, preferably a minimum of 20 percent if not more, which reduces the total amount you’ll need to borrow. If you’re one of the 68% of Gen Z who are living with parents to save money, you’re making a smart choice. Continue to save until you have a substantial down payment. With a strong reserve of savings, you’re demonstrating both preparedness and fiscal responsibility.
Reduce your DTI
Your debt-to-income ratio (DTI) compares your monthly income to your outstanding debts, which can include credit cards, auto loans, business, student or personal loans, or child support. If your income is $5,000 per month, and you have $1,000 per month in debt, your DTI is 20 percent.
Lenders typically like to see a DTI below 43 percent, although for an applicant with irregular income, some lenders may want to see a lower ratio.
You can lower your DTI by paying off or significantly paying down the financed debt you carry, like credit cards and the types of loans mentioned above.
Consider your credit score
Lenders will scrutinize your current credit score as one determining factor of your eligibility to secure a home loan. Credit score requirements will vary by lender and loan type, but a score of 620 is typically considered the minimum for a conventional mortgage. Some FHA loans may allow a score of 500 to 580 with considerations. A credit score of 740 or higher is generally rated “Very Good”. The higher your credit score, the more likely you’ll qualify for a lower interest rate on your loan.
The most effective way to improve or maintain your credit score is to use credit responsibly and demonstrate a consistent history of paying your bills on time. In addition, pull your credit report and review it twice a year, addressing any mistakes, inconsistencies, or errors with your credit card company.
Pay down your balances as much as possible and keep them low. Refrain from taking on large additional debts. The months leading up to your mortgage application are not the time for major purchases or financing a dream vacation with your credit card.
Your credit utilization rate (CUR) reflects how much credit you have available versus how much you use. If you have a credit card with a $10,000 limit and a $1,000 balance, your CUR is 10 percent. Generally, it’s advisable to keep your CUR to 30 percent or less, but some experts recommend even lower if you’re actively trying to strengthen your credit score or maintain an excellent credit rating in preparation for applying for a mortgage.
Look for non-traditional financing options
Consult with an expert mortgage broker experienced in working with freelancers, gig workers, small business owners, or others with irregular incomes. They can help you navigate a path to lenders who are open to borrowers with non-traditional revenue and have more flexible mortgage requirements.
Your mortgage broker may recommend a non-QM mortgage product as an alternative to a traditional home loan. A non-QM, or “Non-Qualified Mortgage,” is a financing option suitable for a borrower who falls outside the income qualification or documentation requirements for a conventional mortgage. Note that non-QM mortgages are not high-risk or subprime mortgages. Rather, they allow a lender to consider a wider range of indicators to prove income and assess credit risk. Some examples of non-qualified mortgages are bank statement loans, asset qualifier loans, or alternative documentation loans.
An unpredictable income doesn’t mean your opportunity for home ownership is a pipe dream. Understand what lenders are looking for, create a plan and prepare your documents, and get your financial house in order so lenders know you’re a worthy risk. There’s a home loan out there with your name on it.
