It is commonly accepted that self-employed loan applicants are more likely to have unpredictable incomes, or be affected by economic slumps, rising operating expenses, or market trends. That's why lenders typically want a business track record of at least two years of increasing income for self-employed home loan applicants.

Generally speaking, it's tougher for the self-employed buyer to qualify for a mortgage. Because cash flow and profitability for the self-employed buyer are often tough to predict, loan-guaranteeing income can be difficult to prove.

Being self employed has many benefits. When you are self-employed, you can write off all of your deductions on your taxes. You have the potential to make more income than someone who is employed by someone else. One of the few times when being self employed has some drawbacks is when you go to get financing for a home.

The primary problem that self-employed borrowers face is that while their accountants are experts at reducing tax liabilities by minimizing current net income, underwriters rely on that same net income as a gauge of a self-employed borrower's earnings.

Two major areas in which self-employed borrowers are challenged by the mortgage loan process are net income and documentation.


Qualifying for Self-Employed Home Loans

In most cases, qualifying for home loans for the self-employed is contingent on your
net income (listed on Schedule C of the tax
TRUE NO DOC return). If you take deductions on your Schedule C, resulting in low net income, it could get in the way of obtaining the self-employed home loan you're looking for. Furthermore, if your income last year was 15% or more below the previous year's, you'll need to provide a good explanation which the underwriter will consider. Your income must be documented by TWO year's tax returns.


In addition to the requested tax returns, the self-employed borrower will have to provide evidence that he or she has been self-employed for a minimum of TWO years or more. A copy of a business license, etc. may be requested.


While income tax deductions are a major advantage of self-employment, they can be a negative factor in qualifying for a mortgage loan. This is due to the fact that deductions lower the business owner's net income. For example, a self-employed individual currently making a $1,200 mortgage payment may find it impossible to qualify for a payment of even half that amount on a new loan, even after the lender adds back some of the deductions for the purpose of evaluating the application.

Self-employed taxpayers are eligible for a long list of tax deductions and write-offs. They can deduct the cost of computers and other equipment, home-office costs and transportation, among other things. From a tax standpoint, it makes sense to claim as many as the law allows. But it can also make it harder to get a mortgage, because deductions reduce the amount of income on a self-employed borrower's tax return.


Underwriting guidelines require that a self-employed borrower must provide full documentation. This is mandated by the secondary market because there's greater room for the "embellishment" of information and verifications by self-employed individuals. Additional documents that may require the self-employed applicant to furnish (apart from the standard items that must be provided) may include, for example, copies of two years of "filed" income tax returns with all necessary schedules, an audited or professionally-prepared balance sheet for the previous two years, and a year-to-date profit and loss statement for sole proprietors. If the business is a corporation or partnership, signed copies of the previous two years' federal business income tax returns (with all schedules), a year-to-date profit and loss statement, etc.


Lenders generally calculate the income of self-employed applicants by using the following formula:  with the provided two years income tax returns, the applicant's net income (after expenses but before taxes) for the past two years is computed. Then the year-to-date income (again, after expenses but before taxes) for the current year is added to the total. Finally, this sum is divided by the total number of months involved to arrive at the borrower's average monthly income.



Loan underwriters "average" the "net income" of the business owner over the two years to establish an estimate of total income. For example, a borrower with a net income of $50,000 in 2004 and $100,000 in 2005 is credited with an average income possibility of $75,000 for 2006. This estimate is used regardless of proof that 2006 is on track to best 2005's income. If the averaged income meets the program's standards, the borrower has a good chance of being approved for the loan.

Some self-employed borrowers are not able to prove a high enough "averaged" tax return income to qualify for the loan program. Some businesses have a year that is off, due to many different reasons. The "averaging" method allows this year to pull down their regularly yearly business income.

Under normal Fannie Mae, FHA, VA underwriting standards, a borrower is self-employed if he or she owns more than 25% of a business that makes an income. If the percentage of ownership is below 25%, the borrower is considered an employee of the business.

If a self-employed borrower decides to go the traditional, full documentation route, he or she must be able to provide:

  1.  Two years of business tax returns
  2.  Two years of personal tax returns
  3.  A year-to-date profit and loss statement
  4.  A current business balance sheet.


ALL lenders require that self-employed borrowers sign an IRS 4506-T form.  During the "loan process", form IRS 4506-T is used by the underwriter to request a copy of your tax return "directly" from the IRS.  The underwriter will review both the borrower provided tax returns, and the IRS provided tax returns to see if they match.  Fraud is a major concern.


Underwriting guidelines differ depending upon the type of mortgage program. FNMA, FHLMC, FHA, VA, non conforming mortgage programs, etc. are very different from each other. The guidelines, eligibility and qualification requirements change on a regular basis. Debt to income ratios will be calculated based on net income, and other factors. Debt to income ratios (DTI) are very important and will determine if the self employed borrower can afford the mortgage loan amount. Debt listed on the mortgage application and credit report will be compared and evaluated.


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