Mortgage Approval for Self Employed: Two Routes

Quick Answer: Self-employed borrowers get mortgage approval by one of two routes. The full-documentation route uses two years of tax returns, which the lender runs through a cash flow analysis that adds back non-cash deductions; it qualifies for conventional and government loans at their usual rates. The bank statement route reads 12 or 24 months of deposits instead and is priced higher. Which fits depends on how much income your returns show after deductions.

There is no special "self-employed mortgage." You apply for the same loans as everyone else; the underwriter's question is which documents prove your income. Most people should try the tax-return route first, because it opens the widest choice of loans and the lowest pricing. The bank statement route exists for the cases where your returns, after legitimate write-offs, show too little income for the house you want.

What documents do self-employed borrowers need for a mortgage?

The tax-return column follows Fannie Mae's Selling Guide on underwriting a self-employed borrower. It counts anyone with a 25% or greater ownership interest in a business as self-employed, and generally asks for a two-year history of earnings. Lenders may verify income with signed personal and business returns for the past two years, or with IRS transcripts of those returns.

Two exceptions shorten the list. A business that has existed for five years, with you owning 25% or more for all five, can qualify with one year of personal and business returns. And with two years of personal returns, the lender may waive business returns if you use personal funds for the down payment, closing costs and reserves, have been in the same business at least five years, and your personal returns show self-employment income rising over the two years.

How does a lender calculate income from your tax returns?

The lender doesn't simply read your adjusted gross income. It prepares a written cash flow analysis, often on Fannie Mae's Form 1084 or the Income Calculator tool, to find the income you can rely on.

For a sole proprietor, Fannie Mae's guide to Schedule C income lists the recurring items that must be added back: depreciation, depletion, business use of a home, amortization and casualty losses. Non-recurring income gets deducted. The lender also looks at trends: gross income, expenses and taxable income year over year, and whether the business can keep producing the income.

A worked example for a sole-proprietor consultant:

Income rose, so a lender would typically average the two years: 64,500 a year, or about 5,375 monthly for qualifying.

The profit and loss statement often worries applicants more than it should. Fannie Mae's guide on analyzing profit and loss statements says a year-to-date P&L is not required for most businesses; if the application is dated more than 120 days after the business's tax year ended, the lender may ask for one to confirm the income is continuing. Keeping your books current means you can produce one in a day.

How is the bank statement route different?

Instead of tax returns, the lender reads deposits. Using the same consultant: twelve months of business deposits total 210,000 after removing transfers and refunds. A program with a 50% expense factor counts half as income, 105,000 a year, or 8,750 monthly. The mechanics of that calculation, and the personal-versus-business statement choice, are explained in what a bank statement loan is.

The trade-off is price and choice. Bank statement loans are non-QM, so they generally carry higher rates, larger down payments and sometimes prepayment penalties. Fewer lenders offer them. And if you also use business money for the down payment, any lender will want to see that taking it out won't hurt the business; Fannie Mae, for instance, requires a business cash flow analysis in that case.

Which route fits you?

Run both numbers and compare them with the payment you need.

1. Work out your tax-return income. Take your last two Schedule C net profits (or K-1 income and W-2 wages from your own company), add back depreciation, depletion, home office and amortization, and average.
2. Work out your deposit income. Total twelve and twenty-four months of business deposits, strip transfers and one-offs, and apply a 50% factor as a rough middle case.
3. Estimate the debt-to-income ratio for each. Add the proposed housing payment to your existing monthly debts and divide by each income figure. The CFPB's debt-to-income explainer shows the calculation.
4. Choose. If the tax-return income supports the payment, use it: a conventional or government loan will almost always cost less. If only the deposit figure works, the bank statement route is the realistic option, and you can plan to refinance once your returns catch up.

Step 2 is quicker when your statements are already rows in a spreadsheet. QuickBankConvert converts business statement PDFs into date, description and amount columns, so a filter on "transfer" removes the money you moved between your own accounts. The income and expense spreadsheet guide shows a layout that doubles as the P&L a lender might ask for.

What are the best home loans for self-employed buyers?

"Best" depends on your numbers, but the order to check is usually:

• Conventional loans if your tax-return income qualifies and your credit is solid.
• Government-backed loans (FHA, VA, USDA) if you're eligible. Each program has its own self-employment documentation rules, so ask the lender which documents it will want.
• Bank loans for self-employed borrowers from portfolio lenders: local banks and credit unions that keep loans on their books may be flexible on a short history or unusual income.
• Bank statement and other non-QM loans when the returns don't support the payment.

Lenders cannot approve you on hope; under the CFPB's ability-to-repay rule they must document income, assets and debts whichever route you use.

Before you apply

• File your returns on time, since an extension can leave the lender with only one usable year.
• Keep business and personal accounts separate; it makes both routes cleaner.
• Talk to your tax preparer before a purchase year. Deductions that lower your tax also lower your qualifying income.
• Gather the statements now. A lender wants complete PDFs with every page; the guide to how many months of bank statements a mortgage needs covers the asset side, and proof of income from bank statements covers what deposits can and cannot prove.

Related guides

• Large deposits and the letter that explains them
• Vetting bank statement lenders