Self-Employed Mortgage Loans

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Being self-employed does not mean you need a special mortgage.

Many business owners, independent contractors, freelancers and 1099 workers qualify for conventional, FHA, VA or USDA financing using standard mortgage guidelines.

The challenge is determining how much of your income can actually be used for mortgage qualification.

Business deductions, depreciation, ownership structure, declining or increasing income, distributions and the length of time you've been self-employed can all affect the calculation.

When traditional tax-return income doesn't provide enough qualifying income, alternative programs such as bank statement loans, 1099 loans and other non-traditional income documentation programs may provide another path to financing.

Fairhope Mortgage evaluates both traditional and alternative mortgage options to determine which qualification method makes the most sense for your situation.

What Is Considered Self-Employed for a Mortgage?

For conventional financing, a borrower with a 25% or greater ownership interest in a business is generally considered self-employed. Fannie Mae Selling Guide

Self-employed borrowers can include:

• Sole proprietors and Schedule C business owners
• LLC owners
• S corporation owners
• Partnership owners
• Independent contractors
• Consultants
• Freelancers
• Commission-based business owners
• Real estate professionals
• Contractors and tradespeople
• Gig-economy workers
• Borrowers receiving 1099 income

How the income is calculated depends heavily on the borrower's business structure and the mortgage program being used.

Conventional Loans for Self-Employed Borrowers

Many self-employed borrowers can qualify for a standard conventional mortgage.

Conventional underwriting analyzes whether the borrower's income is stable, sustainable and reasonably expected to continue. For business owners, the analysis may include both the borrower's personal tax returns and the financial performance of the business. Fannie Mae Selling Guide

Depending on the business structure, income may be reported through:

• Schedule C
• Schedule E
• Schedule F
• Form 1065 partnerships
• Form 1120S S corporations
• Form 1120 corporations
• Schedule K-1 income

The amount shown as taxable income on a tax return is not always the same as the income that can be used to qualify for a mortgage.

Certain eligible non-cash expenses and other adjustments may be added back when calculating qualifying income, while losses or other expenses may reduce qualifying income.

Do Self-Employed Borrowers Always Need Two Years of Tax Returns?

Not necessarily.

Fannie Mae generally looks for a two-year history of prior earnings, but there are circumstances where a shorter self-employment history can be considered.

For example, Fannie Mae allows consideration of a borrower with at least 12 months of self-employment reflected on the most recent tax returns when the borrower has an appropriate prior history earning income at the same or greater level in the same field or an occupation with similar responsibilities. Fannie Mae Selling Guide

There are also circumstances where only one year of tax returns may be required for an established business. Fannie Mae, for example, provides a one-year tax-return documentation option when specific requirements are met, including an established business and ownership history. Fannie Mae Selling Guide

Freddie Mac's current income-calculation framework similarly recognizes circumstances involving one year of tax documentation for businesses that have been in existence for at least five years. Freddie Mac

This means borrowers should not automatically assume they must wait until they have filed two full years of tax returns before discussing mortgage qualification.

How Is Self-Employed Income Calculated?

Mortgage qualifying income is not simply:

Gross business revenue ÷ 12

and it is not necessarily:

Taxable income ÷ 12.

The calculation depends on how the business is structured.

An underwriter may evaluate personal tax returns, business tax returns, Schedule C, Schedule E, Schedule K-1, Forms 1065 or 1120S, and other applicable schedules.

The analysis may make adjustments for certain items such as depreciation and other eligible non-cash or non-recurring expenses while also accounting for business losses, obligations and income that may not be available to the borrower.

Business trends matter as well. Stable or increasing earnings generally present a different underwriting profile from materially declining business income.

Schedule C Income

Sole proprietors and many single-member LLC owners report business income and expenses on Schedule C of their individual federal income tax return.

The net profit shown on Schedule C is an important starting point, but it isn't necessarily the final qualifying-income figure.

Applicable adjustments may increase or decrease the income used for mortgage qualification.

This is why a self-employed borrower should have their complete tax returns reviewed rather than assuming that the net-profit number determines whether they qualify.

S Corporation and Partnership Income

Income analysis can become more complicated when a borrower owns an S corporation or partnership.

The borrower may receive some combination of:

• W-2 wages
• K-1 income
• Business distributions
• Guaranteed payments
• Other business income

An underwriter may need to determine whether business income is actually available to the borrower and whether taking distributions would negatively affect the financial strength of the business.

Fannie Mae specifically requires lenders to consider the stability of the business and whether sufficient income can be distributed while maintaining the viability of the business. Fannie Mae Selling Guide

Bank Statement Mortgage Loans

A bank statement loan can provide an alternative when tax-return income does not accurately represent the cash flow generated by a self-employed borrower's business.

Instead of calculating qualifying income primarily from federal tax returns, eligible bank statement programs analyze deposits into personal or business bank accounts over a specified period.

Depending on the program, qualification may use:

• Personal bank statements
• Business bank statements
• A combination of eligible accounts
• An applicable business expense factor

Business deposits are not necessarily treated dollar-for-dollar as personal qualifying income. When business bank statements are used, an expense factor may be applied to estimate the expenses required to operate the business.

Bank statement loans can be useful for business owners who have substantial legitimate tax deductions that reduce taxable income even though the business generates sufficient cash flow.

Program requirements, documentation periods, expense calculations, credit requirements and down-payment requirements vary.

1099 Mortgage Loans

Independent contractors and other workers paid primarily through Form 1099 may have mortgage options that evaluate their income differently from a traditional self-employed tax-return analysis.

Depending on the program, qualifying income may be calculated using eligible 1099 earnings and applicable expense assumptions rather than relying exclusively on the borrower's complete personal and business tax returns.

1099 loan programs may be useful for:

• Independent contractors
• Real estate professionals
• Consultants
• Sales professionals
• Truck drivers
• Medical professionals
• Tradespeople
• Freelancers
• Other workers primarily receiving 1099 income

The exact calculation and required history vary by program.

A borrower receiving a 1099 should also be evaluated for conventional or government financing before automatically assuming an alternative-income loan is necessary.

Profit & Loss Statement Mortgage Programs

Certain alternative-documentation mortgage programs may allow qualifying income to be evaluated using a professionally prepared profit and loss statement rather than traditional tax-return income.

These programs can be useful for established business owners whose current business cash flow is substantially different from the taxable income reflected on prior returns.

Requirements vary significantly by program and may include verification of the business, business history and preparation or review of financial statements by an eligible third party.

Asset-Based Mortgage Qualification

Some borrowers have substantial liquid assets but do not show enough traditional monthly income to qualify for the mortgage they want.

Certain mortgage programs can calculate qualifying income based on eligible assets rather than relying entirely on employment or business income.

This may be useful for:

• Business owners with substantial accumulated assets
• Retired or semi-retired business owners
• Borrowers with significant investment accounts
• High-net-worth borrowers
• Borrowers transitioning out of active employment

The type of eligible assets, calculation method and required reserves vary by program.

FHA Loans for Self-Employed Borrowers

Self-employed borrowers can qualify for FHA financing.

FHA generally considers self-employment income when the borrower has been self-employed for at least two years. A borrower with between one and two years of self-employment may also potentially use the income when the applicable prior-work-history requirements are satisfied. HUD

FHA can therefore be an important option for self-employed borrowers, particularly when its credit, down-payment or debt-to-income characteristics provide an advantage over conventional financing.

The business and income must still meet FHA's applicable stability and documentation requirements.

VA Loans for Self-Employed Veterans

Eligible veterans, active-duty service members and other qualified VA borrowers can use self-employment income to qualify for a VA mortgage.

VA underwriting evaluates the history and stability of self-employment income and the likelihood that the business will continue generating sufficient income.

VA guidance generally considers self-employment income stable when it has been received for at least two years, while shorter histories may receive consideration when supported by related prior employment or specialized training. Benefits

For an eligible borrower, VA financing should be evaluated before assuming that a non-QM or alternative-documentation mortgage is necessary.

USDA Loans for Self-Employed Borrowers

Self-employed borrowers may also qualify for USDA financing when the borrower, household and property meet USDA eligibility requirements.

USDA requires an analysis of self-employment income and business viability. Current USDA guidance generally calls for applicable personal and business tax documentation and current business-income documentation for self-employed applicants. Rural Development

USDA can be particularly valuable for eligible borrowers purchasing qualifying properties because the program can provide up to 100% financing.

DSCR Loans for Self-Employed Real Estate Investors

A self-employed borrower purchasing an investment property may have another option: a DSCR loan.

DSCR stands for Debt Service Coverage Ratio.

Rather than qualifying primarily using the investor's personal employment or self-employment income, a DSCR loan focuses on the rental property's qualifying income compared with its applicable monthly housing obligation.

DSCR financing may be particularly useful for business owners and real estate investors whose personal tax returns do not show enough qualifying income for conventional investment-property financing.

DSCR loans are business-purpose loans for eligible non-owner-occupied investment properties and are not a substitute for financing an owner-occupied primary residence.

DSCR Investment Property Loans

Which Self-Employed Mortgage Is Best?

There isn't one loan program that is best for every self-employed borrower.

The goal should generally be to determine whether you qualify for traditional financing first and then compare alternative-documentation programs when necessary.

Traditional Conventional Loan

Best to consider when your tax returns provide sufficient qualifying income and you meet conventional underwriting requirements.

FHA Loan

Worth considering when FHA's credit, down-payment or debt-to-income guidelines provide an advantage.

VA Loan

Often an excellent first option for eligible veterans and service members who can document qualifying self-employment income.

USDA Loan

Worth considering for eligible borrowers purchasing an eligible property and meeting USDA household-income requirements.

Bank Statement Loan

Useful when business cash flow is strong but tax deductions substantially reduce traditional qualifying income.

1099 Loan

Potential option for independent contractors and borrowers primarily receiving 1099 income.

Profit & Loss Program

Potential option for established businesses when an eligible P&L-based income analysis better represents current business performance.

Asset-Based Qualification

Potential solution for borrowers with substantial eligible assets but insufficient traditional qualifying income.

DSCR Loan

Designed for eligible investment properties when qualification can be based primarily on the property's rental income rather than the investor's personal income.

Why Tax Deductions Can Affect Mortgage Qualification

Tax planning and mortgage underwriting have different objectives.

A business owner may legitimately reduce taxable income by deducting eligible business expenses. However, lower taxable income can also reduce the income available for traditional mortgage qualification.

That does not necessarily mean every business deduction reduces qualifying mortgage income dollar-for-dollar.

Mortgage underwriting applies specific rules to determine which expenses, losses, depreciation and other tax-return items must be included, excluded or adjusted when calculating qualifying income.

Before assuming you don't qualify because of the income shown on your tax return, have the complete return analyzed.

Buying a Home Before Filing Your Next Tax Return

Timing can matter for self-employed borrowers.

If business income has increased or decreased substantially, filing a new tax return can change the income documentation available for underwriting.

A borrower planning to purchase or refinance a home should consider having their mortgage qualification reviewed before making assumptions about how a newly filed tax return will affect borrowing capacity.

Fairhope Mortgage does not provide tax advice, and borrowers should consult their tax professional regarding tax-filing decisions.

What Documents Should a Self-Employed Borrower Have Ready?

Depending on the loan program, documentation may include:

• Personal federal income tax returns
• Business federal income tax returns
• Schedule C, Schedule E or Schedule F
• Forms 1065, 1120 or 1120S
• Schedule K-1s
• Year-to-date profit and loss statement
• Business balance sheet when required
• Personal bank statements
• Business bank statements
• 1099 forms
• Business license or other evidence of business existence
• Corporate, partnership or LLC documentation
• Documentation of funds needed for closing and reserves

Not every borrower will need every document.

Common Mistakes Self-Employed Borrowers Make

• Assuming gross business revenue is qualifying income
• Assuming the income on one line of the tax return is the final qualifying income
• Assuming two full years of tax returns are always required
• Assuming being self-employed automatically requires a bank statement loan
• Choosing a higher-cost alternative loan before checking conventional or government financing
• Moving large amounts of money between personal and business accounts without maintaining documentation
• Using business funds for closing without considering whether additional business cash-flow analysis may be required
• Waiting until after making an offer to have complicated income reviewed

A detailed income review before shopping for a home can identify the appropriate financing strategy much earlier in the process.

Frequently Asked Questions About Self-Employed Mortgage Loans

Can I get a mortgage if I'm self-employed?

Yes. Self-employed borrowers can qualify for conventional, FHA, VA, USDA and alternative-documentation mortgage programs, depending on their circumstances.

Do I need two years of self-employment to get a mortgage?

Not always. Some conventional and government guidelines permit shorter self-employment histories under specific circumstances. Alternative-documentation programs may have different requirements.

Can I get a mortgage with only one year of tax returns?

Potentially. Certain conventional guidelines permit one year of tax-return documentation for established businesses when specific requirements are met. Other programs may also have different documentation options. Fannie Mae Selling Guide

Can I get a mortgage without tax returns?

Potentially. Certain bank statement, 1099, asset-based and other alternative-documentation programs may not use traditional personal tax returns to calculate qualifying income. Documentation requirements vary by program.

Are bank statement loans only for self-employed borrowers?

They are primarily designed around alternative income documentation and are frequently used by self-employed borrowers. Exact eligibility depends on the specific program.

Can I qualify using business bank statements?

Potentially. Eligible programs may calculate income from business deposits after applying the applicable method for estimating business expenses.

Can I qualify using 1099 income?

Yes. Depending on the borrower's circumstances, 1099 income may be evaluated under traditional guidelines or through an eligible alternative-documentation program.

Can depreciation be added back to my income?

Certain depreciation may be added back when calculating qualifying self-employment income under applicable guidelines. The calculation depends on the tax schedules and loan program.

Can I use money from my business for the down payment?

Potentially. Under conventional guidelines, using business assets for the down payment, closing costs or reserves may require an analysis to determine whether withdrawing the funds could negatively affect the business. Fannie Mae Selling Guide

What if I write off a lot of business expenses?

Large legitimate business deductions can reduce traditional qualifying income. A complete tax-return analysis should be performed first. If traditional qualifying income is insufficient, bank statement or other alternative-documentation programs may be considered.

I just became self-employed. Can I qualify?

Possibly. Prior experience in the same field, the length of self-employment, current income, the loan program and other factors can determine whether the income can be used.

Self-Employed Mortgage Resources

Fannie Mae — Underwriting Factors and Documentation for a Self-Employed Borrower

Fannie Mae — Self-Employment Documentation for Individuals

Fannie Mae — Self-Employment Documentation for Businesses

Freddie Mac — Income Calculator and Self-Employed Income Resources

HUD — FHA Single Family Housing Policy Handbook 4000.1

VA — Lender's Handbook, Credit Underwriting

USDA Rural Development — HB-1-3555 Guaranteed Housing Handbook

About the Author

Tom Kalagher | Founder & Branch Manager, Fairhope Mortgage

Tom Kalagher is the Founder and Branch Manager of Fairhope Mortgage, LLC. Based in Fairhope, Alabama, Tom works with self-employed borrowers, business owners, independent contractors, real estate investors and other borrowers whose income may require more detailed mortgage analysis.

Tom's work includes conventional and government mortgage financing as well as alternative-income options such as bank statement loans, 1099 programs, DSCR investment-property loans and other financing solutions for borrowers whose tax returns may not fully reflect their current cash flow.

His approach begins by evaluating whether a borrower qualifies for traditional mortgage financing before considering alternative-documentation programs, with the goal of finding an appropriate combination of qualification method, cash-to-close, monthly payment and long-term financing cost.

Tom Kalagher — NMLS #2028566
Fairhope Mortgage, LLC — NMLS #2561450
Fairhope, Alabama
Phone: (251) 391-5618
Website: Fairhope-Mortgage.com

Important: Mortgage programs, documentation requirements, interest rates, down-payment requirements and eligibility standards vary by loan program and are subject to change. Alternative-documentation programs may have different rates, fees, down-payment requirements and underwriting standards than conventional or government financing. Not all borrowers or properties will qualify. This information is provided for educational purposes and is not a commitment to lend. Fairhope Mortgage does not provide tax or legal advice.