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Qualifying for a home loan with self employed income

Qualifying for a Mortgage with Self Employed Income – 2017 UPDATE

Self Employed Easier?

On May 30th, 2017 Fannie Mae announced a shocking relaxation of the guidelines that determine how self employed borrowers calculate their qualifying income when applying for a home loan.

Freddie Mac announced changes to their self employment income guidelines earlier this year.

The Fannie Mae update now offers more options to self employed borrowers.

The new Fannie Mae guidelines go into affect after the weekend of July 29th, 2017, when the DU (desktop underwriter) automated underwriting system will be updated to version 10.1

This is a major update that represents a significant move toward relaxing the guidelines for home owners and home buyers wanting to use Conventional financing.

The major event that we are going to talk about here is how Fannie Mae looks at self employed income calculations.

Calculating Self Employed Income

Calculating self employed income has always required average the 2 most recent years Net taxable income from your Federal tax returns.

The averaging of Net taxable income becomes a deal killer if:

  • Your previous year income was very low
  • Your previous year income was higher than your most recent year

If your previous year’s income was very low, averaging it with your current year can still result in an average monthly income that doesn’t quite get you to where you need to be.

If your previous year’s income is higher than your most recent year, then you have a situation where “on paper”, your income appears to be declining.

I’ve seen scenarios where your income does not decline, but your expenses increase, which causes a declining income situation.   In these cases, the underwriter may choose to use the lower of the 2 years to determine your qualifying income, and not the higher income of the previous year.

Fannie Mae DU 10.1 Update (after July 29th, 2017)

With DU version 10.1, conventional loans are now more likely to require only one year tax returns when qualifying for a home loan.

Under the new Fannie Mae guideline, the criteria that determines the documentation required to verify a self-employed borrower’s income will be updated.

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The number of loans that are eligible for the one year of personal and business tax return documentation requirement will increase.

This is not uncommon for Fannie Mae to make updates that considers compensating factors to offer exceptions to the published guidelines.

This feels a little bit like a toe in the water by Fannie, but it’s a big toe, and a great start toward loosening the documentation requirements for self employed income borrowers.

Freddie Mac Self Employed Income

Freddie Mac has always been more flexible than Fannie Mae when allowing for only 1 year tax returns for self employed income borrowers with compensating factors.

In an October 27th, 2016 Update, Freddie Mac made a significant move toward creating more opportunities for the one year only response from the automated underwriting system.

The number of years of required tax returns will be based on the number of years the business has been in existence

  • For businesses operating for five or more years, one year of business and personal returns will be required
  • For businesses operating for less than five years, two years of business and personal returns will be required

This guidelines simplifies the “compensating factor” question to time in business.

FHA Self Employed Income Guidelines

Minimum Length of Self-Employment

An underwriter will consider Self-Employment Income if you have been self-employed for at least two years.

If you have been self-employed between one and two years, the underwriter may only consider the income as qualifying income if you were previously employed in the same line of work in which you are now self employed, or in a related occupation for at least two years.

Stability of Self-Employment Income

Income obtained from businesses with annual earnings that are stable or increasing is acceptable. If the income from businesses shows a greater than 20 percent decline in qualifying income, the loan must downgraded and manually underwritten.

Required Documentation

Complete individual federal income tax returns for the most recent two years, including all schedules.

Alternative Income Options

Do not assume that all lenders understand how to calculate self employed income properly.  Even if you show little to no income on your personal tax returns, there may be an opportunity to adjust those numbers to show more qualifying income.

Depletion and depreciation claimed on a Schedule C or business tax return can be added back into your qualifying income calculation.  In some cases, you can also add back in any deductions for mileage that you take on your tax returns.

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Bank Statement Programs

There are portfolio programs available for self employed income borrowers that cannot show enough income on your tax returns.

These loans tend to require a higher downpayment, higher rates and higher closing costs.

It is common for these programs to allow you to use a percentage of your personal or business bank deposits.  The deposits are scrutinized to make sure they are consistent with the amount and frequency of business related activities.

Bank statement deposits will be averaged over 12 or 24 months, depending on what investor you are using.

Getting Your Questions Answered

All lenders are not created equal.  Most of the readers that find this site because they’ve been researching solutions to challenges, and have been told 10 different things by 10 different loan officers.

We’ve created this resource to help you sift through the endless opinions and articles that may, or may not directly answer your question correctly.

There are several ways to ask questions, and get expert opinions on this website.

  • Submit a Question:  On the bottom of this page, you’ll see a prompt that allows you to ask questions.  These questions come directly to me and are answered very quickly.
  • Leave a Comment:  Below every article is the option to leave a comment or question.  We see these comments and questions in real-time and the always answered, usually pretty quickly.

In addition to researching your questions and providing you with expert advice, I can also introduce you to a lender friend that I know has experience with your specific situation and can help.

About the Author

Scott Schang

A 20+ year veteran of the Mortgage and Real Estate industry, I am passionate about educating and empowering consumers. I have been writing about consumer protection issues and making sense of complicated real estate and mortgage topics on this website since 2007

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  • Abi says:

    Owner business for 5 yr. I have the money for the closing cost and down payment in the business account the lender requesting the CPA to write a letter stating that “using funds from Wells account ending in ###, will not impact the business”. Well the CPA said :
    “No way.

    You can fwd this to the lender.
    We are not able to put this paragraph in the letter, per the lender’s request.

    We prepare tax returns based on information provided to us by the client

    Analysis regarding the financial stability of a company relies on that of the lender and the taxpayer”

    What I can do to proceed with the underwriting & approval don’t fall.

    Any suggestions….

    • Scott Schang says:

      Hi Abi, the CPA letter is not necessarily a guideline, it’s just to make the underwriter more comfortable with the file.

      While some CPA’s are more involved in an owner’s business, most are not. The wording given here will probably work. Also, they can say that they do not perform audited financials and are not aware of the day to day operations of the business, therefore they could not comment on the impact to the business with any authority.

      You’re on the right track. The burden of proof will mostly fall on you to provide enough documentation to the underwriter to show that using that money will not impact your operations.

      Sorry I cannot be more succinct here, it’s not a black and white guideline.

      Hope this helps?

  • Bruce miller says:

    I am currently employed in construction for 1 year as a w2 wage earner prior to w2 income I was 1009 from my current employer for 2.5 years. Do I have enough time as a w2 wage earner to apply for a mortgage Fannie mae

    • Scott Schang says:

      Hi Bruce, you can go from self-employed to W2 employee and use the income you receive on your paycheck as long as it’s hourly or salary. Moving from W2 to 1099 is where you need a 2 year history.

      If you would like, I can introduce you to a loan officer that I know and trust that has experience with these guidelines.

      Shoot me an email to scott@findmywayhome.com and let me know what State you’re in.

      Hope this helps?

  • Renee Clinton says:

    Good afternoon Clinton here I wanted to know if my income has increased with my business since last year along with my w-2 job, and me having very little debit to ratio shouldn’t I get approved for a house

    • Scott Schang says:

      Hi Clinton, self-employment income and W2 income are calculated differently. Your W2 income is always calculated as reported on your W2 as long as it is hourly or salary.

      Depending on what the automated underwriting findings state, you will be required to average your self-employment income (as reported on your tax returns) over 12 or 24 months.

      The challenge you may have run into is how the income is being calculated for your self-employed business. If using traditional financing like Conventional or FHA, you can only count your NET income after deductions and expenses as qualifying income.

      It can be a little bit of a gray area, and really just a long way of saying that as long as you have a 2-year history of being self-employed, you can use that income to help you qualify for a mortgage.

      The biggest challenge you may run into is finding an experienced loan officer that understands the underwriting guidelines and options for calculating self-employed income.

      This is where I can really help. If you would like, I can introduce you to someone that I know and trust that has extensive experience working with self-employed home buyers.

      Shoot me an email to scott@findmywayhome.com, let me know what State you’re trying to buy in, and I can make that introduction.

      Hope this helps?