Being self employed has a number of distinct financial advantages. However, mortgage lenders have very specific criteria necessary to qualify for the best possible terms.
This self-employed income analysis and the included descriptions generally apply to individuals:
- Who have 25% or greater interest in a business
- Who are employed by family members
- Who are paid commissions
- Who own rental property
- Who receive variable income, have earnings reported on IRS 1099, or cannot otherwise be verified by an independent and knowable source
- To calculate income for a self-employed borrower, mortgage lenders will typically add the adjusted gross income as shown on the two most recent years’ federal tax returns, then add certain claimed depreciation to that bottom-line figure. Next, the sum will be divided by 24 months to find your monthly household income.
- Schedule C income is calculated the same way with 2 year average adding depreciation.
- Corporation Income is calculated by the net profit the business made multiplied by the percentage of ownership the borrower has in the business. They will also use the average of two years of the borrowers K-1 income from the corporation
- Common Problem is self-employed borrower’s think the income is based on Gross sales prior to deductions. The Lender will use the net income after deductions in order to calculate the borrower’s income used to qualify. For example, if a borrower shows gross sales of 200,000 then after deductions the adjusted gross net income is 80,000. The lender will use 80,000 to qualify.
- If the borrower has strong credit, the lender will entertain using only 1 year of the most recent tax return to qualify. This is helpful because 2 years prior the return might be significantly lower bringing the average down.
- Income which is not shown on tax returns or not yet claimed cannot be used for mortgage qualification purposes.
- One final tip for the self-employed: If you know you’ll be applying for a mortgage in the next two years, reduce the number of tax deductions that you claim. It’s totally fine to take tax-deductions such as contributions to a Solo 401k or IRA account. These business expenses will come back to haunt you in the form of a lower taxable income — which results in a harder time qualifying for a loan.
AVENUE works with a number of mortgage bankers who offer the best possible terms. Please contact Christopher Poreda, Managing Director at AVENUE if you would like a qualified referral at CP@avenueresidential.com