Taking out a home equity loan while self-employed? Use these 4 expert tips

Savers are enjoying higher yields now thanks to today's high-rate environment, but you might not be happy about those high interest rates if you're a borrower. After all, affordable borrowing options are scarce, with interest rates on personal loans averaging around 12%. 

Luckily, homeowners who want to borrow at a low rate can take advantage of their home equity, tapping into what they've already paid into their home by taking out a home equity loan or a home equity line of credit (HELOC). And, home equity products typically have lower rates than personal loans, making them a great choice for homeowners. However, self-employed homeowners may have a more challenging time securing a HELOC. Proving reliable income is one of the most critical factors in qualifying for a home equity loan or HELOC, which isn't always consistent for self-employed workers.

"It can be more challenging for a self-employed borrower to qualify for a loan because lenders perceive self-employed borrowers to be riskier than salaried or hourly wage earners," says Phil Galante, a mortgage broker with ProMortgage in California. "Self-employed income is often not as regular or predictable as salaried employees, who receive consistent paychecks at regular intervals."

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Taking out a home equity loan while self-employed? Use these 4 expert tips

If you want to take out a home equity loan or HELOC as a self-employed worker, here are a few expert-driven tips that could help you qualify. 

Keep detailed records

The better your record-keeping, the quicker it will be for you to review your business and personal filings, experts say — and the easier it will be for potential lenders to understand what your financial picture is. Meticulous, detailed records are essential in terms of qualifying for a home equity loan or HELOC.

"Don't [commingle] personal and business expenses — they must be 100% separate," Galante says. "Keep accurate and up-to-date records of your business income and expenses."

To ensure that your personal and business financials are separate, it might help to have a business bookkeeper handle your company's expenses and records while having a separate accountant handle your personal expenses. 

After all, business owners can stand out with lenders by showing their profit, according to Joseph Hogan, CFP, mortgage broker and managing partner of WealthFD.

"Conventional loan programs will typically calculate your self-employment income using the average net income on your tax return over the past two years," Hogan says. "Work with your accountant to properly capitalize and depreciate asset purchases. Depreciation is a common add-back for lenders, meaning they will exclude those expenses when calculating your income."

Find out what home equity loan and HELOC rates you could qualify for here.

Boost your credit score

Borrowing of any sort tends to be the least expensive if you keep your credit score in good shape. And, it will typically need to be higher for home equity products than for buying a home, experts say.

"When I worked in home lending for three major national banks, all had a higher minimum credit score to be eligible for a home equity loan or line of credit than for a primary mortgage," Galante says. "The minimum credit score for self-employed borrowers is even higher than for W-2 employees."

So, before applying for home equity products, take some time to pay off as much outstanding debt as you can. Galante suggests paying off credit cards monthly and keeping other debt to a minimum.

Make sure your tax filings are up-to-date

Make sure you are also considered self-employed based on your lender's standards — and that you're keeping up with tax filings on time. For instance, do you own 25% or more of your business? Do you receive a 1099 for contract work? Is your income on a Schedule C form with the IRS? You're considered self-employed if you answered "yes" to any of these. 

"If possible, file tax returns on time instead of filing for extensions," Galante says. "Underwriters usually want to review returns from the two most recent years. If there's an extension for the most recent year, they'll also review the Profit and Loss statement for that year to confirm there isn't a reduction in income from the previous two years."

Filing on time and avoiding extensions shows that your business is operating as normal, which proves to lenders that you're responsible and worth lending to, experts say. Requesting extensions, on the other hand, might be a red flag to lenders.

Shop around to find the right lender

Not all lenders have the same standards and requirements. If you're worried about qualifying for a home equity loan or HELOC with one lender, you might qualify with a different one, so it's important to comparison shop.

"Shop around for the right lender," Galante says. "This isn't always the lender with the lowest rate."

And, in certain cases, simply qualifying for a home equity loan or HELOC may be good enough, Hogan says, even if you don't get the best rate. Self-employed borrowers might face higher rates regardless of their full financial picture, so you may need to find other ways to lower your costs instead.

"Mortgages and home equity loan rates are often higher for self-employed borrowers, especially those with smaller down payments," Hogan says. "Making a larger down payment on your loan and maintaining a minimum of six months of mortgage payments in cash reserves can substantially lower the cost of your loan."

The bottom line

Taking out a home equity loan while self-employed might be more complicated than it is for salaried or hourly workers, but it's not impossible. There are ways to maximize your chances of approval, and the tips above can help. So, before completing an application, make sure you're eligible for a home equity loan as a self-employed worker. You should also focus on keeping meticulous business and personal records, taking steps to boost your credit score and shop around with different lenders to find one willing to work with you.