Getting a Mortgage When You're Self-Employed

Self-employed borrowers can get the same mainstream mortgages as salaried workers. The difference is the proof: a lender usually qualifies you on the income shown on your last two years of tax returns, after deductions, not on what your business brings in. If your write-offs are large, your qualifying income can be much lower than you expect. This guide shows how that math works under Fannie Mae's rules, what a bank-statement loan trades off, how co-op boards look at freelance income, and exactly which documents to gather.

Who lenders treat as self-employed

Fannie Mae, whose rules most conventional lenders follow, says anyone with a 25% or greater ownership interest in a business is self-employed. That covers sole proprietors and single-member LLCs filing Schedule C, partners and S-corporation owners who get a Schedule K-1, and most 1099 contractors and freelancers. If you own less than 25% of a partnership or S corporation, Fannie Mae handles your K-1 income under a separate, lighter rule (see below).

Being paid on a 1099 instead of a W-2 does not by itself disqualify you. What matters is whether you can document a stable, continuing income with tax returns and whether the business looks viable.

How lenders calculate self-employed income

The two-year rule and its exceptions

Fannie Mae generally requires a two-year history of self-employment earnings. You provide signed individual returns with all schedules for the last two years, or the lender pulls IRS transcripts for the same years. Business returns are usually required too, unless the lender waives them.

• One year of returns can be enough if the business has existed for five years and you have owned 25% or more of it for five consecutive years. The lender still has to complete a cash-flow analysis (Fannie Mae Form 1084 or an equivalent).
• Less than two years in business can still work if your most recent signed return shows a full 12 months of income from the current business and you can document earlier income at the same or a higher level in the same or a similar field.
• Business returns can be waived when you have two years of personal returns, you pay the down payment, closing costs and reserves from personal funds, the business meets the five-year test, and your self-employment income rose over the two years.

Trend analysis

Underwriters compare the years. Fannie Mae tells lenders to measure year-to-year changes in gross income, expenses and taxable income to judge whether the business is stable or shrinking. A drop from one year to the next invites questions and may lead a lender to rely on the lower year or ask for more documentation. Lenders apply their own judgment here, so ask yours how it treats a declining year before you apply.

Schedule C: the add-backs

If you file Schedule C, the lender starts from your net profit (line 31), not your gross receipts. It then adds back certain non-cash or one-time deductions. Fannie Mae's Schedule C section lists these recurring add-backs: depreciation, depletion, business use of your home, amortization and casualty losses. Nonrecurring income is subtracted, including any meals and entertainment exclusion reported on the return.

In this example the designer brings in $175,000 but qualifies on about $7,800 a month. Many lenders average two rising years like this; if the second year had been lower, the lender might use only the lower figure. Run the result through the debt-to-income calculator to see what payment it supports.

K-1 income from a partnership or S corporation

If you own less than 25%, Fannie Mae lets lenders count your share of ordinary income on the K-1 only if they document either that the income was actually distributed to you, consistent with the amount used, or that the business has enough liquidity to support withdrawing it. A two-year history is required. If you own 25% or more, you are underwritten as self-employed, which means personal and business returns and the full cash-flow analysis. Guaranteed payments to partners with a two-year history can be added to cash flow.

Why your write-offs lower your qualifying income

Every dollar of expense you deduct lowers the net profit a lender uses. A $20,000 deduction that saves you a few thousand dollars of tax also removes $20,000 a year, about $1,667 a month, from your qualifying income. With lenders often working to a debt-to-income limit, that can cut your maximum loan by a large amount.

Bank-statement loans: what they are and what they cost you

Some lenders offer loans that use 12 or 24 months of bank deposits instead of tax returns to estimate your income. Federal law allows this: the ability-to-repay rule (Regulation Z §1026.43) requires lenders to verify income with reasonably reliable third-party records, and it names "financial institution records" as one example. But Fannie Mae's self-employed rules are built on tax returns or transcripts, so a loan underwritten only on bank statements is generally a lender's own product rather than a standard conforming loan, often marketed as "non-QM" (outside the Qualified Mortgage category).

Terms on bank-statement loans vary by lender, so compare at least two or three Loan Estimates line by line: rate, points, required down payment, reserves and any prepayment penalty. Check whether the loan has features the CFPB says a Qualified Mortgage cannot have, such as interest-only periods, negative amortization, balloon payments or terms over 30 years. If you can qualify on your tax returns, the conventional route is usually simpler to compare.

Buying a co-op when you're self-employed

In New York City, a co-op board reviews you after the lender does, and the board sets its own financial rules. Boards are not bound by Fannie Mae's formulas. Board packages commonly ask for recent tax returns and financial statements, so the same low taxable income that affects your mortgage also shows up in front of the board. Ask the seller's broker or the managing agent early what the building requires for down payment, debt-to-income and post-closing liquidity. See co-op financial requirements and the board package checklist, and check your numbers with the co-op board approval calculator.

A letter from your CPA explaining the business, its history and any unusual year can help a board understand your file. Strong cash reserves also matter more when income is irregular. Some buyers find condos or houses easier because there is no board income review, only the lender's.

Steps to get approved

1. 1

   Pull your last two returns

   Find Schedule C line 31 (or your K-1 ordinary income) and the add-backs. That is your starting qualifying income, not gross receipts.
2. 2

   Estimate your debt-to-income ratio

   Divide your monthly debts plus the expected housing payment by your average monthly qualifying income.
3. 3

   Get pre-approved, not just pre-qualified

   A pre-approval means the lender has looked at your returns. Self-employed files take longer, so start early.
4. 4

   Keep business and personal money separate

   Large unexplained deposits or business funds used for the down payment trigger extra review.
5. 5

   Avoid new debt and big swings

   A new car loan or a sharp drop in this year’s income can change the decision before closing.

Document checklist for self-employed borrowers

• Personal federal tax returns, signed, with all schedules, for the last two years (one year only if the five-year rule applies)
• Business returns (Form 1065 or 1120-S, or 1120) for the last two years if the lender requires them
• All Schedule K-1s for the same years
• A year-to-date profit and loss statement, if the lender asks
• Recent personal (and business, if used) bank statements for the period the lender asks for
• Proof the business exists: business license, state filing, CPA letter or website, as the lender requests
• Statements for any retirement or brokerage accounts you will use for reserves
• Gift letter, if family is contributing (see gift funds)
• For co-ops: whatever the board package lists, often including the same returns and a financial statement