Self-Employed? Here’s How A Lender Looks At Your Income

10 Jul

Self-Employed? Here’s How A Lender Looks At Your Income


By Doug Goelz, Mortgage Services

If you are self-employed, lenders have very specific ways of calculating your “qualifying” income, that is, the income they will use to determine the loan amount you can afford.  If you are self-employed, you should always talk to a mortgage professional to determine the loan amount you can get.  Online calculators or simple online “pre-qualification” apps do not consider enough detailsof self-employment income to give you an accurate idea of the loan amount for which you will qualify.

For conventional loans, rules for self-employment income are complex, but here are a few guidelines used for conventional loans:

  • Lenders will use only your filed tax returns to calculate your income. If you are on extension for the most recent full tax year, lenders will use the returns(s) that have been filed for past years.  This means that if you are extension right now for 2015 taxes, the lender will look at tax returns for 2014 and maybe 2013.  Even though you might have earned a lot more in 2015 than in 2014, the lender won’t consider your 2015 income until your 2015 taxes are filed.
  • Depending on the loan type, lenders will consider either the most recent filed tax return, or the most recent two years of filed tax returns. If the lender looks at two years of tax returns:
    1. They average the net income for the two years if the most recent year’s net income is higher than the previous year’s.
    2. If income declined in the most recent year compared to the prior year, the lender will use the current year income (the lower amount).

For example, if a lender uses two years of tax returns to calculate net income, and Sally has net income of $110,000 in 2015 and net income of $90,000 in 2014, the lender will calculate her income as the average of the two years = ($110,000 + $90,000)/2 = $100,000.  If Sally earned $90,000 in 2015 and $110,000 in 2014, the lender will use $90,000 as the qualifying income.

  • Lenders look at NET income (revenue less expenses). Too often when I ask self-employed borrowers how much they make, they tell me the total revenue amount before expenses.  Also, many times self-employed borrowers try to get their net income on their tax returns as low as possible by claiming many business expenses.  Low net income on tax returns may be good for lowering income taxes, but it isnot helpful for getting a loan.
  • Most (but not all) lenders want to see two years of tax returns showing the self-employed income. I have spoken with many would-be borrowers who had salaried jobs until recently, and then went out on their own as consultants or sole practitioners. Even though they were making as much or more being self-employed as in their salaried jobs, doing exactly the same work, they could not qualify for a loan until their tax returns reflected self-employment income for two years.  This means that most people will need to wait a minimum of two years after becoming self-employed before they will qualify for a mortgage.  If you want to buy a home or refinance, and are thinking of quitting your salaried job and becoming self-employed, you should try to get your mortgage before becoming self-employed.
  • If you own more than 25% of your business, the lender considers you self-employed.
  • If you own more than 25% of your business, and the business pays you a salary and gives you a W2, the lender still considers you self-employed.
  • If you own more than 25% of the business, and it is a C- or S- corporation, lenders will look at the tax returns for the business as well as your personal returns. With some adjustments, the net profit or loss for the business will be added to the income shown on your personal tax return.  This means that if you own 25% or more of your business, and the business shows a large loss, you may not qualify for a loan even if the business is paying you a salary.
  • If you are salaried by a company you DON’T own AND you own a side business, lenders will count your current salary and add it to any self-employment income.

Of course, there are always exceptions to the above rules:

SOME lenders for some loans will look only at your most recent filed tax return (not two years of returns) to determine your qualifying income.

A FEW lenders won’t even look at tax returns to determine your self-employment income.  Rates and terms, such as the down payment required, on these types of loans are typically much higher and more stringent than for conventional loans.

Lenders MIGHT count future self-employment income if you have a contract for at least 3 years with guaranteed payments.

If you are currently self-employed or thinking of becoming self-employed, and you are thinking of buying a property or refinancing, be sure to talk with a mortgage professional so you can plan next steps and timing for getting a mortgage.

Questions?  Feel free to get in touch with me at 415-730-4665 or