Best Home Equity Loans For Self Employed Borrowers
April 2024
Are you self-employed and looking to get a loan using the equity you've built up in your home? Read on to find out about the best home equity loans and other mortgage refinance loan products for individuals who work for themselves.
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Whether it's true or not, self-employed workers are often perceived as having less reliable income than your average salaried employee. This is not necessarily a fair assessment but the perception can make it harder for you to qualify for a loan.
However, whether you're looking to apply for a loan to expand your business, remodel your home, or pay for your child's college education, self-employed borrowers will likely have an easier time securing a home equity loan over other loan products. For example, personal loans or home improvement loans might be more difficult to get because they are usually unsecured, whereas home equity loans are secured using your house as collateral.
Here is SuperMoney's list of the best home equity loans for self-employed individuals.
Alternatives to home equity loans
If a home equity loan isn't the right option for you, there are other types of equity loans to consider. These include a cash-out refinance, a home equity line of credit, or a shared equity agreement.
Home equity investments
Home equity investments, also known as shared equity agreements, can be a great alternative to home equity loans for self-employed workers. Because they're not technically loans, income and minimum credit score requirements are not as strict as with other loan types. For example, a borrower could, in some cases, have a credit score of as low as 500 and still be approved.
Plus, if your self-employment income is somewhat erratic, home equity investors can generally be more forgiving. This is because they're betting on your home's equity to increase as opposed to your ability to make monthly loan payments.
Essentially, a shared equity agreement means an investor will give you a lump sum of money in exchange for future equity in your home. There are no monthly payments, and the money will be paid back at the end of the term or when the house is sold, whichever comes first.
Home equity line of credit
A home equity line of credit, or HELOC, can be a valuable tool for self-employed people. This option is great for those who could use some access to cash but don't necessarily have a designated purpose for the money or plans for a large project where they require a lump sum of money on the spot.
This is because a home equity line is a revolving line of credit like a credit card. It allows you to borrow as much or as little as needed during the draw period, so you only take as much as you need at any given time. This might be ideal for self-employed workers who might need some extra cash here and there to grow their business, such as adding inventory or buying a new tool or piece of equipment.
Furthermore, if you would like to make a few improvements around the house, the interest you pay on that investment in your home is tax deductible just like with a home equity loan.
Cash-out refinancing
Cash-out refinances are another way to harness your home's equity and put it to a better purpose, such as investing in your own business. They differ from conventional loans, second mortgages, and traditional mortgage refinancing in that you're exchanging your existing mortgage for a new and larger mortgage loan. Basically, the equity from the home is rolled into the new mortgage and you receive that equity amount in a lump sum of cash.
If you're looking into a cash-out refinance, know that minimum credit score requirements will likely be higher than with other equity loan products because of the bigger loan amount. In addition, you'll probably be looking at higher interest rates and closing costs as well. On the other hand, a cash-out refinance is a great way to tap your home's equity and keep a single monthly mortgage payment to manage.
How home equity loans work
Home equity is the difference between what you owe the bank or financial institution for your home loan and the value of your house. Simply put, if your house is worth $200,000 and you've already paid off $100,000, then you have $100,000 of equity in your home. The equity amount includes your down payment and anything you've paid on the mortgage loan principal since its inception, plus any added market value to the home.
Home equity loan lenders will allow you to borrow against that money to help you leverage the equity in your home for any number of purposes. Mortgage lenders will usually allow you to borrow up to 80% or 85% of the equity in the home. But keep in mind that if you don't leave at least 20% of the equity invested in the house, you'll probably have to pay private mortgage insurance (PMI), which adds to your overall loan costs.
If you're approved, you'll get the money in a lump sum payment. You can then begin paying it back right away at a fixed interest rate with a predictable monthly payment.
Keep in mind that a home equity loan is considered a second mortgage. This means not only will you have two mortgage payments each month, but also that your house is at risk of foreclosure if you fail to make the monthly payment on either mortgage.
Benefits of self-employed home equity mortgage loans
The biggest benefit of home equity loans for self-employed borrowers is the ability to access a larger amount of cash than they could probably get with other loan products, such as a personal loan. Other benefits for self-employed workers include:
- Interest rates. Home equity loans generally come with better interest rates and loan terms than with other loan products. This is because it's a secured loan using the house as collateral.
- Investing in the business. Self-employed people can obtain a large amount of money that could be used to invest in their business, such as leasing a new facility or opening up a second location.
- Home remodeling. If using the home equity loan for home renovations (such as turning the attic or that old carriage house into a sweet home office set-up), the interest paid on the loan is deductible on your income tax return just like your original mortgage. Plus, any improvements will add to the value of the home, which will also increase the remaining equity in the house.
- Supplementing income. Self-employed workers could use the home equity loan as a down payment on an investment property to bring in extra income. This could be especially beneficial during leaner times if the business is largely seasonal, for example.
- Consolidate high-interest debt. Sometimes when people start up a new business, they wind up in debt out of necessity. If you're self-employed and can get a home equity loan to use for debt consolidation, it will free up some cash for other purposes and save thousands on interest payments.
- Predictable payments. A home equity loan usually comes with a fixed interest rate and equal monthly payments. This makes it more convenient for self-employed individuals to budget for that extra expenditure each month.
Tips for self-employed workers to get a home equity loan
1. Have proof of income
Self-employed people may not have the traditional pay stubs and W2s that a traditional loan officer will ask for, but it's still easy enough to figure out your income. Borrowers will likely need to provide business and personal bank statements to verify your monthly gross income and net income after accounting for taxes and business expenses.
Home equity loan lenders will also want to see your personal and business tax returns from the last two years for further proof of your income and business expenses.
2. Don't take on any additional debt
This is true for anyone looking to take out a significant loan, but especially for those who are self-employed who are, by default, going to be under particular scrutiny.
If you're thinking about applying for a home equity loan, this is not the time to buy a brand new vehicle or get a new credit card. This is especially important if taking on any additional debt would tip you over the 43% debt-to-income ratio required by most mortgage lenders.
3. Check your credit score
Before you even start looking for lenders who specialize in home equity loans, take a good look at your credit score. Get a copy of your free credit reports and make sure all the information is correct (and have it fixed if it's not).
This is also a good time to assess your overall credit and see where you can make some positive changes. This could include paying off high-interest debt to boost your credit score before you begin shopping for home equity loans.
Your credit report is one of the first things home equity lenders are going to look at when deciding whether or not to approve your home equity loan. General guidelines say you need a minimum credit score of 620 to be approved for home equity loans.
However, as a self-employed worker, you'll probably need a much better credit score than that to outweigh your perceived "unreliable" income. In any case, mortgage lenders want to see a respectable history of paying down your debts in a timely manner.
4. Look at your options
Before you decide to apply for a home equity loan, do your homework and see if there are alternative ways to leverage the equity in your home that might better suit your needs right now.
Other possibilities to consider are a cash-out refinance, a home equity line of credit, or a shared equity agreement, for example.
5. Remember other costs
Aside from the home equity mortgage loan itself and the interest rate you'll pay, consider other costs of the loan itself. Not all of these expenses will necessarily apply, but there may be an origination fee, appraisal costs, lawyer fees, and closing costs that will add to the overall cost of the loan.
6. Find a cosigner
If it turns out your self-employment income isn't as stable as a regular paycheck (or you've opened your business too recently for mortgage lenders to take a risk on you), you might need to ask a friend or family member to cosign the loan for you.
This is not a bad thing — it just means the co-signer agrees to take over the loan if you can't make the payments. It can also be great for your credit score. As long as you continue to make timely payments on the loan, your credit score will improve.
How to compare home equity loans
When you're shopping for a home equity loan, be sure to compare and contrast multiple lenders and whether they offer:
- Competitive interest rates
- Loan terms that meet your needs
- Minimum fees associated with the loan
Other things to look out for are loan limits and credit requirements, as these can vary quite a bit by home equity lenders. However, keep in mind that mortgage lenders may have additional documentation requirements for self-employed borrowers during the loan approval process.
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SuperMoney
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