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How To Calculate Self-Employed Income For Mortgage Loans

    To determine if you are eligible for a mortgage as an independent business owner, lenders look at your net income–your total earnings, less any expenses incurred by running the business. Most mortgage lenders will accept an application as long as self-employment income meets the guidelines listed above, and both applicants qualify. If the mortgage lender does indeed accept 12–24 months, you will need to submit the most recent tax filing, demonstrating unequivocally that you earned the self-employment income during the full 12 months covered by the filing. Instead, lenders will recognize only your income in 2016, which is $50,000, and average out just that, your 2016 income, in only 12 months.

    For example, if your tax returns showed that you lost $12,000 the previous year, the lender would decrease the qualifying current monthly income by $1,000. To account for these potential changes, for standard mortgage programs, lenders generally calculate your self-employment income by averaging the monthly income over the prior two years. For example, if last year you earned $70,000 in self-employment income, but the previous year, you earned $60,000. The lender will then take your income from both years–so $130,000 total income for both years–and divide it by 24 months, to come up with $5,415 as the median monthly gross income ($130,000 total income/24 months = $5,415 monthly).

    Only your income from 2016 would yield monthly eligible income of only $4,166 ($ 50,000 divided by 12). The income used for qualifying purposes is $80,000 + $83,000 = $163,000, which is then divided by 24 = $6,791 per month. For example, if you have net income of $95,000 in year one and $98,000 in year two, your qualifying mortgage income would be $95,000 + $98,000 = $193,000 divided by 24. For example, if you are earning $8000 per month now in steady state, but you have averaged just $5,500 per month in self-employment income for the last two years, lenders will use that $5,500 income number when evaluating your mortgage application.

    If your total self-employment income was $100,000 that year, but you had $40,000 of expenses you wrote off as taxes, a mortgage lender would look at your taxable income–or how much money you had to put toward paying your mortgage–as $60,000. A common way of estimating your income, as it pertains to how mortgage companies will evaluate it, is to take your gross earnings over the past two years, then divide it by 24. If the effective federal and state taxes, which typically are paid by a salary earner in a similar tax bracket, are greater than 25% of the income, a lender can use this amount to come up with an adjusted gross income, which is what is supposed to be used to compute the borrowers qualification ratio.

    If income is verified as not taxable, and income and its nontaxable status are likely to continue, the lender may develop the borrowers adjusted gross income by adding to the borrowers income an amount equal to 25 percent of nontaxable income. The lender should verify that the specific source of the income is not taxable. The borrower, however, still might have to prove the borrower is earning enough income to sustain withdrawals.

    You may want to supply a copy of the business license for starters, but lenders also want to see the two years of federal tax filings for the businesss income, signed and dated. Mortgage lenders will want to verify that history from several sources, including your tax returns for the past two years, your CPAs oral or written work-related evidence (VOE), or your copy of the business license. Some lenders, for instance, will review several years of bank statements to establish your income, rather than relying on tax returns. You will have to submit alternate documentation, like bank statements, financial statements with profits and losses, or liquid assets, to prove your income instead of using paychecks, tax returns, and W-2s.

    Most lenders will provide income verification by a loan officer to look at the most complex tax returns, sometimes before you have officially applied for a mortgage. Lenders typically ask you for tax returns from the prior two years in order to confirm the yearly income figures that they are using. The reason for requiring two years is that mortgage lenders realize income from self-employment is typically less predictable than it is for borrowers who work for wages and salaries.

    Mortgage lenders will want to know that you at least had some work experience in a similar line of work, even if that was through employment, and that you had skills, qualifications, and an earnings history to back up the self-employment income used for qualifying. Just like the typical employee who works for wages, the self-employed mortgage applicant will have to show steady, consistent income, along with a good credit score and low debt-to-income ratio. Some lenders may fear you will not make enough consistent income to afford the monthly payments, while others may just be unwilling to handle the extra paperwork that can come with providing a mortgage to someone who works for themselves. Also, since you might not have as stable an income as someone employed at another business, it may be difficult for you to qualify for some types of mortgages.

    If that sounds like a lot of paperwork, do not feel alone: All borrowers, no matter what kind of job they hold, have to submit a large amount of documentation about their income in order to qualify. Fannie Mae and Freddie Mac will approve borrowers who are self-employed — or have had at least one year of self-employment, plus at least two years of documented history earning comparable incomes in comparable roles — for qualifying. Many self-employed borrowers took out a mortgage with no qualification, since that did not require them to file income tax returns (only bank statements) and allowed them to stretch their mortgage payments beyond the 30-year standard. The methods lenders use to determine your qualifying income vary, depending on if your business is a sole proprietorship, partnership, or corporation.

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