Before the mortgage crisis, self-employed individuals used to rely on the NINA (no income, no assets) and SISA (stated income, and stated assets) loans to overcome the hurdle of not having stable paychecks or tax returns. During the mortgage crisis people who truly didn’t qualify for mortgages used the NINA and SISA programs to obtain loans for the houses they could not afford.
Everyone suffered after the mortgage crisis and had difficulty getting loans. But, the restrictions on self-employed individuals have taken longer to overcome. Without the use of NINA and SISA programs, self-employed borrowers have a tough time proving income. Recently, those restrictions have started to loosen making it very possible for self-employed individuals to start purchasing homes again. However, there are no longer any shortcuts.
Who is Considered Self-employed (Traditional Requirements)
Self-employed individuals are those who have a 25% or greater ownership interest in a business.
Before approving a mortgage for a self-employed borrower the guarantors. FHA, Fannie Mae/Freddie Mac and VA will want proof of the following:
- A two-year history of income showing self employment
- The stability of the borrower’s income
- The location and nature of the borrower’s business
- The demand for the product or service offered by the business
- The financial strength of the business
- The ability of the business to continue generating and distributing sufficient income to the borrower
Specific Tax Documentation Required
- 1099(s) or W2(s) from self-employed business status (paying yourself a salary)
- Schedules C, D, E and F (as appropriate based on your type of business)
- Some schedules will show income which are not counted if they are onetime events
- Business tax returns as appropriate based on your type of business
- Schedule K-1’s
- 1120 or 1120 as appropriate based on your type of business
- Year to date profit and loss statement
- CPA letter verifying current business activity
- Explanation letter(s) as appropriate based on lender questions
- Questions can range from explaining why a bulk of income comes from one customer, a resume or experience, business formation, explaining lower profit and loss for the year, etc.
Updated Requirements to Qualifying a Self-employed Borrower
Although some lenders will require two years self employment income, you can accomplish buying a house with only one year of tax returns. If the lender is requiring two years documentation, search for another lender and/or mortgage broker! Officially, Fannie Mae states, “a person who has a shorter history of self-employment — 12 to 24 months — may be considered, as long as the borrower’s most recent signed federal income tax returns reflect the receipt of such income as the same (or greater) level in a field that provides the same products or services as the current business or in an occupation in which he or she had similar responsibilities to those undertaken in connection with the current business. In such cases, the lender must give careful consideration to the nature of the borrower’s level of experience, and the amount of debt the business has acquired.”
The lender may verify a self-employed borrower’s employment and income by obtaining copies of his or her signed federal income tax returns. The lender will want both individual returns and in some cases, business returns filed with the IRS for the past two years (with all applicable schedules attached).
Alternatively, the lender may use IRS-issued transcripts of the borrower’s individual and business federal income tax returns. The transcripts include the information from all of the applicable schedules (See B3-3.1-06, Requirements and Uses of IRS Form 4506-T). You can get IRS transcripts by calling 1-800-829-1040 and requesting them by fax.
Shopping for a Lender while Self-employed
You definitely want to shop around with at least three people. The credit inquiries will hurt your credit but only slightly.
- If you are self-employed getting a loan from a traditional bank like Chase, Bank of America or Wells Fargo will more than likely require 2 years of tax returns. Dealing with these banks will be toughest but, it doesn’t hurt ask
- Credit Unions might be a little less stringent but could still be difficult and want the 2 years tax returns
- Local or community banks are worth a shot. These banks normally will not have to conform to the same mortgage guidelines as national banks. Therefore, they might relax their lending practices and/or requirements
- Definitely try contacting a mortgage broker as they will have access to several lenders and products
The key components are the tax return and lender. You might have a tax return without having worked an entire year as a self-employed individual. This is fine, just know that whatever income you have on that tax return, is the income the lender will use. For example:
- You worked 8 months as a self-employed individual and made 80,000 in gross income and deducted 20,000 in expenses. This would leave you with 60,000 for the year or 60,000 / 12 (months) is 5,000 a month.
- If you worked a full twelve months, you would have made 120,000 in gross income and deducted 30,000 in expenses. This leaves you with 90,000 for the year or 90,000 / 12 (months) is 7,500 a month.
You can see why it would be appealing to wait for one full year of income to report on your tax return. But, remember you only file taxes once a year. Because the lender will only look at the yearly tax return you will have to wait until the tax filing. In addition to tax returns, lenders will examine cash flow to ensure the business has enough monthly income to service debt.
Having a business tax return is not enough, that business must show a NET profit not just a GROSS profit. This means if you are trying to lower your business income to the point where you pay fewer taxes, this is not productive if you are trying to buy property. It will not matter if you currently making a good monthly income now. What matters in the tax return and the income on it. Whatever is on your tax return is divided by 12 and used to determine how much house you can afford.
Not every business owner uses a CPA. However, it is a good idea to get one especially if you are trying to buy a house. This will make preparing the documentation easier. For example, if you are planning to use business income as a down payment a CPA can validate using the money will not hurt the operations of the business.
The Bottom Line
Trying to calculate your qualifying income while self-employed is difficult. Unlike salaried employees who can calculate their monthly income and debt to income easily, self-employed borrowers have several variables. Make sure you talk with lender about your situation before having your credit run. See the article on finding the right lender here.
If you are self-employed, the LAST thing you want to do is show you have made little to no money with your business by claiming hefty deductions. If you are trying to buy a house the net income on your tax return is what gets used to calculate your buying power. A gross income of $200,000 with deductions on $195,000 means you made $5000 that year. This will not qualify you to purchase a house.
The Purpose of This Article
It’s almost impossible to tell you what you can and can’t do in the mortgage world. There are so many lenders out there and so many mortgage products that you will usually find something to fit your needs. It’s just a matter of knowing where to search. Keep in mind there is a difference between what guarantors will allow in their programs and what the lender will allow. If you are told no by one LENDER, you can shop around. If you are told no because your circumstance is against the guarantors requirements then going to another lender will not help.