Self-employed borrowers often have a harder time qualifying for a mortgage. It’s not that they can’t get a mortgage; it’s just riskier for lenders. Among the available programs is the USDA loan. People often overlook this loan when they work for themselves. They assume they wouldn’t qualify. However, as long as you meet the income guidelines for USDA loan eligibility, you may qualify. Let’s look at the parameters of this loan program.
Requirements for the Self-Employed
The USDA doesn’t have many strict guidelines for borrowers. One they stick to, however, is the employment history of the self-employed. If you meet any of the following, you work for yourself:
- A contract worker receiving a 1099
- A W-2 employee working on 100% commission
- Own your own company
The last one is obvious. But, the first 2 aren’t as obvious. Even W-2 employees often fall into the self-employed category.
If you fall into one of these categories, you must provide at least 2 years of income from it. This means you can’t start a business and 6 months later secure USDA financing. They want to make sure your income is consistent. This helps them reduce the risk of default on your loan.
In order to prove you worked for yourself for the last 2 years, the lender will ask for:
- Tax returns with all schedules for the last 2 years
- Letter from your CPA stating that you are self-employed
- The articles of incorporation from your business
Meeting the Same USDA Guidelines
In order to qualify, you’ll have to meet the eligibility guidelines for USDA loans. In other words, you can’t make more than 115% of the average income for your area. For eligibility purposes, the USDA uses your household income. This includes everyone over the age of 18 that makes money. Once you total your household income, you can take the following allowances:
- $480 for every child under 18 years old
- $480 for every child over 18 years old and in school full-time
- $480 for every disabled relative living with you
- $400 for every person over 62 years old living with you
The resulting income is your eligibility income. You can compare it to the amounts on the USDA website. If you fall beneath the allowed amount, you are eligible for the USDA program.
Qualifying for the USDA Loan
Once you are eligible for the program, you must qualify for it. This means show you can afford the loan. Because you are self-employed, your lender will take a 2-year average of your income. They use the amount you claim on your tax returns, in most cases. They take a 2-year average to account for any ups and downs your income experiences throughout the year. This ensures that they don’t under qualify or over qualify you for a loan.
For example, if they used income from a 2-month period that was extremely successful for you, they could give you more loan than you can afford. On the other hand, if they used a 2-month period where your income was rather low, they may give you less than you can afford. Averaging out the last 2 years provides the best results.
Aside from your income, you’ll need to prove you have decent credit and can afford the closing costs. The USDA focuses more on the credit history than your score. That being said, you can have a rather low score and still receive approval. However, if you have many late payments or you defaulted on a federal loan, you won’t qualify. You must also prove you can pay the closing costs. You can do this by providing 2 months of bank statements showing you have the assets. Luckily, the USDA loan doesn’t require a down payment, even if you are self-employed.
Paying the Funding Fee and Mortgage Insurance
Something to remember about the USDA loan is the insurance charges. First, you’ll pay a funding fee. This is an upfront fee you pay to get the USDA loan. This fee is separate from any origination fees the lender charges. It goes directly to the USDA. They use the funds to continue guaranteeing more loans. The USDA is self-funded. That means they rely on the funds from borrowers to keep the going. Because they guarantee the loans, they sometimes have to pay lenders back for defaulted loans. Without the funding fee, this wouldn’t be possible. Right now, the funding fee equals 1% of the loan amount.
You’ll also pay mortgage insurance for the life of the loan. Right now, you’ll pay 0.35% of the loan amount. This amount changes slightly each year. It’s based on your average outstanding loan balance each year. Since you pay the principal down every year, it slowly decreases the amount of insurance you pay.
Getting a USDA loan as a self-employed borrower isn’t impossible. In fact, it’s like any other loan. The largest difference is the timeline. The USDA loan goes through not only the lender, but also the USDA. They have the final say in whether you can have the loan. If you use an experienced lender, though, you shouldn’t have a problem. Just be prepared for the lender to ask for 2-years of self-employment. If you don’t have 2 years’ worth, you may have to wait.
The good news is that the USDA loan is rather flexible. Even with a slightly elevated debt ratio or low credit score, you may qualify. This is in contrast to the conventional loan. This loan requires higher credit scores for self-employed borrowers. Usually working for yourself means higher risks for lenders. Because the USDA loan provides a guarantee, though, lenders are more willing to overlook some of the riskiness of your loan.