HELOC for Self Employed: What to Know

A HELOC for self employed individuals lets you borrow money using equity in your home as collateral. Here’s the thing, though: getting a Home Equity Line of Credit (HELOC) isn’t always straightforward if you’re self-employed. For one, lenders will likely apply greater scrutiny.

In this article, we’ll explain what you need to know about HELOCs when you work for yourself. We’ll cover the perks and potential drawbacks, what paperwork you’ll need, and tips for managing your HELOC wisely.

What’s a HELOC and How Does It Work?

As a self employed individual considering taking out a HELOC to manage your finances, it’s super important to understand how the flexible mortgage option works before taking the plunge.

A HELOC lets you borrow money using the equity in your home as collateral. Equity is basically the difference between what your home is worth and what you still owe on your mortgage.

When you’re approved for a HELOC, you get a credit limit based on your home’s equity. You can borrow from this limit during the draw period, which usually lasts about 10 years. During this time, you can access the money as needed. You’ll only have to pay interest on the amount you borrow during this period. As you repay the principal, those funds become available to borrow again.

After the draw period ends, you enter the repayment period, which typically lasts another 10 to 20 years. During this time, you can’t borrow any more money, and you’ll start paying back both the principal and the interest.

Who Is Considered Self Employed?

When you’re looking to get a HELOC, it’s important to know what lenders consider self-employment. The Internal Revenue Service (IRS) says you’re self employed if:

• You run a trade or business as a sole proprietor or independent contractor
• You’re a partner in a business partnership
• You’re in business for yourself, even if it’s part-time

Basically, if you earn money through your own hustle or as a gig worker and don’t get a paycheck from an employer, you’re self employed. This covers a lot of individuals, including business owners, freelance writers, and independent contractors (think plumbers, electricians, and handymen). You’re self-employed if you’re your own boss.

Can Self-Employed Qualify for a HELOC?

Yes, you can qualify for a HELOC if you’re self employed. However, it can sometimes be trickier for self-employed individuals to get a HELOC because lenders might see your income as less stable than traditional employment income. Also, since you typically can’t submit pay stubs or a W-2 form like regular employees, you’ll likely face a stricter qualification process.

But don’t worry, though. With the right paperwork and a strong financial profile, you can still get a HELOC. So, if you’re self employed and considering a HELOC, make sure you know what your lender needs and have all your documents ready.

What Lenders Look for When You’re Self-Employed

When you apply for a HELOC, lenders will want to see proof of your income and business activities so they are sure you can handle paying back the loan. Here’s what lenders look at when deciding if you qualify for a HELOC as a self-employed:

Proof of Income

• Tax Returns: Lenders will ask for your personal and business tax returns from the last 2 years to see how much you’ve been earning.
• Profit and Loss Statements: You’ll need to show your business’s profit and loss statements to show if your business is making enough money to support the loan.
• Bank Statements: Provide bank statements from the last 12-24 months to show your cash flow. This helps lenders figure out whether you have enough funds to cover the HELOC payments.

Financial Stability

• Length of Self-Employment: Lenders prefer if you’ve been running your business for at least 2 years. It shows them you’re established and have a stable income.
• Revenue Trends: They’ll want to see if your business income has been steady or increasing over the past few years. It reassures them that you can consistently pay back what you borrow.

Credit Profile

• Good Credit Score: Aim for a credit score of 680 or higher. It tells lenders you’re responsible with credit and can be trusted to repay the HELOC.
• Low Debt-to-Income (DTI) Ratio: A DTI below 43% shows you have enough income to handle the new debt without strain.

Home Equity

• Sufficient Equity: Make sure your home has enough equity, usually 15-20% or more of its value.

When Should You Consider a HELOC?

No doubt, you can use a HELOC for almost anything, but it’s important to be smart about it. Using your home as collateral for this kind of loan requires careful consideration, especially since your income can fluctuate when you’re self-employed.

Here are some situations where a HELOC could be a good move.

Home Improvement Projects

If you’re planning to renovate or make upgrades to your home, a HELOC can be a handy way to get access to cash as you need it. This flexibility is super useful when you’re tackling big projects where surprise costs tend to pop up out of nowhere.

A RenoFi HELOC is a great way to finance a home renovation project. Unlike a traditional HELOC loan, which is based on the current value of your home, a RenoFi HELOC leverages the After Renovation Value of your home, which significantly increases the available equity and your borrowing power - on average by 11 times! 

Business Financing

For small business owners, a HELOC can help you get some extra cash to keep things humming. It can help cover costs such as buying new equipment, stocking up on inventory, or even hiring new employees. Plus, the interest you pay on a HELOC used for business purposes might be tax-deductible.

Debt Consolidation

A HELOC can be a great way to roll multiple high-interest debts into one payment. The best part is that you might snag a lower interest rate when you consolidate your debts.

College Expenses

As a self-employed parent trying to cover college costs, a HELOC could be a lifesaver. Instead of taking out a massive student loan all at once, you can dip into your home’s equity as you need it – whether it’s for tuition, housing, or any other education-related expenses.

Emergency Expenses

Life can throw us curveballs, such as medical emergencies or economic downturns. These challenges can really throw a wrench in your finances, especially if you’re self-employed. With a HELOC, you can tap into your home’s equity to cover those unexpected costs without draining your savings or getting stuck with high-interest debt.

Steps to Apply for HELOC if You’re Self-Employed

To apply for a HELOC as self-employed, here’s what you need to do to meet the lender’s requirements:

1. Gather Your Documents

Although specific documentation may vary between lenders, you can start by gathering the following documents:

• Recent bank statements
• Your business and personal tax returns from the last two years
• Profit and loss statements
• A statement from your accountant showing your business’s financial health
• Any documents proving ownership of the business

2. Do Some Research and Prequalify

Check out different lenders who offer HELOCs and compare what they offer. Look for ones that understand self-employed individuals and offer things like flexible payment options or lower starting interest rates. Prequalify with a few lenders to see if you meet their requirements and get an idea of the rates you might qualify for.

3. Fill Out Your Applications

Once you find some promising lenders, complete full applications for the ones that seem best after prequalifying. They’ll want detailed information about both your personal finances and your business, including your business tax ID, if you have one, and your monthly or annual revenue.

4. Provide Comprehensive Information

Along with your application, submit thorough documentation that supports your income stability. This includes detailed financial statements and any other paperwork that shows your business is financially healthy and you can pay back the HELOC.

5. Wait for the Lender’s Decision

After you submit everything, it’s time to wait. Lenders will review your information and decide whether to approve you. Depending on your lender, this process can take anywhere from a few weeks to a couple of months.

6. Review the Financing Agreement and Sign Up

If the lender approves your application, carefully review the terms and conditions of the HELOC agreement they offer. Pay close attention to the repayment terms, interest rates, fees, and any other conditions specific to your loan. Sign the agreement if you’re satisfied with the terms.

Advantages of HELOC for Self Employed

Flexible Access to Funds

One big plus of a HELOC is the ability to access cash as you need it instead of taking a lump sum loan. This flexibility is great for self-employed individuals with variable incomes because it means you only pay interest on what you use.

Potential Tax Benefits

When you use HELOC funds for business expenses, the interest you pay could be tax-deductible. As a self-employed individual and small business owner, this perk can be a real advantage for your bottom line.

Lower Interest Rates

HELOCs usually have way lower interest rates than other loans or credit cards because they’re backed by your home’s equity. That means you could save some serious cash on interest, especially if you need to access funds over a longer period.

Simplified Income Verification

With HELOCs, you don’t have to jump through hoops with income documentation since they’re secured by your home. This is handy for self-employed people with diverse income sources.

Preserve Business Assets

When you get approved for a HELOC, you can access funds without draining your business’s assets or savings. It’s a smart way to maintain your working capital and keep your business running smoothly.

Potential Drawbacks of HELOC for Self Employed

Detailed Financial Review

As a self-employed borrower, lenders will dig deep into your finances. They’ll want tax returns, profit/loss statements, and bank records to verify your income.

Income Fluctuations

One major risk for self-employed individuals is income ups and downs. If your business income drops, keeping up with HELOC payments could get tough and put your home at risk.

Tougher Qualification

Lenders see self-employment as less stable, so they usually have stricter rules. In other words, you should expect higher credit scores, a lower DTI ratio, and more proof of income stability.

Variable Interest Rates

HELOC rates can change, and if they go up, your payments might become hard to manage, especially if your income isn’t steady.

Potential for Overspending

HELOCs make it easy to access cash, but be cautious not to rack up too much debt against your home’s equity. It could make paying off the HELOC or selling your home later on tricky.

HELOC Alternatives for Self-Employed Individuals

Sometimes, it can be difficult to qualify for a HELOC, especially if your income fluctuates. Here are a few alternatives you might want to consider if you can’t get a HELOC:

Home Equity Investment

A home equity investment might work for you if your income doesn’t meet the requirements for a HELOC. Instead of a loan, it lets you get cash upfront in exchange for a share of your home’s future value increase. With this option, you don’t make monthly payments, which can be helpful for your cash flow. You can pay back the investment whenever within a flexible 30-year period by selling your home or refinancing.

Cash Out Refinance

With cash out refinance, you replace your current mortgage with a bigger one. You get the difference in cash, which you can use for home improvements or starting a new project. Keep in mind, though, that your mortgage terms and interest rate may change, so it’s smart to refinance only if you can secure a lower rate.

SBA Loan

You might want to opt for an SBA loan if you need funds for your business, especially if you own a business. These government-backed loans cover things like working capital or refinancing debt. SBA loans usually have good terms and lower interest rates. You’ll need to make fixed monthly payments over a term that can stretch up to 25 years.

Is a HELOC Right for You?

Although a HELOC for self employed individuals might come with stricter requirements, it’s not impossible to qualify for the loan. However, whether or not it is the right option for you depends on your financial needs and goals.

If you’re planning to do some upgrades on your home, RenoFi loans are the smartest way to finance a home renovation project. Unlike traditional loans, which are based on your current home value or require you to refinance your primary mortgage and give up your low rate, RenoFi loans are based on the after renovation value of your home. This allows you to borrow, on average 11x more, get a low monthly payment, and keep your low rate on your first mortgage. 

Reach out today, and we’ll be happy to work with you to determine if getting a HELOC is the right choice for you.