Lending Guidelines for the Self Employed
You decided a long time ago that you wouldn’t be somebody else’s employee so you started your own company. Yet when it comes to getting a mortgage the self employed borrower will face a little more paperwork and preparation than for those who get a paycheck and a W2 from their employer.
First, exactly who is self employed?
For the purposes of getting a mortgage a person is considered self employed if there is more than a 25% ownership in an active business. This active business might be a sole proprietorship, a partnership or a corporation. Most of the self employed borrowers own 100% of their business and report their income on Schedule C of their federal income tax returns.
Also, any individual that receives a 1099 and is able to deduct certain expenses on their federal tax returns, an Independent Sales Person or a Consultant for instance.
What are the lending guidelines for the self employed borrower?
First, you’ll need to provide what anyone else applying for a mortgage will provide: a mortgage application, two years tax returns, most recent bank and investment statements in addition to other lender required documents.
Required Documents for a Self Employed Borrower
The self employed borrower will also be required to provide a few more items before a loan can be approved.
Note that you are not penalized because you are self employed. Far from it. You have mortgage loan options that are afforded any other consumer. This applies to conventional loans that conform to Fannie Mae and Freddie Mac guidelines, Jumbo Mortgages and FHA mortgage programs as well as VA loans and USDA programs. There are no special loan programs reserved for, or required of the self employed borrower.
Your business will be analyzed for cash flow and profitability. This information is derived from your tax returns. An underwriter can tell if you’re making money by reviewing your cash flow. An underwriter will also look to see how much income your tax returns say you make and how much you actually listed on the mortgage application.
Calculating Net Income
This income review is performed because most of the self employed borrowers don’t pay themselves the exact same amount on the 15th and 30th of the month as those who receive a W2 every year. A self employed borrower will list the approximate income on the mortgage application.
Here’s an example. A dog groomer takes in $10,000 per month grooming and shampooing a lot of dogs, cats and other pets. The dog groomer also lists about $5,000 per month in expenses for things such as rent, shampoo and insurance. So how much does the dog groomer make...$10,000? Yes, but the underwriter will look at net income, before taxes. In this example, the underwriter will use the $5,000 expense, deduct that amount from the $10,000 revenue and use the $5,000 number for qualifying purposes.
As a self employed borrower, you will also be asked to provide your most recent business bank statements to show regular deposits and expenses. The underwriter will compare those funds to the income listed on the application and tax returns. If you are one of the few self employed borrowers who don’t keep a separate bank account for their business it will be a chore to parse personal expenses from business ones. And the underwriter will certainly want to see your results.
Year to Date Profit and Loss
A year-to-date profit and loss statement is a standard staple for the self employed borrower. This P&L can be drafted by you, yet if you need the income from the P&L to help you qualify for a mortgage the P&L will need to be performed and audited by an actively licensed CPA.
A business will also need to have a minimum of two years filed business tax returns included with your mortgage application. A business with less than a consecutive two year history won’t be accepted by the lender so if you’re just starting out, either wait until you've met this two year requirement or qualify with other income.
A Note About Side Businesses
One final note on a side business: Many times a person will have a side business in addition to their regular job, a relatively common occurrence. And even though the business may not necessarily generate any income, if there is a loss that is identified on the tax returns for that business the lender will take that loss into consideration when calculating income. For example, your regular job as a software engineer pays you $7,000 yet your dog grooming business shows a loss of $1,000 per month. Your qualifying income will then be $6,000, not $7,000.
You really want to make sure you speak with a qualified Loan Officer before making any assumptions about your verifiable income, it is quite common that we will be able to add certain expense items on your tax returns back into your income.
Mortgages for the self employed may seem to be rather daunting at first glance. Yet they’re really not, lenders just look for additional information in order to make a loan approval. Just be prepared, provide the required documents and watch out for any potential pitfalls.
One of our friendly mortgage professionals can guide you step by step through the entire process, give us a call.