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5 Tips for Refinancing When Self-Employed

Thanks to a desire for work flexibility – especially in light of the pandemic and its impact on the work force – the self-employment and gig economy is going strong. There are financial pros and cons for this sector and the ability to purchase a home or refinancing when self-employed definitely factor into it. Benefits of a refinance program – whether a W2 employee or small business owner – can include:

  • Taking advantage of low interest rates for a reduced monthly payment. The Federal Reserve has indicated that rates will remain low as the economy recovers.
  • Reducing your mortgage term to 10, 15, or 20 years in order to save money on the life of your loan.
  • Converting an adjustable-rate mortgage (ARM) to a fixed rate loan for long-term stability.
  • Potentially eliminating private mortgage insurance (PMI) required on many original mortgages including government-backed FHA loans.
  • Accessing the equity in your home for a cash-out refinance, which can be used for various reasons – like reinvesting back into your business!

If one or more of these are factoring into your decision to replace your current mortgage, then consider these five areas that will make refinancing when self-employed easier to navigate.

1 | Income Stability & Consistency

The main difference between refinancing as an hourly or salaried employee and a business owner is the documentation. Lenders will require verification of your business such as a license or LLC paperwork. They’ll also want to see that you have consistent and reliable income so you can make your monthly mortgage payments.

Instead of W2s or paystubs, you’ll need to provide two years’ worth of tax returns, bank statements, and/or profit & loss statements. If you’re an independent contractor or gig employee who receives more than $600 from one source, then 1099 tax forms will be necessary. 

If your business or is newer than two years, there may be flexibility with lenders and programs, especially if you’re working in the same field as your previous employment. Consistent income and work are of importance, as well as any other liquid savings or assets you can show.

2 | Strong Credit Score & History

Your personal credit score – or FICO – and general credit history is naturally taken into consideration if refinancing when self-employed. A very good or exception score (740 to 850) will greatly improve your chances of approval, however a lower score doesn’t mean automatic disqualification.

Prepare in advance by checking your score for any errors or balances that can be resolved. Don’t add to your debt or apply for any additional cards or loans until after the refinance is complete. There are lenders with FHA programs and bank statement loans that will look at the big picture of your business, a strong, on-time payment history, as well as your FICO range.

3 | Debt-to-Income Ratio

Your debt-to-income ratio – or DTI – indicates how much of your gross monthly income goes to paying debts that can include mortgage, credit cards, auto loans, etc. Mortgage lenders look at the front-end DTI that measures monthly housing costs in comparison to your income, and the back-end DTI which covers other monthly debt payments. An ideal front-end DTI is 28% or less, and back-end DTI would be less than 43%.

Excessive credit usage may suggest that you’re relying on credit too much, so revolving credit balances shouldn’t be more than 30% of your gross monthly income. Lender guidelines will vary, but any debts you can pay off before refinancing will show additional cash flow in your favor.

4 | Loan-to-Value Ratio

With any refinance, self-employed or otherwise, your home’s equity is considered in the qualifying process. If the home’s value has increased substantially and is more than the loan, the loan-to-value ratio (LTV) can favorably impact your chances. It’s the metric that lenders use to determine eligibility and rates; ideally, a ratio of 80% or lower, indicating less risk for them.

5 | Mindful Deductions

A common practice for the self-employed and small business owners is to take as many deductions as they can, which will save them money at tax time. While it’s true that deductions and expenses will reduce your annual income, it’s important to remember if you’re refinancing when self-employed that lenders only count taxable income toward your new mortgage.

Look at your deductions through that lens and ask your financial advisor or mortgage lender how to best approach it if you’re looking to refinance in the near future.

While it may involve more work to refinance your home when you’re the boss, there are distinct advantages lenders will consider. If a traditionally employed person loses their job, their income is likely to be zero, however many self-employed and gig contractors have multiple clients and sources of income. They’re accustomed to picking up the slack elsewhere if something changes, and they’re already used to filing extra tax forms and documents in the daily process of their business.

Our team at Titan Mutual Lending Inc. understands the aspirations and “can do” mindset of the entrepreneur and sole proprietor. Let’s sit down and discuss your options and objectives for refinancing as well as helping your business thrive.

When refinancing an existing loan, total finance charges may be higher over the life of the loan.

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