If you’re self-employed, you need to meet totally different requirements than a salaried person if you want to qualify for a mortgage. The rules about how this all works were recently updated to take an even closer look at your business income, so here’s why it’s so important to review them. I recently came across an article with the main points from them, listed below:
Two of the most important things lenders review to qualify you for a mortgage are income and assets, which determine how much monthly payment you can afford and where your down payment is coming from. Self-employed borrowers report income as sole proprietors or owners of entities like corporations, partnerships or LLCs. You’ll file your own self-employed income on IRS Schedule C, which tracks your income and expenses for a given year. Unlike with salaried employees that get to use their gross income for loan qualifying, sole proprietor borrowers need to qualify using their net income from Schedule C. Lenders calculate a 2-year average of net income for sole proprietors, and if the most recent Schedule C has lower net income than the year before, then lenders will calculate a 12-month average of the most recent year to use worst-case income.
If you’re self-employed and conduct business through a corporation, partnership or LLC, then the IRS will require these entities to file separate sets of tax returns. If you own at least 25 percent, then you’ll be required to provide lenders with full business tax returns, in addition to your personal returns. Self-employed borrowers will sometimes need a lot of money in their business in regards to assets, and may want to use those funds for a down payment. Some lenders will let you do this, but often require that your tax preparer verify that use of business funds for a home purchase won’t have any material impact on it.
In February of this year, Fannie Mae updated self-employment income calculation guidelines for borrowers who own partnerships and S corporations, which impose stricter analysis on income and debt trends to determine if the company in question has sufficient assets to support the withdrawal of earnings to pay its owners. If this describes your business, then your income will show up on a form called “Schedule K-1”, a part of the entity’s tax filing that gets carried over to your personal tax return as income.
The new rules for self-employed borrowers now impose conditions on whether you can use either of these forms of income. For example, if distributions are greater than ordinary business income, then ordinary business income may be used to qualify. However, if distributions are less than ordinary business income or don’t exist, then there are plenty of guidelines to determining how you qualify. The best way to determine whether you qualify for a loan is to find a local lender who will be able to analyze your tax returns for you.