January 26, 2023
How to Get a Loan When You Are Self-Employed
If you own your own business and are self-employed, you may be wondering how hard it is to get a mortgage. I am going to review loan program options, qualification, and requirements for self-employed borrowers.
Traditional W-2 wage earners are generally able to qualify for a home loan by simply providing copies of their W-2, tax returns and verifying that they have a job. But, when you own your own business, things become a little more complicated. I will break down some of the general requirements in place for self-employed borrowers to qualify for a home loan. You will want to check with us to find out more specific loan programs that we may have available, but as a general rule, let’s dive in and look at what you will need.
We will begin with an especially important rule and that is verification of how long you have been self-employed. Most lenders and loan programs require that you have been self-employed in your current business for a minimum of two years.
Self-Employed Mortgage Rules
Lenders define “self-employed” as a borrower who has an ownership interest of 25% or more in a business, or one who is not a W-2 employee.
However, there are exceptions to the two-year rule.
You might qualify with just one year of self-employment if you can show a two-year history in a similar line of work. You’ll need to document an equal or greater income in the new role compared to the W2 position.
Some lenders will even count one year of related employment plus one year of formal education or training as an acceptable work history.
If you’ve been self-employed for less than one year, you’re not likely to qualify for a home loan.
If you meet the self-employment history requirement, the next thing that your lender is going to ask is for two years of income documentation. This typically means two years of tax returns. This is where most self-employed borrowers throw up their hands and say, I don’t have two years of tax returns or I don’t have a lot of income.
There are many loan programs available today that will verify your income based off of your bank statements, so don’t throw in the towel yet.
The next item we will talk about in this video is self-employed borrowers income.
Mortgage lenders will generally consider any source of income that is “stable, consistent, and ongoing.”
That means all kinds of self-employment income is eligible for mortgage financing, including (but not limited to):
• Business owners
• Freelance income
• Contract work
• Seasonal work
• Gig work/side jobs
These types of income can be considered on their own, or as additional funds on top of a primary income source.
Lenders will sometimes even count unemployment income for contract or seasonal workers with a regular, documented history of receiving unemployment in the off-season.
For any source of income, a lender must determine it will be “ongoing.”
Generally, this means the income seems likely to continue for at least 3 years after closing. A history of declining income will not improve your chances with a mortgage lender.
For self-employed borrowers, a lender may conduct a review of the borrower’s business to determine its stability and the likelihood their income will continue at the same level.
If you’re in a declining industry — such as a hotel owner during the coronavirus pandemic or a builder during a housing crash — this could pose problems with your approval.
Underwriters use a somewhat complicated formula to come up with “qualifying” income for self-employed borrowers. They start with your taxable income, and add back certain deductions like depreciation, since that is not an actual expense that comes out of your bank account.
Business owners and other self-employed workers often take as many deductions as they can. While this can save you a lot of money come tax time, it can also hurt you when it comes to your mortgage application.
There are many new bank statement loan programs that are available today. These programs are often call non-qualified (non-QM) mortgages. This means they lack some of the consumer protections of major loan programs and have higher interest rates.
So, how will your lender document your income?
Documenting Self-Employed Income
In most cases, self-employed borrowers need to provide the following documents to prove their income to a mortgage lender:
• Two years of personal tax returns
• Two years of business tax returns including schedules K-1, 1120, 1120S
• Business license
• Year-to-date profit and loss statement (P&L)
• Balance sheet
• Signed CPA letter stating you are still in business
These documents can be prepared by a Certified Public Accountant (CPA), accountant, or tax preparer.
If the business is a sole proprietorship — not a partnership, corporation, or S corporation — you may not have to provide business tax returns.
If you’ve been self-employed at the same business for 5 years or more, you may only have to provide one year of business and/or individual tax returns instead of two.
If your income is not regular and reliable, lenders generally won’t count it.
However, many businesses go through ups and downs. You should also prepare to explain any significant year-over-year decrease in income when you apply for a mortgage as a self-employed borrower.
You don’t have to own your own business to be considered ‘self-employed.’
A lender will likely consider you self-employed if:
• You own 25% or more of a business
• You do not receive W-2 tax forms
• You receive 1099 tax forms
• You are a contractor or freelancer
• At least 25% of your income is from self-employment
• Most of your income is from dividends and interest
If you’re part owner of a business but your share is less than 25%, you are not considered self-employed for home loan purposes.
And remember you are not required to report self-employed income under Fannie Mae and Freddie Mac’s lending rules.
If you have a freelance job or small business on the side, and you don’t need the income from it to qualify, your lender can ignore it on your application.
You may be wondering if you can get a joint mortgage if one person is self-employed?
Maybe you want to apply with a spouse or co-borrower, but one of you is self-employed and the other is ‘traditionally’ employed.
Most mortgage lenders will be fine with this, provided the self-employment income meets the guidelines and both applicants meet loan requirements.
You also have the option not to count your co-borrower’s income source if you wish.
If you qualify for a loan with your own income, and your co-borrower is self-employed, your lender can ignore that business in underwriting.
Why would you want them to ignore that business? Because many small ventures, or even larger start-ups, don’t show income on tax returns. At least on paper, they generate losses.
While these business write-offs are great for reducing taxes, they can reduce your qualifying (taxable) income when you apply for home financing.
If you’re self-employed and want to buy a home, it helps to plan in advance. Work with a mortgage professional and involve your accountant as well.
Self-employed borrowers have access to the same mortgage programs and the same low rates as other borrowers in today’s market. Be sure to work with a lender who has loan program options for self-employed borrowers.