How to Get a Mortgage When You’re Self-Employed

By Dwayne Holt, Mortgage Lending Director

For most mortgage lenders, the application review process starts by comparing the borrower’s proposed housing payment with his or her monthly income. But that’s not easy to do if the borrower doesn’t get a regular pay stub. Many freelancers, business owners and other independent workers are considered “self-employed.” 

If you (or someone you know) would fit in that category, income is determined by reviewing documents like profit-and-loss statements, 1099s and tax returns. Here are some considerations to help those self-employed individuals figure out if they can buy or refinance a property. 


Defining Self-Employment
Lenders have a basic definition for a self-employed borrower: anyone who receives more than 25% of annual income in non-salaried pay. You can probably be considered “self-employed” if you: 

• Own your own business
• Are a partner with at least 25% ownership in a business
• Receive more than 25% of your income in commissions or bonuses
• Are a contract worker (even if you work for only one company)
• Receive 1099 forms instead of W2s
• Are primarily a landlordReceive royalties
• Make most of your income through dividends and interest

Required Documentation for Mortgage Applications
To begin, a lender will want evidence that you’ve been self-employed for at least two years, which means documentation in addition to your business license. The following will likely be required:

• 2 years’ personal tax returns with all schedules 
  • 1099s
  • W2s from your self-employed business (if you pay yourself a salary)
  • Schedule C, D, E, F
• 2 years’ business tax returns with all schedules 
  • K-1s 1120 (Corporate Tax Returns) 
  • 1120S (Partnerships and S Corps)
• Year-to-date profit and loss statement showing current income is consistent with previous years 
• CPA letter stating you are still running your self-employed business
• A letter of explanation if you receive most of your income at a specific time of year. If your income is seasonally weighted, your profit and loss statement may look out of line.
• Another tip: if you’re part of a business that has multiple owners, you need your partners’ permission before you turn over your business tax returns to a lender.

Issues in Tax Returns for Mortgage Lenders
Lenders look for some key information and indicators when reviewing tax returns related to a home loan application. Common issues for self-employed individuals include: 

• Two-Year Self-Employed Average Income: lenders review business income for the most recent two year period. It’s calculated by adding both years and dividing by 24 (months). For example: in year one, the business income is $70,000 and year two, $78,000. The income used for qualifying purposes is $148,000 ($70,000 + $78,000), then divided by 24 = $6,167 per month. 
• Expenses: lenders consider net profit, not gross profit. Therefore, if you earned $70,000 last year in revenue, but had to pay $30,000 in rent, supplies, utilities and insurance, a lender will only consider $40,000 in profit as real income. 
• Declining Self-employed Income: lenders also look at consistency of income from year to year. For example, if year one income was $75,000 and year two was $45,000, the total would be $120,000. Though the average is $5,000 per month, a serious decline in income could indicate a failing business. Lenders assess income trends – and a business suffering from declining income seems in doubt. However, there is no mandatory rule regarding income decline; it’s up to the underwriter. The borrower may have a legitimate reason, such as taking time off to care for a new baby. This can be easily documented, in which case the underwriter might ask for three year’s tax returns instead of just two.
• Cash Flow: Bank statements are reviewed for cash flow. Businesses such as restaurants or retail stores rely on daily purchases of their goods and services. Others rely on just a few transactions per year. Lenders need to confirm that there are enough funds to pay the bills consistently.

Calculating Self-employed Income is Complicated
Self-employed income calculations often mean a judgment call by the underwriter, especially for borrowers who have multiple businesses or properties, or whose business may be non-traditional.
That’s why it can be extremely helpful to give your tax returns to a mortgage professional for review. Most lenders offer this service for more complicated tax returns, sometimes even before the official mortgage application. This review establishes a starting point, since the underwriter can determine qualifying income ahead of time.

The self-employed borrower does endure more scrutiny that the standard employee with a pay stub. If you’re self-employed and begin your loan application with the proper expectations, you’ll close your mortgage loan with very few surprises.