Self-employed? How lenders count your income

For self-employed buyers, it starts with how income is counted

The line self-employed borrowers hear most is "your tax returns don't show enough income." Often the problem isn't the income itself but how the lender counts it. Different methods can produce very different loan amounts, so sort this out before you start touring homes.

Under Fannie Mae's rules, anyone with a 25% or greater ownership interest in a business is self-employed, even if they also draw a salary from it. Restaurant and business owners, 1099 contractors, rideshare drivers and online sellers all fall in this group.

The federal Ability-to-Repay rule (12 CFR 1026.43) requires lenders to verify income with reliable third-party records. Tax returns are one kind; W-2s, payroll statements and records from banks and other financial institutions are others. That is why self-employed borrowers have two paths: a conventional loan based on tax returns, or a Non-QM loan based on bank statements.

Path one: a conventional loan based on your tax returns

Conventional loans follow Fannie Mae's rules for self-employment income:

• Usually a two-year history. Fannie Mae generally requires two years of earnings history: two years of signed personal tax returns with all schedules, and sometimes business returns. The lender may pull IRS transcripts instead of copies; you will usually sign IRS Form 4506-C for that (the IRS's IVES service).
• When one year of returns is enough. If the business has existed for five years and you have owned 25% or more of it for five years, Fannie Mae allows the most recent year's returns alone, with the lender completing a cash flow analysis such as Form 1084.
• Less than two years self-employed. If your most recent return shows a full 12 months of income from the current business, and you earned the same or more before in the same or a similar line of work (say, a W-2 engineer who now consults), Fannie Mae lets the lender consider it.
• Trends matter. The underwriter compares gross income, expenses and taxable income year to year to judge stability. Income that keeps falling will draw questions.

More than net profit: what gets added back

Many people assume the lender only looks at the bottom line of Schedule C (line 31). Fannie Mae's Schedule C rules add back expenses that were deducted but aren't cash out of pocket: depreciation, depletion, business use of the home, amortization and casualty losses. Non-recurring income, on the other hand, is subtracted.

An illustration only, not your numbers: net profit of $60,000 plus $15,000 of depreciation and a $5,000 home-office deduction gives about $80,000 of qualifying annual income, a third more than net profit alone. Each year is calculated this way and then averaged as the rules require.

Path two: bank statement loans (Non-QM)

If your deductions are large and the add-backs still don't get you there, Non-QM loans skip the tax returns:

• Bank statement loans: 12 or 24 months of personal or business statements. Deposits are totaled, transfers between accounts and non-business money are taken out, and an expense factor set by the lender (or your CPA's actual expense ratio) converts deposits into income.
• Profit and loss (P&L) loans: a P&L prepared by a CPA or tax preparer instead of tax returns.
• 1099-only loans: for independent contractors.

Non-QM loans fall outside the standard qualified-mortgage rules, so the rate is usually higher than a conventional loan and the down payment is usually larger. In return, income is based on what actually comes in. See self-employed and alternative-income loans for the programs. Many clients buy with a bank statement loan and later, once their reported income catches up, look at refinancing into a conventional loan.

Five places self-employed buyers get stuck

• Mixing personal and business money. A bank statement loan needs business income separated out. Personal spending in the business account, or money moving back and forth with friends, means explaining deposit after deposit. Clean up the accounts a few months ahead.
• Using business funds for the down payment. When business assets pay the down payment, closing costs or reserves, Fannie Mae calls for a current balance sheet and several months of business account statements, and the lender must judge whether the withdrawal will hurt the business. Plan the transfer with your CPA.
• Filing taxes without checking the mortgage impact. Every extra deduction lowers qualifying income. If you plan to buy within a year or two, have your CPA and your loan officer look at it together before you file. Your CPA has the final word on taxes.
• Applying during tax season. Early in the year your latest return may not be filed yet, or be on extension. Ask before you apply which year will be used and what else will be needed.
• Large cash deposits. Cash from a cash business needs to match your business records. Large deposits with no clear source will need a written explanation and proof.

Document checklist

For the tax return path (conventional), usually:

• Two years of signed personal returns with all schedules, and sometimes business returns (1120S, 1065 and so on) and K-1s
• A signed IRS Form 4506-C
• The last two months of complete statements for all bank and investment accounts
• If using business funds: a business balance sheet and recent business account statements
• A photo ID

For the bank statement path (Non-QM), usually:

• 12 or 24 months of personal or business statements, every page
• A business license, formation documents or a CPA letter showing the business exists and your ownership share
• Statements showing the down payment and reserves

Underwriting may ask for more; the lender's actual conditions apply.

Available in Georgia and California

I'm a loan officer licensed in Georgia and California (NMLS #2869394, OrangePath Financial) and can do both paths. Before you apply, I can run the same documents both ways and show you which path qualifies you for more at a lower cost.

Buying in Atlanta? I'm also your real estate agent, so the offer and the loan run on one schedule; see how to choose an Atlanta real estate agent. Still deciding where to buy? Check prices with the home value estimate and next year's tax with the Georgia property tax calculator; both go into your monthly housing cost.

Next steps

• Get pre-approved: a 5-minute call or WeChat, no credit pull. Send two years of returns or a few months of statements and I'll calculate your qualifying income first
• Self-employed and alternative-income loans: bank statement, P&L, 1099 and VOE programs
• First-time buyer loan guide: six steps from pre-approval to closing
• DSCR investment property loans: buying a rental, qualified mainly on the rent
• Atlanta home loans · California home loans